Single Teacher Learns a Lesson in Retirement

Situation Near career end, woman wants to stretch resources
Strategy Optimize withdrawals, minimize taxes
Solution A stable, financially secure retirement

A teacher we’ll call Emily lives in northern Alberta. Now 57 years old, she plans to retire when she is 59. She brings home $5,781 per month from her job, after tax. Emily also has a rental property not far from Edmonton, which, after mortgage payments, produces a small monthly cash loss. She also has a portfolio of mutual funds that has produced disappointing returns.

The central issue in Emily’s financial future is whether she has enough money to retire and figuring out what she can afford in transferring her life to Edmonton or to another part of Alberta. She could move into her rental house or buy a house or condo in the $450,000-to-$600,000 range, taking out a mortgage to cover the difference between the estimated market value of her present house, $380,000, and the price of the new dwelling.

Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Emily. “Emily’s dilemma is a model of the problem of most retirees — how long will the money last?” he says. “In her case, pensions will make up most of her retirement income. So, we can estimate her income with a high level of certainty.”

Cash Flow

Assuming Emily does not get major salary increases and the resulting pension boosts in the two years until her anticipated retirement and that her investments do not produce significant changes in value, she will have approximately $600,000 net worth when she quits work. That will buy a retirement home almost anywhere in Alberta, he says.

Emily will have pension income of $56,000 per year at retirement, indexed to much of the changes in the provincial consumer price index. About 35% of her pension is not indexed and may lose purchasing power by about a third of the annual gain in the Alberta CPI. Over a period of several decades, this shrinkage will reduce her purchasing power substantially.

After 10 years, assuming a 3% annual rate of inflation, Emily’s pension will be worth only $50,696. After 20 years, its purchasing power will be just $41,547. After 30 years, it will be $37,613, Mr. Moran says.

Emily should delay application for Canada Pension Plan benefits until age 65. CPP will be her largest fully indexed pension. If she seeks the pension before age 65, she would have to accept a hefty penalty of 0.6% of the full monthly payment for each month prior to age 65 that she begins to receive benefits.

Emily’s RRSPs are currently worth $75,000. She can add no more than $1,440 per year because her employer makes large contributions to its own plan for her. If she were to contribute her maximum each year, then she would have $78,690 at retirement. If no further contributions were then made — perhaps as a result of parttime work — and if the RRSP balance were to grow at 3% after inflation for the next 14 years, the RRSP would have a value of $119,026 when she is 72, the first year in which actual withdrawals must occur. That sum would produce annual indexed income of $8,654 to her age 90. She can compensate for purchasing power erosion by delaying withdrawals from registered savings, extending the years of tax-free growth.

Adding up the various streams of retirement income, Emily will have $56,000 of pension from her retirement date. At age 65, she will be able to add $10,380 of Canada Pension Plan benefits and $6,204 of annual Old Age Security payments, for a total income of $72,584. At age 72, she can add RRIF income of an estimated $8,654 per year, for total income of $81,238 per year. The OAS clawback, which begins at $66,733 in 2010, will reduce her income slightly. She can draw on $75,000 on taxable investments and $10,000 cash at any time, the planner says, using the money to buy another house or as a supplement or to bridge to her RRIF income, Mr. Moran says.

Managing Retirement Income

Emily can add to retirement income by harvesting equity in her house when she moves south. She can also sell and perhaps take a capital gain on the rental property. It has an estimated market price of $290,000.

She can manage taxes on money her RRSP pays her. If she lets the fund build to age 72, when withdrawals must begin, she will have higher tax bills and lose more of her OAS to the clawback than if she takes money out each year between retirement and the beginning of OAS. She can transfer annual withdrawals to her TFSA to insulate these sums from further taxation. But premature withdrawals that put money into taxable accounts make no sense, the planner warns. If Emily does not need money for living expenses, she should keep it in the RRSP, Mr. Moran says.

There is a lot more that Emily can do to boost retirement income. The returns from her portfolio of mutual funds have been poor. Her asset selection is fine, but she is paying an average annual charge of $1,600 per year just for mutual funds in her RRSP. There’s a similar charge for her taxable portfolio. She should consult with a financial advisor about selling her high-fee funds and using the proceeds to buy exchangetraded funds with lower fees, Mr. Moran suggests.

Planning Her Own Care

The big unanswered question that Emily raises is who will look after her and her money in the later years of her retirement if required. She could sell the rental house, harvest $60,000 in equity or a similar amount from downsizing her home and moving somewhere warmer. That sum could be added to her $160,000 of financial assets. That would be enough capital to qualify for a personally managed portfolio of low-fee funds. That way, she might save about half the money she now pays for management through her mutual funds, Mr. Moran says.

Emily needs to plan a way she can be looked after later in life. She has no children on whom she can rely. She has siblings, but they might be in a similar dilemma when she needs their help.

Emily could discuss a trust arrangement with her lawyer. A trust company — most are units of chartered banks — could collect her income, pay her bills and act as custodian for designated property. She might also consider an annuity for some of her investment income. A life annuity would provide guaranteed income that would last until her death.

Annuity income may not keep pace with inflation, but the payout, which includes return of capital and a bonus based on life expectancy, would exceed what GICs and bonds pay.

“Emily is an example of a person without others to look after her,” Mr. Moran says. “Her responsibility for her own well-being won’t end until she makes a plan for eventual care and for the safeguarding of her assets. Without such a plan in place, others may plunder her fortune.”