Accepting that life will always be financially difficult, a couple we'll call Herb, 50, and Sally, 48, live not far from Toronto on $4,035 per month after tax. They spend modestly and save for a rainy day that has already arrived. Unemployed since the summer of 2008, Herb has run out of severance pay. He considers finding another job, yet wonders if it is really necessary, given that he plans to make his departure from the workforce permanent at 55.
Sally, the breadwinner, continues to work in sales for a large company. She and Herb get by, saving aggressively, even impressively, to build up reserves for hard times.
Before he lost his job, Herb figured he could retire in his mid-50s. Sally assumed she would quit her job soon after. Now they worry that they will not have enough money to last through what will have to be a restructured retirement. Their situation is complex, even though their plans to retire and live modestly are simple.
Family Finance asked Derek Moran, a financial planner who heads Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Herb and Sally. His take on the situation is that given their low living costs, high net worth and scant expenses, they will get through their lives and their retirement with ease and grace.
Living For Today
Herb and Sally get by in spite of Herb's loss of income because their total disbursements, including $300 per month in RRSP contributions and $1,500 a month in cash savings, are less than Sally's $4,035 take-home pay.
Even without Herb's paycheque, they can increase their future income from their $254,314 of non-registered assets and $487,354 of RRSP investments by doing two things:
First, reduce cash holdings that total $67,238 or 26% of their nonregistered assets. The returns on cash are almost nothing and, while the short-term risk of loss in insured savings accounts and bonds is slight, the long-term returns from holding cash virtually guarantee that inflation will erode their way of life. If $50,000 of the cash was invested in stocks that have a history of paying steady or rising dividends, and if those dividends are just 3% per year, they would add $1,500 per year to their income. If they have 5% from a combination of high-dividend utility stocks and corporate bonds, they would add $2,500 per year to their income. The dividend tax credit would enhance the income of stocks in their non-registered accounts.
Second, restructure investments in mutual funds they hold in their RRSPs. Those funds bear average management fees of 2.4%, with some funds as high as 2.8%. Management fees eat up about $17,800 of their money per year, Mr. Moran estimates. While the funds, which are strong performers, can beat many peers and even market averages for periods of a few years, there is almost no chance they can outperform over long periods of 10 or 20 years. Just by reducing management fees to 1%, Herb and Sally could capture about $10,400 per year that would otherwise be paid to mutual fund management companies.
That 1% annual fee would cover the services of a professional portfolio manager who could provide custom handling for their stocks. This kind of service usually requires a minimum of $500,000 assets under management and Herb and Sally would qualify for this.
Herb left his job with his defined-contribution pension, a group RRSP, intact. Sally continues to contribute to her company's defined-benefit plan. It should pay her $14,680 per year at age 55, plus a bridge benefit of $1,910 payable to age 65 or her death, whichever comes first. If she works until she is 62, the pension will be $31,780 per year, plus a $2,580 bridge.
Herb's RRSP, with a present value of $309,989 and Sally's, with a present value of $177,415 (total value of $487,404), should grow to $626,979 by Sally's age 55. If they spent this money over the next 35 years, allowing for increases of 3% per year to match inflation, they could take out $29,180 per year, Mr. Moran estimates.
The couple's taxable account, currently $254,314, with an assumed 2% real rate of growth over inflation (at 3% per year) would become $292,450 by Sally's age 55. If this sum were spent over the next 35 years, they could draw $13,595 per year, the planner says.
At age 65, each will receive Canada Pension Plan benefits. At age 65, Herb will be able to receive annual Canada Pension Plan benefits of $7,847. Sally will have annual CPP benefits of $8,520. Total CPP benefits will therefore be $16,367 per year. As well, at age 65, each will receive Old Age Security benefits of $6,204 per person per year.
Adding up their retirement income -- assuming Sally retires at 55 -- they should have $59,365 per year from age 55 to 65. At her age 65, they will lose the bridge but add CPP total payments of $16,367 and $12,408 in OAS payments for total income of $86,230 per year, all in 2010 dollars. Their tax exposure will not be great, for they can split pension income. As well, each can use the $2,000 annual pension income deduction, effectively lowering their tax rate by several percentage points.
Herb and Sally have exposure to loss if either were to have a costly illness that might require long-term care. They could use some of their monthly saving capacity to buy long-term care insurance. Rates are variable, depending on the care one selects.
A Balanced Financial Life
"It is clear to me that the couple need not worry about their retirement incomes," Mr. Moran says. "The income that they can generate beyond age 65 is so much higher than their budget expenses that they should consider withdrawing more in the first decade of retirement before they receive CPP and OAS benefits."
Not only will their cash income after age 65 be far higher than what it is now, but they will still have their home as a reserve asset. They could monetize it through sale or rental if they require a personal care home.
Herb and Sally are more secure than many other couples with far higher incomes. Their extraordinary savings rate, including RRSP contributions, amounts to 45% of after-tax income. That gives them the ability not only to indulge their taste for travel, but to become philanthropists on a small scale. Indeed, they may wish to consider bequests to worthy causes, the planner notes.
"You can read this case as an example of successful adaptation to adversity or as a case of just living within one's means without debt and evidently without undue sacrifice," Mr. Moran says.
"This exercise has shown what we are paying for investment management," Herb says. "It has given us assurance that in spite of my premature retirement, we don't have a problem continuing to live as we do now."
Couple wants to know if they can ease into retirement with husband laid off
Reduce investment fees and raise returns
High-income retirement with opportunities for travel and philanthropy
AFTER-TAX MONTHLY INCOME $4,035
House $375,000, RRSP $487,404, Non-registered $254,314
Property taxes $270, Food $255, Restaurants, entertainment $105, Car and home insurance $390, Utilities and phones $340, Car gas and repair $275, Clothing $50, Gifts and charity $100, RRSP $300, Travel $150, Home repair $300, Savings $1,500
(c) 2010 The Financial Post, Used By Permission