COUPLE CAN FEEL SECURE IN EARLY RETIREMENT PLAN, THANKS TO $1M PORTFOLIO AND PENSIONS

Annuitize investments, cut investment fees and costs, consider health insurance

In Ontario, a couple we’ll call Bruce and Patricia, each 54, anticipate retiring in the next two years — Patricia in 2016 and Bruce in 2017. They should feel secure with a net worth of about $1.9 million, but their income doesn’t really match their wealth. They would seem well fixed to terminate their careers, hers as a midlevel administrator, his as a transportation consultant. They have no debts, their $800,000 house is fully paid with no mortgage debt remaining, and their 25-yearold child is moving out in a few months.

They worry they cannot maintain their pleasant way of life based on a $10,375 take home income each month. If she quits at 56, Patricia will get a $52,000 annual defined benefit pension from her employer plus a bridge of $8,000 a year to age 65 when CPP starts. The pension is indexed to 75 per cent of changes in the Consumer Price Index. For the rest, Patricia and Bruce will have to rely on financial assets of about $1.06 million spread over about four-dozen mutual fund positions.

“I am concerned about bridging my income until I collect CPP and OAS perhaps as late as 67,” Bruce says.

“We want to have $82,500 after tax and we want our money to last for as much as 35 years. Is that reasonable?”

Family Finance asked Rod Tyler, a financial planner who heads the Tyler Group in Regina, to work with the couple. His view: Yes, it should work.

“They can indeed achieve their retirement,” Tyler says. “We have even done an analysis on the remote possibility that the defined-benefit pension, which Patricia has, ceases to be indexed. Even then, their plan will work.”

EARLY RETIREMENT MEANS A DELAY OF GOVERNMENT BENEFITS

The core issue: delaying government benefits to their mid-60s means they will rely on Patricia’s job pension and their own financial assets for about a decade.

Assuming that to age 69 their financial assets of about $1.03 million return four per cent a year after inflation and that, after 69, returns based on a shift to fixed-income assets decline to two per cent per year, after inflation, they would have a blended, long-term return of three per cent. That return would generate about $31,000 a year. Patricia’s company pension would pay $60,000 to her age 65. That’s $91,000 a year to age 65. If they split eligible pension income and pay tax at an average rate of 15 per cent, they would have $77,350 a year to spend. That is below their $82,500 after-tax target. They could close the gap at age 60 by taking early CPP benefits at a cost of losing 36 per cent of age 65 benefits.

At 65, Patricia would lose her $8,000 bridge but gain CPP benefits of $10,224 — 80 per cent of the maximum, and full benefits of $12,780 for Bruce. At 66, each would get $6,839 old age security benefits at 2015 rates. Their income would then be $119,682 before tax. Allowing for splits of eligible pension income and average tax of 18 per cent, they would have $98,140 a year — well above their $82,500 annual retirement income target.

If they pay out their financial assets on an annuitized basis starting at age 56 for 34 years so that all capital is exhausted at 90, their $1.03-million capital would support cash flow of $47,320 a year on the assumption that investments continue to grow at three per cent after inflation. Thus, their initial income would be Patricia’s $60,000 company pension and the $47,320 from the annuity process, for a total of $107,320. After pension splits and payment of income tax at an average rate of 17 per cent, they would have about $89,100 a year to spend. Their problem would be solved, Tyler notes. Loss of the $8,000 bridge income at 65 would be balanced by the addition of $23,000 of combined CPP at 65 and $13,678 of combined OAS at 66, leaving them with $136,000 before tax and $109,000 after 20 per cent average tax — well above their $82,500 target.

ADDING TO THEIR ASSETS

The annuity solution is, of course, at the cost of much of the inheritance they might pass on to their only child. They can provide for a bequest to the child by preserving the value of their $800,000 house. They plan to downsize to a condo in 2020 when they are 59, liberating perhaps $200,000 after selling expenses, moving costs, etc. That $200,000 could be part of their bequest. They can also designate the child as a beneficiary of their other assets, perhaps after the last partner passes away.

There is another dimension to Bruce and Patricia’s plans: what it will cost to make things work out as intended. About $890,000 of their financial assets is invested in mutual funds and exchange traded funds. Most of the funds are equity portfolios with average management fees of 2.7 per cent, including GST on the fees. Each year, therefore, the couple parts with an astonishing $24,000 in management charges. In the 34-year horizon we are using for the annuity payout, that’s going to add up to $816,000 in fees if the asset base does not change.

Mutual fund companies and many financial advisers take the view their advice adds value and it may well do so. But in Bruce and Patricia’s situation, funds range from balanced U.S. assets of stocks and bonds to specialized entertainment funds, global infrastructure, high yield bonds, global real estate, U.S. dividend stocks, global bonds and more. There is a tilt toward stocks with healthy dividends and a clear preference for U.S. equities. But understanding and managing so many funds is a challenge. Moreover, half the positions are under $10,000 and eight under $5,000 — small change for a million-dollar portfolio.

RAISING RETURNS

The couple should consolidate their holdings into fewer funds, mainly funds with long historical records of sustained results, Tyler suggests. If they stay with mutual funds, consolidation could save 0.75 per cent a year in fees, he says. Or they could move the lot to a professional portfolio manager who might charge one per cent to 1.5 per cent a year.

In retirement, the couple’s cost of living should decline. Their child will move out. They may shed one or two of their three cars and save $200 of the $700 a month they now spend operating them. They can eliminate RRSP and TFSA contributions and taxable savings of $840 a month to bring allocations down to $6,292 a month or $75,500 a year, leaving room for travel, other discretionary spending or their child.

“There is no financial need for the couple to delay retirement beyond 2016, when Patricia plans to leave her job,” Tyler says. “What is not clear is how the couple will spend what could be four decades. I suspect that they will find some part-time work. That would add income and perhaps reduce their draw on their savings.”