In rural B.C., a couple we'll call Beatrice, 59, and Saul, 62, have built an existence many would find idyllic. A flight attendant for a major airline for 35 years, she has her choice of overseas routes. Saul, a businessman, manages a global design consultancy with Beatrice as co-owner. It's been a great life for the well-traveled pair, but they are ready to quit, perhaps in three years when he is 65. The question — can they support a retirement on an income similar to what they have now with so much of their assets tied up in real estate?
Their monthly income, $6,739 after tax, is ample for their needs. They have no debts, no children and no illnesses. Their assets total $1.4-million, most of it in their $1-million house and surrounding acreage. They are dreaming of retirement in a new beautiful, bigger, home. Their plan is to build another $500,000 house on their five-acre lot and either rent out the existing, more modest house or even operate it as bed and breakfast. But that would eat up their financial assets and would be a speculation on an already heady market.
What will retirement really cost?
"We want to have income from our investments," Beatrice says. "We want less stress as we slow down. What should we do?"
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. of Kelowna, B.C., to work with Saul and Beatrice. His suggestions to get ready for retirement? Forget building the second residence, restructure income, increase RRSP contributions, and boost investments.
Saul has earned an average $60,000 annual pre-tax income from his import/export business. Given that Canada Pension Plan benefits will be the couple's largest source of indexed retirement income and that Saul has only about half the credits he needs for full benefits, it would make sense to take all income as salary. That would mean he would pay CPP tax of 9.9% a year (for he is self-employed) on income up to about $50,100 and then use some of the extra income to invest in RRSPs to bring his taxable income down.
Beatrice expects a company pension of about $1,300 a month, or $15,600 a year, when she retires at age 65.
The couple has $6,739 disposable income less expenses of $3,873 a month. That produces saving capacity of $2,866 a month, or $34,392 a year. Saul has $42,000 of unused RRSP room, so he can use this strategy for a few years. If he takes the suggested salary, he should make an RRSP contribution of about $17,300. For this, he will get a refund of $5,140. He can do this until he is 65. His annual savings will be $34,392 from salary plus his annual tax refund of $5,140, for total annual saving of $39,532.
Planning retirement income
If the couple's current financial assets of $378,000 plus $39,532 a year were to grow at 6% a year less 3% for estimated inflation, they would have $538,906 in 2012 dollars by Saul's age 65 in 2015.
If this money were to continue to grow at 3% a year on an inflation-adjusted basis and were spent evenly to her age 90, it would generate pre-tax income of $16,400 a year. Part of this cash flow would be non-taxable payouts from tax-free savings accounts, the planner says.
Assuming Saul takes salary instead of dividends from their corporation, at 65 he will have earned 50.4% of the credits needed for full CPP benefits, or $5,967 a year. Beatrice will have earned 100% of credits needed for the full CPP payout and therefore receive $11,840 a year at age 65.
Both Saul and Beatrice will have 40 years of residence in Canada and will therefore be eligible for full Old Age Security benefits of $6,481 a year per person at age 65.
Adding it up and Beatrice and Saul should have an annual retirement income of $62,769 a year when both are 65. If they split their pensions and RRIFs, they will fairly evenly balance their pre-tax incomes. If they are taxed at an average rate of 15% in retirement, they would have $53,354 a year to spend, which is more than sufficient to support the present expenses net of savings of $46,476 a year. They can dip into cash for the relatively short time until all their pensions begin, Mr. Moran suggests.
Beatrice and Saul could double their investment income if they were to sell their $1-million property and buy something for about $400,000, thus liberating $600,000. This move would increase investment income by about $18,000 at a 3% real return and make total pre-tax income $80,769 a year.
There are unknowns in this retirement outlook, Mr. Moran says. They can keep their $1-million house and lot and live comfortably or add risk by investing in a B&B that might be profitable or could turn into a money pit. Or they can sell the property and put $600,000 into a diversified portfolio of stocks and bonds.
If Saul and Beatrice choose to keep the land and build on it, they will have to borrow, adding further risk. If they sell the land and want to invest the proceeds, they need to focus on stocks with substantial and rising dividends and high-quality corporate bonds with yields in a range of 3.5% to 4.5% per year. They can invest in property through real estate investment trusts that yield 5% to 8%, depending on market — office buildings, hotels, shopping centres, etc.
"Saul and Beatrice will retire with most of their capital tied up in their house and land," Mr. Moran says. "If they want to increase cash flow in retirement, they need to diversify their assets or risk their fortune by building a B&B. Their choice will determine the style in which they retire and their subsequent choices."
(C) 2012 The Financial Post, Used By Permission