How to manage assets to prepare for retirement
This couple could pay off debt faster by reallocating their funds
Justine and Gary are married federal public servants in their late thirties. They have two young children, earn $215,000 a year and live well within their means. The problem: The couple isn’t sure of the best strategy for managing their assets. They would like to retire in 18 years, the earliest opportunity to get an unreduced defined benefit pension plan from their employers. Ideally, they will pay off their mortgage in the next 10 years, pay back a loan from their parents and they want to save enough for their children’s post-secondary education. Forty-three per cent of their investment portfolios are allocated to equities, a big chunk of which is held in one individual stock. That single position makes up 28 per cent.
Gary likes to manage the assets himself and uses self-directed accounts. But he hasn’t had much time to spend on the investments.
The particulars: Assets: Home: $950,000 Gary’s managed RRSP: $10,750 Gary’s self-directed RRSP: $3,568 TFSA: $15,641 RESP: $8,868 Individual stock: $25,000 Cash: $24,000 Liabilities: Mortgage: $252,394 Personal loan from parents: $35,000 (1.5 per cent interest rate) The plan: Gary and Justine are in a great place financially, as long as they remain with their current employers until they retire, says Robyn Thompson, a financial planner at Castlemark Wealth Management in Toronto.
“Defined benefit pension plans are like gold in a retirement plan because their retirement fund is already taken care of,” she says. “They will have more than enough income to meet their needs. Their focus, therefore, should be on pre-retirement debt reduction or topping up their tax-free savings accounts.” They can add to their TFSAs by using their cash to contribute $12,000 each.
As for paying off the mortgage in 10 years, Thompson recommends the couple reallocate their annual $2,200 RRSP contributions to mortgage payments to make $8,200 in annual prepayments for the next six years. (They currently add $6,000 in annual mortgage prepayments.)
“This strategy will see their home paid off in 10 years,” she says. “Given that the defined benefit and government pensions provide more than enough funds to cover expenses in retirement, the $2,200 is better served as debt repayment.”
Of course, the couple also needs to repay a $35,000 loan to their parents. Thompson says they could choose to use the $8,200 toward that goal instead. If their parents are in a hurry to be repaid, that will take precedence over eliminating the mortgage more quickly.
Alternatively, in four years, when the two children are in school full time, daycare costs, now at $27,204 a year, will decrease dramatically. The difference in funds could be used to pay back the loan.
If Gary and Justine continue with the annual $5,000 RESP contributions in addition to the current investments in the plan for the next 14 years, or until the oldest child is in university, they will have accumulated $184,000, Thompson calculates. This is based on a 7.47-per-cent rate of return — the benchmark for a balanced portfolio — and includes $7,200 per child in Canada Education Savings Grants.
The couple’s investment portfolio needs a rethink. Justine and Gary are balanced investors, yet their portfolio asset mix does not reflect this philosophy. Forty-five per cent of the portfolio is in cash, 12 per cent in mutual funds and the entire equity position across all of their investment accounts is 43 per cent. One stock figures heavily in their equities.
Investing in an individual stock is not sound strategy, it’s gambling, Thompson emphasizes, and suggests the couple consult a financial planner to assist if Gary no longer has time to manage the portfolio properly.
For example, a balanced portfolio with an asset mix of 5 per cent cash, 25 per cent Canadian fixed income, 35 per cent Canadian equities, 25 per cent U.S. equities and 10 per cent international equities has delivered an average annual compounded rate of return of 7.47 per cent historically over a 20-year period.
Gary and Justine need to spend time on estate planning. They have some life insurance, but do not have wills or powers of attorney for property or personal care.
“This is a major weakness in their current situation and should be addressed promptly, especially given that they have two young children,” Thompson says. “Guardianship should also therefore be addressed, and life insurance needs should be reviewed.”
The real risk to their current situation is if one or both loses their job, becomes ill or disabled, or dies. A properly conceived financial plan will allow them to consider such worst-case scenarios objectively and plan for different outcomes now, while they have the resources and time to plan for it.
“Life does not go in a straight line, so proper planning is truly essential for this couple,” Thompson says.