Bill and Beverley.Christinne Muschi/The Globe and Mail
Bill is 54; his wife, Beverley, 55. They have two grown children who are financially independent.
Although he makes good money – $150,000 a year including bonus – Bill is wondering if he can afford to retire in a couple years. Beverley, who is self-employed, brings in $15,000 a year in the wellness field. Bill figures they could pick up another $5,000 a year renting out their basement flat to students.
They have substantial savings, including Bill’s company-sponsored registered retirement savings plan (RRSP), to which he contributes 2 per cent of his earnings and his employer 1 per cent. Their Montreal-area house, valued at $900,000, is mortgage-free.
Beverley and Bill’s goal is to spend three months a year in a warmer climate and maybe rent out their home while they’re away. “If, in the first few years, the math doesn’t work, we would scale back the three months to something within our budget,” Bill writes in an e-mail.
They have a $20,000 line of credit that they plan to pay off by year end from their cash-flow surplus, “after which we will be contributing $50,000 per year to top up my RRSP and tax-free savings account [TFSA], until retirement – which I hope for me, will be by Jan. 1, 2022,” Bill writes. He will be 56. Their retirement spending target is $65,000 a year after tax.
Lending hope to Bill’s early retirement plan is the prospect of a substantial inheritance at some point in the future.
We asked Ross McShane, vice-president of financial planning at Doherty & Associates in Ottawa, to look at Bill and Beverley’s situation.
What the expert says
To achieve their goals and be financially secure, Bill and Beverley would definitely have to rely on the anticipated inheritance, “which may not be as robust as contemplated, and of course, the timing is uncertain,” Mr. McShane says. “I don’t suggest basing an early retirement goal on an expected inheritance” that could be 15 years away.
If they chose to, the couple could downsize their house. “Downsizing to a less expensive home and drawing on $300,000 would reduce the risk of outliving their capital,” the planner says. Net proceeds from the sale of the house could be used to fund their TFSAs and use up the TFSA carry-forward room, Mr. McShane says.
“Otherwise, they’ll have to defer retirement, semi-retire, or reduce lifestyle expenditures during late retirement,” he says. Lifestyle expenses of $65,000 a year “are fairly modest, however, and they haven’t allowed for vehicle replacement and other contingencies.” Although their children are independent, costs associated with weddings could come into play. As well, the Canadian-U.S. dollar exchange rate will add to cost of spending winters in a warmer climate.
By the end of 2021, when Bill retires, they should have about $1,140,000 of investable assets, Mr. McShane says. Beverley will generate about $15,000 of business income and they will draw the balance to cover lifestyle expenses from their investment portfolio. Therefore, they will need to draw about $75,000 out of their registered plans to cover living expenses and income tax, he says. This equates to a payout of more than 6.5 per cent. “This is high and could well lead to a premature erosion of capital,” the planner says.
“When you consider a 3-per-cent average dividend yield, depending on what stocks they hold, they are left being dependent on capital appreciation for the bulk of the required cash flow.” The portion of the portfolio required to cover capital draw-down in the near term (two to three years) should be held in short-term cash equivalents to avoid having to sell stocks in a down market, Mr. McShane says. With interest rates so low, this will dampen their potential rate of return.
“Delaying their dependency on investments for cash flow, or at least lowering it (working longer or working part-time) will reduce the risk of eroding capital prematurely.”
Bill has $100,000 of RRSP room that he should utilize before he retires. The benefit of doing so is that he can deduct the contributions in a tax bracket that is higher than the bracket he will be in when he retires and they are able to split income (effective when he is 65 years old).
Because they have an unequal balance of assets, Bill should make spousal RRSP contributions to build up assets in Beverley’s name, Mr. McShane says. “This is important because they will not be able to split income on Bill’s registered plan withdrawals until he is 65.” They need to be mindful of the three-year attribution rules when Beverley is withdrawing from her spousal RRSP, he says. Beverley must wait until 2022 to withdraw money Bill contributed in 2019. Otherwise, the withdrawal will be taxed in Bill’s hands.
The planner suggests Beverley withdraw from her RRSP before the age of 65 to take advantage of her lower tax bracket during those years and effectively equalize their income streams, Mr. McShane says. The idea is to withdraw enough from her RRSP each year to bring her income to $43,790, which is the top of the lowest bracket in Quebec (27.53 per cent).
In drawing up his forecast, Mr. McShane used a 4.5-per-cent average annual rate of return on their investments, net of fees, and an inflation rate of 2 per cent a year. He assumed Bill retires at the end of 2021 and Beverley in 2026. Bill would begin collecting full Quebec Pension Plan benefits starting at 65, while Beverley would get only partial benefits at 65. They would begin collecting Old Age Security benefits at 65. He did not include the anticipated inheritance.
Client situation
The People: Bill, 54, and Beverley, 55.
The Problem: Can they afford for Bill to retire from work in two years without jeopardizing their financial security?
The Plan: Rethink their goals. Consider downsizing the house, working longer, at least part time, or spending less in later life.
The Payoff: Avoiding the risk of relying on an anticipated inheritance for financial well-being.
Monthly net income: $9,135.
Assets: His TFSA $1,000; his RRSP and locked-in retirement account $692,000; her RRSP $121,000; RPP at work $13,000; residence $900,000. Total: $1.73-million.
Monthly outlays: Property tax $275; home insurance $65; utilities $215; maintenance, garden $250; transportation $335; groceries $585; clothing $200; gifts, charity $250; vacation, travel $835; dining, drinks, entertainment $625; club memberships $165; sports, hobbies $180; subscriptions $85; health care $210; life insurance $150; telecom $115; RRSP $335. Total: $4,875 (The surplus of $4,260 is currently being used to pay off the line of credit.)
Liabilities: Line of credit $20,000.
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