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Money Makeover: Retirement plan on razor's edge

Like many Canadians, semi-retired cat lover will have to work a little longer

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KATHY is a woman of few luxuries. She doesn’t take vacations and she sticks to a tight budget, something she perfected years ago when she was a single mother raising three children.

What money she had surplus over the last 20 years she put against the mortgage, now paid in full.

In fact, Kathy is more likely to spend money on her two cats — both of which have health issues — than on herself. This includes about $60 a month on just medication for the cats and vet bills and $30 to $40 on cat food and litter.

But despite her frugality, she has also started to get a sinking feeling about her financial future.

"I just turned 60, and I feel that I’ve reached a sort of a milestone," she says. "My friends of the same age have pensions and they’re all retiring."

But Kathy says she doesn’t see retirement in the cards for herself anytime soon.

She is working part-time for the federal government. As a term employee, she doesn’t get benefits, but she recently bought into the pension plan — at a cost of $8,300 — and will receive a monthly pension payment of about $240 when she fully retires. She used savings in a tax-free savings account (TFSA) to cover $5,000 of the cost and now pays $100 a month on the $3,300 owing to the pension.

She has about $8,400 in savings and chequing accounts, which she plans to use for needed renovations on her home.

And she has about $98,000 split between a LIRA and RRSP, both made up of growth-oriented mutual funds.

Her work income is enough to cover her expenses of about $1,800 a month. When she recently started collecting CPP, she decided to invest it in her RRSP to help reduce her income tax bill.

While Kathy is able to save money when she’s employed, she worries about life after work.

"I feel now it’s not a question of ‘When can I retire?’" she says.

"It’s ‘Can I even retire at all?’" Certified financial planner Valerie ChatainW hite, whose firm is called The Next 30 Years, says Kathy’s worries about retirement are not without merit.

"Her budget is already slim," says the Winnipeg- based planner.

Obviously once Kathy stops working, her budget will only get tighter. If she can continue working until age 65, her monthly expenses will run around $1,700, about $100 less than today because she will no longer be making payments on the remaining $3,300 to the Federal Public Service Pension Plan.

Her projected income once she stops work will be about $1,423 before taxes.

This income stream would include her CPP of $459, her work pension of $240, OAS of about $524 and a payment from her LIRA, which would be converted to a life income fund (LIF).

"Let’s assume that the government formula allows for a six per cent withdrawal, so in current value the LIF payment would be approximately $200 a month," Chatain-White says.

Without adequate income, Kathy would need to draw on her RRSP, which at a five per cent annual return would be a little more than $76,000 by age 65.

Chatain-White says Kathy could withdraw about $450 a month from her RRSP/RIF to make up the income/expense shortfall, but it’s likely those savings would be depleted before age 80.

"Some people want their money to last while others understand they will use all of it, and they are OK with that," she says. "For some, it’s a shock."

Even with all these sources of income, it will be tight once taxes are factored into the equation, and it’s more than likely she’ll need to cut expenses.

Another source of concern is her investment strategy for the LIRA and RRSP.

Chatain-White says Kathy’s investment portfolio is extremely aggressive for someone of retirement age. Most of her funds are growth equity mutual funds, which will provide superior long-term returns, but they’re also prone to volatility in the short term.

"While there certainly could be money to be made within the next years, she might want to tone this down or make sure her adviser helps rebalance profits," she says, adding profits would be reinvested in more conservative investments like GICs. "She can’t afford to lose whatever growth she captures in the next few years."

Further complicating matters are the planned renovations. She has saved about $8,400 for a possible kitchen upgrade and building a new garage.

"Most kitchen renos run way, way more than that," Chatain-White says, adding a garage would cost at least $10,000.

Kathy would more than likely need to get a home equity loan for the upgrades, which would add to her costs. She could pay only the interest costs on the loan indefinitely until she sells the home, but she would still be vulnerable to rising interest rates.

Then, there are unforeseen expenses.

"One never knows if there might be additional vet expenses as the pets age," Chatain-White says.

While Kathy continues to work for the next few years, she should try to save as much money as possible.

"In her case, she should invest money in a TFSA with a balanced portfolio." The money would be invested in a roughly 50-50 mix of growth mutual funds and fixed-income investments.

She might even steer clear of growth-only funds, instead opting for mutual funds that invest in dividend-yielding stock, providing both income and growth of capital.

"Investing in a TFSA will likely provide a better cushion for her future years because it does not adversely affect her ability to qualify for government benefits," she says.

And based on her projected income, excluding OAS, Kathy will qualify for the Guaranteed Income Supplement (GIS). This is income-tested so any further contributions to her RRSP could eat into her GIS payment down the road when she withdraws from those savings.

In contrast, withdrawals from a TFSA would have no effect on GIS payments because money in a TFSA is not seen as taxable income by the CRA.

This strategy may result in her paying more taxes in the short term because she isn’t getting a refund from RRSP contributions, but it will provide more flexibility in the long run.

Yet even with additional savings and GIS payments, Chatain-White says Kathy will always be on the razor’s edge financially when she fully retires. It’s best to work as long as she can and build up a TFSA war chest as much as she can.

"These days, like many other Canadians, she will have to work a little longer."

giganticsmile@gmail.com

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