Digging a foxhole

At age 50, a woman in Ontario who we’ll call Brenda worries she has not made adequate preparations for retirement. Separated from her husband and awaiting a divorce, she is on her own in unfamiliar and complex territory.

Brenda lives with her 20- year old daughter in the $ 800,000 dream house she and her husband built. Her husband — both have amicably agreed to a divorce — retains a 50% interest in the house that, Brenda says, he is in no hurry to cash in. “He will let me keep the house until I decide to move. That could be in as much as a decade,” she says. “There is no plan for now to sell. Once I do sell, he might ask for his share, which would be $ 400,000. At the moment, I have the house and no obligation to pay. That is how things will be for as far ahead as I can see.”

Her bulwark against future problems has been to build up financial assets of about $ 621,000, of which $ 315,000 is in cash earning almost nothing. She puts more than half of her take- home salary into savings. With her fortress of money, she still worries it won’t be enough or that she might lose her job and its handsome salary.

But a net worth of more than $ 1million is a pretty good cushion, says Benoit Poliquin, a chartered financial analyst who is lead portfolio manager for Exponent Investment Management Inc. in Ottawa.

“Brenda is in an unusual situation,” says Mr. Poliquin, who Family Finance asked to estimate Brenda’s retirement needs. “Her marriage ended a year ago. At the moment, she has the house and no demand for the value of her husband’s half. In effect, he is allowing her to keep the house as long as she wishes and to defer payment of his equity in the house until she sells it.”

Saving and investing

Brenda brings home $ 6,000 every month from her job as a manager in a construction company. If she changes her cash- management style from hoarding to investing, she can loosen her purse strings to live more today. If she builds up enough net worth, the potential future demand for $ 400,000 for the husband’s share of the house might be easily covered. Moreover, given the likelihood that there will be no demand for many years under their friendly separation agreement, the house is likely to appreciate. That appreciation could facilitate payment of some of the $ 400,000 which Brenda nominally owes her husband at some date in future. “This is a case in which patience will be its own reward,” Mr. Poliquin says.

Brenda has bridged her past comfy life and her future by digging a financial foxhole. She saves $ 3,200 a month, 54% of her take- home pay, maxing out RRSP and TFSA contributions and adding $ 1,300 to cash each month. She needs to put those financial assets to work and get a more solid return from the rest of her portfolio. She could move her cash to a portfolio of dividend- paying stocks and corporate bonds with an average yield of 4.5%.

A blend of 70% stocks and 30% corporate bonds purchased individually or through mutual or low- fee exchangetraded funds would make her nearly $ 621,000 portfolio of financial assets generate nearly $ 28,000 a year. In 15 years, if she were to maintain her present rate of savings, the portfolio would grow to $ 1.9- million, not including capital gains. At age 65 she

The main question now is when she wants to boost her spending. Waiting until retirement seems unnecessary

would have total returns of $ 85,500 from her portfolio. From that income, she could draw $ 74,000 a year, allowing the undrawn $ 11,500 balance to grow. In this case, a $ 400,000 reduction of invested capital would cut her investment income to $ 67,500.

Retirement

At 65, Brenda’s work experience should give her Canada Pension Plan payments of $ 11,350 a year based on 70% of the maximum and Old Age Security benefits of $ 8,715 a year, all in future dollars. Allowing 2% annual indexation, that would be a total annual pre- tax pension income of $ 94,065. She would lose almost nothing to the OAS clawback that now starts at $ 69,562 and which will have risen to $ 93,560 in 15 years by these assumptions. Allowing for a $ 400,000 payout at retirement, her income would be reduced by $ 18,000 a year. She could cover most of the difference by raising her draw from her investments and eliminating the undrawn balance of annual investment income.

Brenda’s tax rate at a 35% average could leave her with after- tax income of $ 61,142 in future dollars or $ 49,440 after settling the house with her husband. Her disbursements, inflating at the same rate and net of saving, would have risen to $ 3,780 a month, or $ 45,360 a year.

She would have about $ 16,000 of annual discretionary income in future dollars for travel, home repairs or whatever she wishes, plus the undrawn value in her still growing registered and non- registered accounts. In the event she pays her husband the $ 400,000 at retirement, her discretionary income would fall to $ 4,080. She can wait to 65 to spend some of this surplus cash or begin to spend some of it now, Mr. Poliquin suggests.

That might mean more travel or other spending, or boosting donations to good causes. Even after she pays the $ 400,000 in a decade or more, she will be able to retire with a real income almost identical to what she now earns. The difference, of course, will be that in retirement, she won’t have to save so zealously.

“Her frugal ways will pay off in retirement,” Mr. Poliquin says. “She controls disbursement of her husband’s house share under the separation agreement. The main question now is when she wants to boost her spending. Waiting until retirement seems unnecessary. In my view, Brenda can have a better standard of living now and in future.”