Hey there, time traveller!
This article was published 23/5/2014 (710 days ago), so information in it may no longer be current.
John and Jane have a big financial decision ahead of them. The married couple is trying to figure out if they're on firm enough financial footing for John to retire from his job in the civil service once he qualifies for his pension next year.
"You never know how much is enough," said Jane, 51, who plans to continue working part time herself until she's 60. "Once retired, he hopes to find something part time because he is still young and doesn't want to sit around home."
Instead of working in management, earning about $85,000 a year, John will be looking for employment with much lower compensation and a lot less stress.
"Like a Walmart greeter," she said.
Upon retiring, John's defined benefit pension will provide him with a base income of about $43,000 annually before taxes. In addition, they have about $200,000 in RRSPs, TFSAs and non-registered savings to help with additional costs.
Jane, earning about $12,000 a year, says their current expenses would likely remain much the same. While some costs would be reduced, such as gasoline, those savings would be offset by an increased spending on vacations.
With no debt, the couple figures their plan has a shot, but they want an expert to help them to figure out if the numbers actually add up to 'Freedom 56' for John.
Certified financial planner Jamie Kraemer says based on their reported expenses, income and savings, John and Jane appear to be in good shape.
"The big question they have to answer is if his pension is $43,000, that's about $34,329 after tax, so is it enough to cover their expenses?" said the financial adviser with TFI Financial in Winnipeg.
Given they spend about $33,000 annually, the answers seems to be 'yes.'
"Even better is they have about $1,000 of wiggle room, along with savings they can dip into from time to time," he said. "Not to mention they will also have both his and her part-time incomes continuing on until they can collect CPP at 60."
So everything is hunky dory going forward, right? Well, not quite, Kraemer says. Although their estimates appear to add up, that doesn't mean much if the numbers aren't accurate. Kraemer suspects there could be some discrepancies.
For one, John needs to examine his pension plan more closely to ensure he can expect $43,000 a year, not a reduced amount after accounting for the cost for a two-thirds survivor benefit for Jane, which is mandatory in Manitoba for pensioners with spouses.
John and Jane also don't seem to have a very good grasp of what investments they own. In addition, Kraemer even questions whether their expenses are even accurate.
"Most people have a tendency to underestimate what their actual expenses are."
He says it seems they have "ballparked" their financial numbers, and that's simply not good enough with retirement just around the bend.
Yes, their $200,000 in savings along with income from part-time work should be enough to cover additional costs such as helping their adult children, the odd big-ticket vacation and emergency expenses such as home repairs.
To ensure their money can handle the load, they will need to develop a detailed financial plan that includes an investment strategy to match their goals.
"What they will want to do is manage their tax brackets every year," Kramer said.
This means they should have a plan to strategically withdraw from their RRSPs on an annual basis to minimize taxation so their money goes as far as possible.
Kraemer says John and Jane should have a lot of flexibility in this regard because most of their registered money is in Jane's name, and her work income -- $12,000 a year -- leaves ample room to withdraw cash, taxed at about 26 per cent, up to the first income tax bracket of $31,000 a year. Furthermore, they will also benefit from splitting John's pension income. A strategy to melt down their RRSPs slowly over time would help them withdraw their registered money at the lowest tax rate possible instead of waiting until their 70s, for example, when they will also have OAS and CPP income and along with mandatory registered retirement income fund (RRIF) withdrawals that could increase their taxes.
Kraemer says they don't need to spend the withdrawals. Rather, they could invest for the future, and a good place to park it would be in their TFSAs.
For that matter, they could be making better use of these tax-free accounts right now.
"It looks to me that they haven't maximized their TFSAs, and yet they do have about $24,000 in their chequing account and $11,000 in a savings account."
With about $10,000 each in contribution room, they could shelter some of their non-registered savings in their TFSAs. Moreover, they should consider investing some of the money in assets that offer a higher yield than they're currently earning in savings accounts.
Although their current TFSA assets and their RRSPs are invested in a fairly good global-dividend mutual fund, John and Jane may want to invest further contributions to their TFSAs in securities that can provide them with tax-free income. One option is a floating-rate fixed-income fund.
"What I've found is floating-rate income funds are a nice investment choice in this low interest rate environment because, even though the returns are not guaranteed, they're expected to be in the four to six per cent range," Kraemer said.
Unlike government bond funds, floating-rate funds are not susceptible to interest-rate hikes, so they won't fall in value when interest rates rise from historic lows.
"You have a little more credit risk, but at least you've eliminated the interest rate risk."
While floating-rate bond funds are neither a long-term solution, like a global-dividend fund, nor a short-term one such as a savings account, they are a good middle ground option for a portion of John and Jane's savings because they provide a decent return that outpaces inflation.
Yet their investments are a much less important part of their overall retirement picture than determining whether John's pension will be more than enough to cover the projected expenses.
"They need to spend some time educating themselves on their own finances, or work with a certified financial planner to get the figures straight," he said.
"Because if they're spending figures are at all accurate, then they should be quite comfortable."