Liam, 64, and Olivia, 62, are deciding between the Galapagos or New Zealand as their first big retirement vacation.Christopher Katsarov/The Globe and Mail
Like many people their age, Liam and Olivia are eager to retire from the work force, take a big trip to some far-off place, then come home and dote on their grandchildren. Liam is 64 and Olivia is 62. Liam, who was downsized some time ago, is making $25,000 a year as an independent contractor. Olivia earns $70,000 a year as a technician.
They have saved a substantial sum.
The couple have a mortgage-free house in the Greater Toronto Area and two adult children who are financially independent.
“We have always been savers,” Olivia writes in an e-mail. “We paid cash for everything. Once the house was paid, we saved and put our two children through university. We travelled every year with our children when they were at home and we try to now even though they are adults,” she writes.
For their first big retirement vacation, they can’t decide between the Galapagos or New Zealand, but say “we will be toasting each other and enjoying our retirement!” Neither has a company pension. Now that they have saved, they are unsure how to withdraw. Their retirement spending target is $70,000 a year after tax.
We asked Gregor Daly of Efficient Wealth Management Inc. of Mississauga and Florin Pop, a portfolio manager at Tactex Asset Management Inc. of Thornhill, Ont., to look at Liam and Olivia’s situation. Mr. Daly is a chartered financial analyst (CFA) Level 2 candidate and has passed the certified financial planner (CFP) exam. Mr. Pop holds the CFA and CFP designations.
What the Experts Say
Olivia and Liam have accumulated more than $1-million in their savings and investment accounts and will qualify for close to maximum Canada Pension Plan and full Old Age Security benefits, the planners say in their report. “Their main concern is the viability of a plan that would allow them to retire as soon as possible and spend $70,000 yearly, after taxes.”
First off, they should consider delaying both their CPP and OAS until age 70, the planners say. The government will boost their CPP benefit by 0.7 per cent and their OAS benefit by 0.6 per cent for every month after the age of 65 that they delay taking the benefit. At age 70 (with CPP boosted by 42 per cent and OAS boosted by 36 per cent), most of their expenses would be covered by government backed, inflation-indexed benefits.
“To illustrate, roughly $66,000 in today’s dollars of their $70,000 target would be covered at age 70 by their government benefits, which would lower their financial risk to a minimum and allow them to live the rest of their life worry-free.”
Inflation is a retiree’s worst enemy because it erodes the purchasing power of unindexed pensions and decimates the real value of savings and sometimes, investment accounts, they say. “For individuals trying to protect against longevity risk – the risk of having an above-average lifespan – government benefits offer very compelling attributes because the payments are guaranteed and inflation adjusted for the entirety of their life.”
In Olivia and Liam’s case, deferring CPP and OAS benefits is even more compelling because they have sufficient investments to fund their retirement years until age 70. “If delaying both CPP and OAS is a hard pill to swallow, they should consider at least delaying CPP because the benefits of deferring are so attractive.”
A second concern for Olivia and Liam is developing a withdrawal and tax strategy.
“From a tax perspective, we would recommend that in retirement, Olivia and Liam target gross income of about $49,000 a year each,” the planners say. With a household gross income of $98,000 and an approximate tax bill of $11,000, they could sustain their desired $70,000 after-tax spending budget, contribute yearly to their tax-free savings accounts (currently a combined $13,000 a year) and still have modest additional discretionary funds. Any unexpected expenses should be funded with money from their non-registered accounts or their TFSAs.
The planners recommend that Liam and Olivia convert their RRSPs to registered retirement income funds and take the necessary withdrawals to meet their targeted income level yearly. “The advantage of using RRIFs is that, after age 65, they would each receive a $2,000 federal pension income tax credit. As well, their RRIF withdrawals would be eligible for income splitting, potentially reducing the family’s tax bill.
When accumulating assets, being exposed to the volatility of the stock market can be a good thing, the planners say. “In retirement when we need to begin spending these assets, volatility becomes a problem.” The risk of needing to sell investments at a loss can threaten the capital retirees have spent their working lives building, they add.
“The five years immediately preceding and following retirement are of particular concern as heavy losses in a portfolio during this time can be difficult or impossible to recover from.” This is known as sequence of returns risk and the solution is to ensure that they set aside enough capital in low-volatility (or no volatility) assets each year to provide the required cash flow. “We prepare our clients for this by adjusting portfolios in the lead up to their retirement using a laddered portfolio of guaranteed investment certificates, with GICs maturing each year to cover cash flow requirements.”
Liam’s RRSP is about 80 per cent globally diversified equities and 20 per cent fixed income, while Olivia has about 90 per cent globally diversified equities and 10 per cent fixed income. As such, they are both heavily exposed to the stock market, so there is a risk that they would need to sell assets at a loss when they need the cash flow, the planners say. “They should reconstruct the portfolio to address this risk. A portfolio including some laddered GICs would certainly work well for both.” After age 70, when their reliance on the portfolio is minimal, they can reassess their investments and assume a higher risk level in line with their risk tolerance.
Assuming investment in a medium-risk, 60 per cent stocks-40 per cent fixed income portfolio with a 4.6-per-cent expected return, 3 per cent inflation and life expectancy of 95 years for both, the planners’ projections show that Olivia and Liam can fully retire immediately if they choose to. “In fact, with the desired spending of $70,000 per year after tax, Olivia and Liam’s retirement is overfunded.”
A full financial plan can provide people with answers to all the questions they had when they embarked on the journey, the planners say. “Sometimes, even more important questions arise. For Olivia and Liam it is figuring out how their surplus wealth will enrich their or their loved ones’ lives.”
Client Situation
The People: Liam, 64, and Olivia, 62.
The Problem: Can they afford to retire from work in a year or so with $70,000 a year after tax? Will their retirement savings last?
The Plan: Consider deferring government benefits to age 70 to take advantage of the higher guaranteed payout. Convert RRSPs to RRIFs and begin withdrawing. Target gross income of $49,000 a year each.
The Payoff: A financially secure retirement.
Monthly net income: $7,915.
Assets: Cash $35,000; her TFSA $100,500; his TFSA $102,000; her RRSP $475,000; his RRSP $346,000; residence $1,200,000. Total: $2.3-million.
Monthly outlays: Property tax $520; water, sewer, garbage $105; electricity $105; heating $155; maintenance, garden $55; car insurance $230; fuel $500; maintenance, oil $225; groceries $800; clothing $20; car loan $350; gifts, charity $225; vacation, travel $835; dining, drinks, entertainment $395; personal care $45; subscriptions $55; health care $125; life, disability insurance $160; communications $270; RRSPs $900; TFSAs $920. Total: $6,995.
Liabilities: Car loan $13,225 at 0.5 per cent.
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