Ashley Fraser/The Globe and Mail
Ted and Natalie have well-paying management jobs, Ted in the private sector and Natalie in government. He is age 52, she is 51. They have two children, 18 and 21. The younger one still lives at home.
Ted has earned good income over the past five years, averaging about $200,000 a year including commission. His base salary is $115,000. Natalie is making $118,000 a year, plus a bonus that ranges from $5,000 to $25,000.
Natalie and Ted bought a rental property not long ago with a small down payment; the property is barely breaking even.
Natalie recently joined her defined benefit pension plan and wonders whether she should use funds from her previous employer’s registered pension plan to “buy back” service in her new plan.
Ted, who had a recent health scare, is looking to the day they can both retire, travel extensively “while we can,” and winter in a warmer climate. Short term, they want to replace one of their cars and do some renovations to their house. Longer term, their goal is to retire from work in six years with a budget of $140,000 a year after tax.
We asked Matthew Ardrey, a vice-president and financial planner at TriDelta Financial in Toronto, to look at Ted and Natalie’s situation.
What the expert says
Ted and Natalie have been able to pay off the mortgage on the family home, do some renovations and make other big-ticket purchases thanks to Ted’s substantial commission income and Natalie’s bonus, Mr. Ardrey says. Ted expects this extra income to fall markedly in future, averaging about $10,000 a year each.
“Unfortunately, with the reduction in this extra income, they may not be able to afford even their short-term spending in full,” the planner says. They have enough to pay for their yearly big trip ($10,000), but may not have enough for home renovations ($25,000) or a car purchase ($35,000). “If they want to proceed with these, they may either need to finance them or reduce spending in other areas.”
Ted saves 4 per cent of his salary each month in his defined contribution pension plan, which the company matches. Then he uses the remainder of his RRSP room to contribute to his group RRSP at work. He also makes a $100 contribution each month to his tax-free savings account. Natalie contributes $10,000 a year to her RRSP.
In addition to his DC pension, Ted also has a defined benefit pension that will pay him $26,400 a year when he retires at age 58, not indexed to inflation. Natalie has just joined her defined benefit plan and has the opportunity to buy back service, the planner says.
If Natalie uses the full $226,000 in her DC pension plan to buy back service with her new employer, her pension will increase from $1,000 a month to $2,500 a month, fully indexed, at her age 58. “We recommend she does this.”
Natalie and Ted recently bought a rental property worth $550,000 with a $500,000 mortgage on it. The property earns $2,700 a month gross and zero after fixed expenses. “This is concerning because at best, it is cash-flow neutral and if any ad hoc expenses come up, it will be cash flow negative,” Mr. Ardrey says. In preparing his forecast, he assumes they sell the rental property when they retire.
After all spending and saving are added up, the couple show a surplus that is not accounted for. They said they use the money for unexpected expenses such as car repairs. “Though that makes up some of the surplus, I feel that there is budget leakage in their spending,” the planner says. They should work on improving their budget so they will have a more accurate picture of their retirement needs.
If they retire at Ted’s age 58, they will get reduced Canada Pension Plan benefits. The forecast assumes they start collecting CPP and Old Age Security at age 65. They will get 80 per cent of the maximum CPP benefit at age 65 as well as maximum Old Age Security benefits, subject to any clawback.
Their portfolio is 23-per-cent cash, 32-per-cent bonds and 45-per-cent stocks, Mr. Ardrey says. Of the stocks, 20 per cent are Canadian, 20 per cent U.S. and 5 per cent international. “With headwinds on the fixed-income side because of rising interest rates, the expected return on this portfolio is 3.04 per cent,” he says.
Inflation is now a larger concern for portfolios than it once was and this will likely last for a while, the planner says. “Thus, we are using a 3-per-cent inflation rate in this projection, meaning their investments are barely keeping pace with inflation.” Worse, the mutual funds they hold outside of their group plans have an average management expense ratio of 2.14 per cent. In comparison, the investments in the group plans would be at a relatively low cost.
Taking all of these variables into account, with their spending goal of $140,000 a year, they fall short very early in their projection, running out of savings just 10 years into retirement, in 2038,” the planner says. ”Given this drastic shortfall, we deem this scenario unviable.”
To improve their retirement plan, Mr. Ardrey recommends they hold less cash, add to their stock holdings, and add some income-producing, non-traditional investments such as private residential real estate investment trusts. “These investments provide uncorrelated and steady returns that are in excess of what we are expecting for fixed income today.”
With 55-per-cent cash and fixed income, their portfolio has embedded risk that they likely don’t recognize. “For the past 50 years or so, fixed income has been a safe haven for investing,” the planner says. “This is less so today.” An increase in interest rates leads to a decline in the price of existing bonds. Inflation also poses a risk to fixed-income securities. “If the current rate of inflation is stickier than predicted, the real rate of return on bonds will continue to be negative.”
Earning better returns improves Ted and Natalie’s retirement prospects but more is needed, he says. Mr. Ardrey puts his forecast through computer software known as a Monte Carlo simulation to gauge the likelihood of success given different variables. To improve their likelihood of success, Ted and Natalie will either have to cut their retirement spending by about a third, to $96,000 a year, or delay retiring for six additional years, from 2028 to 2034.
“Unfortunately, there is no magic bullet to retirement planning,” Mr. Ardrey says. “If you cannot achieve your goals, then it typically involves one or more of working longer, saving more, investing better, or spending less.” This is the situation Ted and Natalie must now manage through to meet their goals in the future. “Thankfully, they still have the time to do it.”
Client situation
The people: Ted, 52, Natalie, 51, and their children, 18 and 21
The problem: Can they afford to retire in six years with $140,000 in spending?
The plan: Take steps to improve investment returns, lower retirement spending expectations or plan to work much longer than anticipated.
The payoff: A clear picture of what needs to be done
Monthly net income: $15,100
Assets: Cash $2,000; his RRSP $410,000; her RRSP $235,000; his defined contribution pension $235,000; her DC pension $226,000; estimated value of his DB pension $634,000; estimated value of her DB pension $72,000; his TFSA $17,000; registered education savings plan $27,000; residence $820,000; rental property $550,000. Total: $3.2-million
Monthly outlays: Property tax $450; water, sewer, garbage $120; home insurance $170; heat, hydro $300; maintenance, garden $260; car insurance $235; fuel $700; maintenance $275; parking, transit $300; groceries $1,200; tutoring $400; clothing $250; gifts, charity $350; vacation, travel $1,000; other discretionary $600; dining, drinks, entertainment $1,300; personal care $200; club memberships $50; golf $25; pets $85; subscriptions $65; health care $100; communications $235; his RRSP and DC pension contributions $1,440; registered education savings plan $100; her DB pension plan $1,380; her RRSP $835; his TFSA $100. Total: $12,525.Surplus goes to occasional and unallocated expenses.
Liabilities: Mortgage on rental $501,590
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Some details may be changed to protect the privacy of the persons profiled.
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