Carlos Osorio/The Globe and Mail
At age 61, Frank has been laid off from his $100,000 a year government job. His wife, Diane, earns about $39,000 a year working in retail. She is also 61. They have a house in small-town Ontario and no debt.
“The prospects of finding new employment in my field are remote,” Frank writes in an e-mail. “There are not a lot of opportunities locally without moving, and even then it seems my age is already working against me.”
Frank will qualify for a reduced defined benefit pension at age 61. “The penalty for taking the pension now is a 20 cent reduction,” Frank adds.
Frank and Diane have more than $1-million in savings. “Can we retire safely now with a $65,000 after-tax income?” Frank asks. “How do we arrange our investments for the best tax-advantaged decumulation?”
We asked Warren MacKenzie, a fee-only certified financial planner (CFP) and chartered professional accountant in Toronto, to look at Frank and Diane’s situation.
What the expert says
“Simple math and conservative assumptions show that Frank and Diane can afford to retire now, spend $65,000 a year after tax and still never run out of money,” Mr. MacKenzie says. The key to their financial independence is their modest spending goal, the planner says.
Starting in January, 2024, Frank’s reduced pension will pay about $44,200 a year indexed to inflation. In addition, Diane should turn her spousal registered retirement savings plan (an RRSP of $506,000) into a registered retirement income fund (RRIF) and withdraw $45,000 a year, the planner says. That will give them cash flow of more than $70,000 a year after tax.
At age 70, in nominal dollars, they’ll be getting about $73,000 a year, indexed, from the Canada Pension Plan, Old Age Security and Frank’s work pension, Mr. MacKenzie says, surpassing their spending target by about $8,000 a year.
Diane’s RRIF withdrawals and Frank’s work pension should be split for income tax purposes. “By taking RRIF payments before starting CPP and OAS, they will avoid having any of their OAS clawed back,” the planner says. They will also avoid paying tax at the higher rate that would apply if the RRIF payments are received while they are also collecting CPP and OAS.
Any additional cash flow requirements should be met by first using nonregistered funds, then by using tax-free savings account funds.
“Over the next nine years to age 70, they can get by without CPP and OAS income,” Mr. MacKenzie says. Because Frank and Diane are in good health and have longevity in their genes, they should delay the start of CPP and OAS until age 70. By doing this, the CPP payments will be 42 per cent higher and the OAS payments 36 per cent higher.
To the degree that they have nonregistered funds on hand, they should continue to move these funds into TFSAs, the planner says.
Frank and Diane are not concerned about the cost of health care or a nursing home later in life because if the time comes when they can no longer manage their house, they’ll sell it and use the proceeds to fund an assisted living home. “Cost is not a concern because most of their income is indexed pension income.” In his forecast, Mr. MacKenzie assumes an assisted living cost of $6,000 per person per month in today’s dollars, for an annual cost of $144,000. That includes most of their basic lifestyle expenses, he notes.
If, for example, they need assisted living at age 85, their pension and government benefit income will total about $135,000 a year. That assumes an inflation rate of two per cent. After the sale of their house, their investment assets will be about $3-million, more than enough to see them through to age 100.
Frank and Diane manage their own savings and investments. About 96 per cent of their $1,050,000 of investable assets are in guaranteed investment certificates and other fixed-income securities.
They would benefit from a disciplined, goals-based investment process that would give them better balance and greater diversification, Mr. MacKenzie says. “They would probably have better results if they worked with a fiduciary investment professional.”
What if Frank or Diane dies early?
“Frank has an indexed government pension and the larger CPP entitlement,” Mr. MacKenzie notes. “If he dies before Diane, she will be entitled to receive 66 per cent of Frank’s work pension and a portion of his CPP as well. “The bottom line is that if Frank predeceases Diane, the pension income will be reduced but with lower basic spending and lower income tax, Diane will still have more than enough to achieve all of her financial goals.”
In sum, Frank and Diane have some important decisions to make: whether to retire now and take a big cut in pension income, how to invest their savings, how to prepare for possible future health care costs, when to start taking government benefits and how and when to make their RRSP withdrawals, the planner says. They should also update their wills and appoint powers of attorney for health and finances.
“They’ve worked hard to become financially independent, they don’t need any more money, so now is the time to enjoy their retirement by wisely using the capital they’ve accumulated,” Mr. MacKenzie says. “With no family expecting an inheritance, they should feel comfortable spending their savings and perhaps giving a little to their favourite charities or community groups, he says.
Assuming a rate of return on investments of five per cent and an inflation rate of two per cent, if they both live to be 100, they’ll leave an estate of about $2-million with today’s purchasing power, the planner says.
Client situation
The people: Frank and Diane, both age 61.
The problem: Can they afford to retire soon even though Frank’s pension will be reduced? How should they draw down their savings?
The plan: Go ahead and retire. Frank’s pension can be supplemented by Diane’s spousal RRSP/RRIF withdrawals. Defer CPP and OAS to age 70.
The payoff: Awareness that they have achieved financial security.
Monthly net income: Diane’s salary plus cash savings as needed.
Assets: Joint bank account $28,000; his GICs $25,670; her GICs $140,620; his TFSA $125,000; her TFSA $98,825; his RRSP $113,695; her spousal RRSP $506,000; residence $450,000. Total: $1.5-million.
Estimated present value of Frank’s defined benefit pension: $1-million. This is what a person with no pension would have to save to generate the same cash flow.
Monthly outlays: Property tax $320; water, sewer, garbage $65; home insurance $125; electricity $95; heating $100; maintenance, garden $120; car insurance $90; fuel $240; oil changes, maintenance $80; groceries $750; clothing $20; charity $150; vacation, travel $1,000; dining, drinks, entertainment $170; personal care $20; subscriptions $10; doctors, dentists $120; drugstore $150; phones, TV, internet $230; miscellaneous credit card charges $1,500; TFSA contributions $1,165. Total: $6,520.
Liabilities: None.
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