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Cloudy crystal ball?

Early retirement plans must respond to changing conditions

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Brenda has her finances intricately planned for when she retires in five years.

And she's only in her mid-30s.

A professor, the mother of a young child wants to stop working full time to savour life a little.

"I don't think retire is the right word. The way I see it is I've worked really hard for more than 20 years and I feel like at that point I'd rather have time with my child than work more," she says, adding she and her husband are considering having another child.

Her husband, Paul, will continue to work, and their goal is to save enough in the next five years while paying down their mortgage as much as they can.

Although Paul -- who works for the province -- can expect an increase in pay over the next decade, his $60,000-plus annual gross income will fall far short of their current combined income of about $190,000.

Brenda earns about $130,000 a year, and their current take-home pay is more than $9,600 a month.

Brenda says she's run the numbers, and despite the sizable drop-off in income, they should be able to live off her husband's income and withdrawals from her RRSPs when she retires.

"What I've come up with is a five-year, very aggressive savings plan and we'd be able to draw on that pool of money to fund the shortfall after I stop working," she says, adding she'd take the commuted value of her work pension and invest it for the long term to use when Paul, also in his mid-30s, retires in 20-plus years.

One concern for her, however, is their investments. Their mutual funds have been consistently underperforming since 2007, and they fear losing capital in the future -- money they need to reach their goal. But the alternative -- GICs -- seem ill-equipped to provide them with enough of a return to grow their savings for early retirement, she says.

Still, Brenda says she's confident her plan will work, even if her husband is less convinced.

"I think it works, but my husband is a little bit skeptical, because my plan doesn't factor in inflation and interest-rate hikes," she says. "What we're hoping for is a second opinion on whether it's a feasible plan."

The fact Brenda and Paul have done so much planning, including forecasting their future income needs as well as how much they need to save to meet those goals, bodes well for their success, says Karen Diamond, a certified financial planner.

"Moreover, they seem to have the discipline they need to carry out the plan," says the adviser with Diamond Retirement Services in Winnipeg.

Still, Diamond says she has some concerns about their ability to reach their goal. On the surface, they appear to have their numbers shored up, but even Brenda admits they have never tracked their expenses closely.

"If they did that, they might find that the actual expenditures on variable items such as food, clothing, personal care and entertainment are very different from their estimates," she says.

Even without firm spending numbers, Diamond is concerned about their ability to live on less income because all their income seems to be accounted for in their budget. They presently earn $116,000 a year after taxes and deductions, and they spend about the same amount, including RRSP contributions.

Having no child care, parking and other expenses related to Brenda working full time will certainly reduce their expenses, but Brenda's current salary represents such a large portion of their income they have little margin for error.

"Their master plan seems to rely on Paul receiving salary increases of six per cent year-over-year for the next 20 years," Diamond says. "Is this realistic? If that does not happen, what is Plan B?"

Furthermore, their income will likely be reduced if they have another child and either one of them takes substantial time off on parental leave.

Diamond also says Brenda's retirement savings for the long term may not be enough to meet her needs. Brenda expects the commuted value of her pension when she retires to be about $250,000 -- based on her income and annualized growth of five per cent.

"Twenty-five years down the road, the value would be more than $500,000 at the same modest rate of return over that time," Diamond says. That's about $336,000 in today's dollars based on only two per cent inflation.

Another concern for her will be CPP. Although Brenda will not be penalized for reduced earnings while the kids are under age seven because of the 'drop-out provision' under CPP rules, she may not receive the maximum CPP benefit because of the length of time she expects to remain outside the workforce. These factors, however, do not make her plan untenable.

Still, Diamond says they should take more steps to shore up their plan. One option would be to choose a home equity line of credit-style mortgage -- such as the Manulife One plan -- when they renew their mortgage this year.

"This may be a little more expensive, but they would have the flexibility to pay down the principal, or to not pay it down, as long as they make the interest payment each month," she says. "They can put all their excess cash against the balance knowing they can withdraw it again if they need to, which may come in handy if their plan doesn't unfold as expected."

This may be a better strategy than their current plan, which calls for using their tax-free savings accounts, investing in high-interest savings and GICs, and then using those savings to pay off the balance of the mortgage when Brenda retires.

Diamond would prefer to see them use their TFSAs for long-term goals such as retirement. Furthermore, GICs earn so little over the short term they wouldn't save much in taxes on interest in these tax-sheltered accounts.

"A conservative, diversified income fund might be a better option for them for TFSAs to enhance returns, one which includes a number of yield-generating securities," she says.

And if they do choose a mutual fund, they need to pick one with no-load fees. That way, if they redeem their investment in the next few years, they won't end up paying penalties for early withdrawal.

Other elements of Brenda's plan, however, do make a lot of sense, including using her RRSPs to supplement family income. She's earning money now at the highest marginal rate, but when retired, she can withdraw RRSP money, which will be taxed at a much lower rate since she'll be earning much less income -- if any at all. One note of caution: Brenda will lose RRSP-contribution room if she returns to work.

Still, Diamond says Brenda and Paul can make their plan work, but they will need to review and revise it often as conditions change.

And they certainly need to look at reducing their costs over the next five years so they don't experience a budget-shortfall shock when she retires.

"Their projections are a very good start on their long-term plan, but they need to also plan for contingencies in case things don't unfold as expected."

giganticsmile@gmail.com

Brenda's and Paul's finances

INCOME (MONTHLY TAKE-HOME):

Brenda: $133,130 ($6,506)

Paul: $60,712 ($3,153)

Total: $9,659

ñü MONTHLY EXPENSES:

$9,261 (excludes annual RRSP contribution)

DEBTS:

Mortgage: $254,300 owing at 2.15 per cent variable

Car loan: $4,767 at zero per cent interest

ASSETS:

Home: $437,000

Brenda RRSP: $41,540

Brenda work pension: $79,743 (estimated value)

Brenda TFSA: $20,746

Paul RRSP: $10,832

Work pension: unavailable (recently started new job)

Paul LIRA: $6,554

Paul TFSA: $20,746

Joint savings: $29,127

NET WORTH: $394,443

Republished from the Winnipeg Free Press print edition January 5, 2013 B10

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