Short- term pain, long- term gain

In a corner of Saskatchewan, Marion, 51, and Sam, 57, have a family of five children, two grown and on their own and three at home, ages 18, 13 and eight. They support their brood on Sam’s take- home income of $ 9,000 a month and manage to save nearly $ 4,000 of that. Marion quit her work as a health- care professional two decades ago to be a stay- at- home mom. Sam hopes to work to 60.

The next three years are critical, for Sam, an engineer by training, works on contracts. He has little faith that they will be renewed for three more years. He has a backup plan, which is to take on other jobs that, if he is fortunate, would equal his present gross income of $ 13,920 a month. For now, he is working and saving 44% of takehome income. If he is laid off at 58 or 59, his assets, with some adjustment, will carry him to 60. Call it retirement or layoff, he will have ended his career.

Family Finance asked Graeme Egan, a financial planner and portfolio manager with KCM Wealth Management Inc. in Vancouver, to work with Marion and Sam. In his view, the problem the couple faces is indeed cash flow. They have financial assets of $ 1.12- million and no liabilities in the usual sense of owing money to pay off loans.

They have a different sort of liability, however. Their three children have only $ 2,400 in a Registered Education Savings Plan. Sam and Marion do, however, have $ 283,000 in cash and non- registered investments.

The plan is to spend $ 150,000 building their cottage, though, for now, as a hedge against the layoff he sees coming, Sam has put the project on hold.

INVESTMENT ADJUSTMENTS

The couple can add to their financial security by adjusting their investments, Mr. Egan says. First move — direct all of Sam’s RRSP contributions to Marion’s spousal plan. He can put $ 15,000 a year into her plan using cash savings. They can add $ 5,500 a year to their respective tax- free savings accounts. Additional funds can go to the children’s Registered Education Savings Plans.

They have been putting $ 200 a month into the plans. They should raise contributions to $ 2,500 a year for each of their two younger children. They will get a total boost of $ 1,000 a year from the Canada Education Savings Grant.

In four years, the 13- year old will be able to draw on about $ 26,000 of RESP savings. While he is in a post- secondary education program, funds can continue to be contributed to the family plan for the eightyearold so that in five more years, there would be $ 15,000 available for post- secondary education.

The parents could easily average out the $ 41,000 total, giving each child about $ 20,000 for tuition and books. They can subsidize their children’s university costs out of their substantial non- registered savings, Mr. Egan suggests. The kids can get summer jobs to aid with their costs.

Assuming that Sam works for three more years, adds $ 5,500 a year to TFSA savings and puts the remaining $ 36,500 a year ( after RESP contributions) to various savings portfolios registered and non- registered, and that he gets 3% after inflation, then he and Marion would have financial assets of $ 1,186,000 even after setting aside $ 150,000 for completion of their cottage. Those funds, still producing 3% a year after inflation, would generate $ 35,580 a year before tax without touching capital.

FUNDING RETIREMENT

On top of their investment returns, at age 65, Sam would receive $ 12,460 a year from Canada Pension Plan. Marion would receive very little CPP since her tenure in the labour force as a paid employee was just a few years. At 65, Sam would receive Old Age Security in the amount of $ 6,618 a year in 2013 dollars. At 67, Marion would receive her OAS.

Their problem will be to bridge the years from Sam’s age 60 to 65. The choices are to tap savings to maintain scaled- down spending for five years. Excluding savings and with some reduction in their $ 1,500- a- month food budget to $ 1,000 and reduction of the untracked $ 1,000 miscellaneous spending to $ 500 a month, they could get by with $ 4,100 a month or $ 49,200 a year. To generate that income, they would need about $ 58,000 a year taxed at an average rate of 15%.

Their prospective investment income, $ 35,580 a year, would need $ 22,420 a year as a supplement from savings. For five years, that would take $ 112,100 from savings. The yearly cost in future income at 3% a year after inflation would be $ 3,363. Alternatively, they could apply for early Canada Pension Plan benefits for Sam at age 60. That would take $ 4,485 a year from his age 65 CPP benefit amount. Over a 25- year period to his age 85, the cost would be $ 112,140. The costs seem close, but taking money from savings is the better solution. CPP will be the largest indexed part of Sam’s retirement income and should be preserved intact, Mr. Egan says.

RATIONALIZE PORTFOLIO

In 16 years, when Marion begins to receive her Old Age Security payments, total family income before tax would be $ 32,217 a year based on reduced savings of $ 1,073,900 at 3% per year plus $ 12,460 CPP for Sam and two OAS payments totalling $ 13,236. The total before 15% average tax, $ 57,913, would leave them with $ 4,100 a month after tax in 2014 dollars. That would precisely equal adjusted present spending.

Sam and Marion could raise their investment income by rationalizing their investment portfolio, a collection of excellent low- fee exchangetraded funds, some high- fee but profitable mutual funds, some large- cap U. S. stocks and a failed biotech. The portfolio has no evident design and is difficult to manage. A professional portfolio manager hired for an annual charge of 1.0% to 1.5% of the portfolio’s net asset value could help. Large cash holdings should be invested. If the restructuring of the portfolio and concurrent cuts in management fees were to add just 1% to total return, it would add $ 10,000 a year to pre- tax investment income, Mr. Egan estimates.