Dennis and Gwen plan to downsize, keeping a small place in Vancouver and a modest cabin on one of the Gulf Islands.DARRYL DYCK/The Globe and Mail
It’s sometimes said that people in certain professions tend to make poor investors simply because they’re too busy with their own fields of endeavour. So it is with Dennis and Gwen, a middle-aged couple imagining how they’ll live once their teenage children have grown up and moved out.
Dennis is age 52 and earns more than $160,000 a year in the sciences. Gwen is 45, a self-employed wellness consultant grossing $97,390 a year. Once the children have gone, Gwen and Dennis plan to downsize, keeping a small place in Vancouver and a modest cabin on one of the Gulf Islands.
An immediate question is what to do with the $97,000 or so Dennis has built up in his chequing account over the years – on top of the $872,500 from an employee buyout. They wonder whether they should pay down their mortgage more quickly or invest. “We would like to hire a professional who can hold our hands through these steps,” Gwen writes in an e-mail. “Each of us is an expert in our field, but we are quite clueless in the finances department.”
Dennis plans to retire at age 65 although he wants to scale back before then. “In five years, I’d like to transition to self-employment and work less,” he writes. He has a defined-benefit pension plan at work that would pay him $39,800 a year if he continued in his present job to 65. Gwen plans to keep working to age 70. “I don’t ever really want to retire,” she writes. Their retirement spending goal is $100,000 a year after tax.
We asked Cecilia Tsang, a certified financial planner at RGF Integrated Wealth Management in Vancouver, to look at Dennis and Gwen’s situation.
What the expert says
Dennis and Gwen have good cash flow, with net income of $13,300 a month and lifestyle expenses of $10,855, leaving them a surplus of $2,445, Ms. Tsang says. They are paying $5,000 a month on their $1,145,000 mortgage. They could use the surplus to pay down the mortgage more quickly, but with a mortgage rate of 2.57 per cent, “it would likely be better for them financially to keep their payments at the same rate and invest the excess cash flow,” the planner says.
They have not fully maximized their registered retirement savings plans and tax-free savings accounts. “As long as their risk tolerance allows for a diversified portfolio, their net worth would grow more quickly by investing.”
As for downsizing and buying a cabin, they should be able to manage two properties as long as they are comfortable with carrying debt, Ms. Tsang says. Their mortgage still has 26 years to run. “As long as their total debt payments are about the same or lower as they are paying now, the goal of having the two properties is achievable.”
Key to their having sufficient retirement income is the proper investment of the cash sitting in Dennis’s bank accounts, the planner says. Her retirement projections assume the money is invested in a diversified portfolio designed for moderate growth – about 5 per cent in cash, 25 per cent in Canadian and global fixed income, and about 70 per cent in Canadian, U.S. and international equities. To be conservative, the planner subtracted 1.75 percentage points from the 25-year historical return for this portfolio, using an average annual rate of return of 4.9 per cent in her projection and an inflation rate of 1.8 per cent.
The first “action item” the planner recommends is for Dennis to contribute the maximum to his TFSA, which has a balance of $10. “Ideally, over time, money invested in their non-registered account can be optimized and transferred to both Dennis and Gwen’s TFSAs,” Ms. Tsang says. Because Dennis’s income and tax rate are high, he should contribute as much as possible to his RRSP or to a spousal account for Gwen. This would lower his taxes now and enable them to split future income from their RRSPs/registered retirement income funds, giving them more money to spend later.
Gwen, who has no RRSP, would also benefit from investing in one, the planner says. Even though her marginal tax rate may not drop in retirement because of income splitting with Dennis, the money that she would save in taxes now will allow for the savings to compound. She will pay taxes later when she begins withdrawing the funds.
“For example, if Gwen’s combined marginal tax rate is 28.2 per cent and she invests $10,000 into an RRSP, she would have an extra $2,820 in her pocket,” Ms. Tsang says. “If she invests the $2,820 in an RRSP, she can save another $795 in tax the next taxation year,” she adds. “This would mean that she now has increased her $10,000 to $13,615 by investing in her RRSP.”
Before Dennis and Gwen invest their savings, they should determine what type of investments they will be comfortable with. “One of the most important things to consider is risk tolerance,” the planner says. They should have an investment policy statement prepared as a road map to how the portfolio should be invested. “The investment policy statement includes a snapshot of their total net worth, an assessment of each of their risk tolerances, and an ideal asset allocation of how the portfolio should be allocated,” she says.
In her analysis, Ms. Tsang has Dennis working to age 65 and then taking his work and government pensions. Gwen, who will be 58 then, will still be working. To be conservative, the planner has assumed no further registered savings for Dennis from now on. Depending on his future consulting income, Dennis may be able to leave the company and work on his own as a consultant, the planner says. If he continues to be employed for another five years, his pension entitlement will continue to grow more than the planner’s forecast indicates. As well, their monthly surplus gives them some room for Dennis to earn less as a consultant. Or perhaps he could save and invest the surplus until he goes out on his own.
“As a self-employed consultant, Dennis may also be able to take other deductions and pay less in taxes overall,” Ms. Tsang says. So although his gross income will drop, “the take-home net income may not be as affected.”
Client situation
The people: Dennis, 52, and Gwen, 45
The problem: What should they do with the money in Dennis’s savings account? Can they afford to downsize and maintain both a city condo and a cabin? Can Dennis go out on his own?
The plan: Invest the money, starting with a risk tolerance assessment, an investment policy statement and a suitable asset allocation. As long as they are comfortable with carrying debt in retirement, they can afford to downsize and maintain two properties.
The payoff: Knowing how to put their capital to work to help them achieve their retirement goals
Monthly net income: $13,300
Assets: Joint bank accounts $7,900; her personal and business bank accounts $11,650; his savings account $21,850; his other bank accounts $969,600; her tax-free savings account $45,000; his TFSA $10; his RRSP $205,000; estimated present value of his defined benefit pension $250,000; RESP $3,275; residence $1.9-million. Total: $3.4-million
Monthly outlays: Mortgage $5,000; property tax $410; home insurance $200; utilities $250; maintenance $225; transportation $525; groceries $1,280; clothing $215; children’s activities $275; charity $100; gifts $200; vacation, travel $500; dining out $620; personal care $320; pets $95; sports, hobbies $210; health care $260; communications $170. Total: $10,855. Surplus $2,445
Liabilities: Mortgage $1,145,000
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Some details may be changed to protect the privacy of the persons profiled.
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