TODD KOROL/The Globe and Mail
A health scare last year got Andrew thinking about stepping aside from his high-pressure executive job and taking early retirement. He’s 59. He’d be leaving behind a salary of $200,000 a year. His wife, Abigail, is a self-employed consultant with business income ranging from $50,000 to $100,000 a year. She is 58.
They have a mortgage-free house in Alberta and no debt.
Abigail and Andrew have three children, ages 16 to 20, with the youngest still at home and another partly dependent.
“This health episode has made me really look at how much longer I want or need to work,” Andrew writes in an e-mail. “Maybe it’s time to slow down.” They have money set aside in a registered education savings plan and in trust accounts for their children’s higher education.
“We are not big travellers, so in retirement we may do one trip in Canada each year to visit relatives,” Andrew writes.
“How soon could I retire with an after-tax income of $120,000 a year?” he asks. “When would we have to sell our house to augment our depleted savings?”
We asked Clay Gillespie, a financial planner and managing director of RGF Integrated Wealth Management Ltd. in Vancouver, to look at Andrew and Abigail’s situation.
What the expert says
“This couple is in very good financial shape,” Mr. Gillespie says. Andrew is already collecting a defined-benefit pension of about $39,600 a year, indexed to inflation, from a previous employer.
“The first analysis we did was to see how much income they could generate if they retired today,” the planner says. “This gives us a starting point.” If they both retired today, they could generate a net income, after-tax and inflation, of about $100,000 a year. This assumes they earn a 4-per-cent rate of return on their investments after inflation. This analysis did not include the value of their house. The forecast also assumes a life expectancy for Abigail of age 95.
The second analysis looked at when they would need to use the equity of their principal residence if they generated a net spendable income of $120,000 today.
“If they retired today and generated $120,000 after tax, they would need to use some of the equity from the principal residence in about 17 years,” Mr. Gillespie says. They could sell the house and rent, downsize to a smaller home, take out a home-equity line of credit or even a reverse mortgage.
If they wait three more years to retire, he estimates they could generate about $113,000 a year to Abigail’s age 95, short of their target, without tapping the equity in their home. If they really want $120,000 year, they might need to use the equity of their principal residence some time around 2050, he says.
“It appears that this couple can retire on January 1, 2025, and maintain the desired retirement income until Abigail’s age 95,” the planner says. Depending on their income needs in later years, they may never have to sell their house.
The analysis assumed that their income increases every year by the rate of inflation. However, there is a growing body of work that suggests this is not how it works, he adds.
The first two or three years of retirement tend to be the most expensive because people are dealing with pent-up demands that they could not fulfill while working full-time, the planner says. The last two years can also be very expensive because of long-term care costs.
“But we’ve also found that you do not need to increase your income every year by the rate of inflation to maintain your lifestyle in retirement,” he says. In most cases, people usually increase their income every three or four years. “We have found that clients can start with an initial withdrawal rate up to 5.5 per cent of their savings and still maintain their lifestyle throughout retirement,” Mr. Gillespie says.
Andrew is in a high marginal tax bracket. In retirement he will be in a lower marginal tax bracket. As long as he is working, Andrew should increase contributions to his registered retirement savings plan. “In fact, we recommend he transfers a portion of his tax-free savings account into his RRSP. If you are in a lower tax bracket in retirement, then an RRSP is the best alternative.”
The planner recommends both Andrew and Abigail start collecting Old Age Security benefits at age 65. “They should design their income strategy to avoid the OAS recovery tax,” he says. If they split income in retirement, they will need to generate a gross income of about $77,000 a year each. This will give them after-tax income of about $60,000 each. The “clawback” starts at annual income of $81,761 and OAS is completely clawed back when taxable income reaches $133,141.
He suggests they delay collecting Canada Pension Plan benefits to age 70. This will increase their benefit by 8.4 per cent a year, making the benefit 42-per-cent higher than if they had taken it at age 65. “The only caveat to this advice is health-related,” Mr. Gillespie says. “If they’re concerned about Andrew’s health, I would start the CPP at retirement.”
As for their portfolio, they can maintain the 60 per cent stocks and 40 per cent fixed income strategy in retirement, the planner says. However, they need to have a strategy to generate their desired income. “We believe you should be prepared for a stock market correction every single day in retirement. You do not want the stock market to dictate your retirement income in any given year.”
As part of their fixed income, the planner suggests they transfer three years’ worth of their estimated annual withdrawals to cash and short-term securities such as guaranteed investment certificates to insulate them from a possible market downturn. “In retirement, we would suggest they have one year of withdrawals in a high-yield savings account, one in a one-year GIC and one in a two-year GIC,” Mr. Gillespie says.
If at the end of the year, the stock market is up, they would take the following year’s withdrawal from the equity side of the portfolio. If the stock market is down, they would take it from the maturing GIC.
If the GIC is not needed, it would be reinvested for a guaranteed period of two years.
“This strategy means that unless we have a stock market decline that lasts more than three years, Andrew and Abigail should not be forced to take income from their investments while they are declining in value,” Mr. Gillespie says. “This strategy works because they avoid selling investments when they are down in value.”
Client situation
The people: Andrew, 59, Abigail, 58, and their three children
The problem: Can Andrew and Abigail afford to retire soon and have spending power of $120,000 a year after tax? When will they have to tap the value of the house?
The plan: They can retire from work in January, 2025, and maintain their desired lifestyle to Abigail’s age 95. When they retire, they should set aside three years’ worth of savings withdrawals, the first year in a high-interest savings account, and the second and third in one and two-year GICs.
The payoff: Financial security
Monthly net income: $16,975
Assets: Joint bank account $10,000; her business account $85,000; joint stocks $70,000; his TFSA $51,000; her TFSA $0; his RRSP $188,000; her RRSP $434,000; his defined-contribution pension plan $130,000; estimated present value of his DB pension $1.32-million; registered education savings plan $102,000; residence $1-million. Total: $3.39-million
Monthly outlays: Property tax $550; water, sewer, garbage $100; home insurance $160; electricity, heating $500; security $45; maintenance, garden $750; transportation $975; groceries $1,400; clothing $700; gifts, charity $800; vacation, travel $750; financial assistance to child $1,000; dining, drinks, entertainment $800; club memberships $505; sports, hobbies $300; subscriptions; health, dental insurance $400; cellphones $300; phone, TV, internet $300. Total: $10,335. Surplus goes to savings, big-ticket items and unallocated spending.
Liabilities: None
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Some details may be changed to protect the privacy of the persons profiled.
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