Winnipeg Free Press - PRINT EDITION
Posted: 03/29/2014 1:00 AM | Comments: 0
Some people dream of the good life in California or Arizona, but Jack and Diane's retirement dreams lean more to the supernatural side.
British Columbia, that is.
Their retirement plan has been in the works for some time now. They bought a home on the West Coast -- worth about $315,000 -- a while back and have been renting it out. They also have a small mortgage on their home, valued at about $275,000.
When they retire, they will sell their Winnipeg home and use the proceeds to pay off the mortgage on the home in B.C., while using any remaining money to fund renovations.
Diane, who works in the corporate sector earning about $70,000 a year, says they'd like to retire "like, yesterday." With that in mind, the couple -- in their early 60s -- wants to know if they can afford to retire now.
They know that will involve living on less than what they've been earning while working, especially given Jack, who works in construction on a contract basis, earns a variable, pre-tax income of about $150,000 annually.
Once retired, they don't expect to live much differently than they do now and estimate their costs will be much less without mortgage payments and savings contributions to worry about. "We don't have extravagant plans -- maybe a little bit of travelling," says Diane, who will earn a defined-benefit pension of $1,100 a month.
In contrast, Jack has no work pension, so their investments will play a big role in generating their income once they retire. Their savings are more than $448,000 but they are uncertain whether their money is properly invested, Diane says.
"Is there something smarter that we should be doing?"
The couple suspect they may need more time to grow their portfolio, maximizing their TFSA and RRSP contributions, while paying down mortgage debt.
Even though they have nearly $500,000 saved, what they have heard in the media suggests they haven't saved enough.
"I read you need something like $673,000 just to not be living at the poverty level," Diane says. "For a modest retirement, what do we need?"
Scott Madams, portfolio manager with Madams investment group with CIBC Wood Gundy, says Jack and Diane are like many other pre-retirees -- worried whether they have enough to retire so they can live in much the same way they have been while working.
The first step in answering this question is determining their spending once retired. To evaluate this aspect of their finances, Madams enlisted the help of a certified financial planner at CIBC Wood Gundy, Lucio Riccio.
Without mortgage costs and savings contributions, Riccio estimates the couple will spend about $43,000 annually once retired.
"The second step is to understand what income streams will be available to them once they retire," Riccio says.
To start, they need to look at their guaranteed sources of income: OAS, CPP and Diane's work pension.
Combined, these will provide them with an annual pre-tax income of about $42,000 -- partially indexed to inflation, excluding her pension -- starting at age 65. After splitting her pension and factoring tax benefits such as the pension income and age amount, their tax cost on this income will be very low, so their retirement savings should be more than enough to cover their remaining expenses while providing them with income for emergencies and other needs, such as buying a car or splurging on a big vacation.
Yet if they retire tomorrow, they'd still have about four years before they could begin collecting OAS and CPP, so Jack and Diane's savings would carry much of the load early in retirement.
"The amount of money they would need to have saved would be $384,000 if they were receiving a pre-tax rate of return of five per cent, or $499,334 if they were receiving a pre-tax rate of return of 2.6 per cent," Riccio says.
"The good news for Jack and Diane is they have accumulated approximately $450,000."
This should be enough to fund most of their retirement income needs from now until age 65, and it will continue to supplement their guaranteed sources of income adequately well into their 90s.
But Jack and Diane should proceed with caution regarding these figures, because after matching their current income to their stated expenses, including savings contributions, they have about $50,000 in free cash flow annually unaccounted for in their budget.
"This is a significant amount for any family," Madams says, adding they need to track their spending much more closely to get a firmer account of their actual lifestyle costs.
If they are spending more than they realize, Jack and Diane may be facing a dramatic change in their lifestyle once retired.
Alternatively, they could work longer, saving more while seeking an investment strategy that will provide them with a combination of growth and steady income.
Madams says while their current portfolio appears to be properly diversified to achieve this goal, it could be better.
What they require is a conservative approach, but the problem they face in this regard is bond and GIC returns don't keep pace with inflation, and after taxes, the returns are even lower.
Although their current portfolio of mutual funds in their RRSPs and TFSAs -- a balanced strategy investing in equities and fixed income -- does address this concern, it's also costly, with an average management expense ratio (MER) of more than three per cent.
"Jack is likely paying close to $9,000 per year in management costs, which is too much considering the alternatives are substantially less," Madams says, adding Diane's costs are about $2,100 annually.
Annual management costs are an important consideration because if their portfolio is required to yield five per cent annually to fund retirement, for example, they would need to achieve eight per cent returns every year, with a portfolio-management cost of three per cent.
With a portfolio of almost $450,000, Jack and Diane could do better, hiring personalized-portfolio management for a substantially lower management cost.
"We feel they should be looking at an annual investment cost of about 1.5 per cent," he says. "This would add a great deal to the return over time."
Another benefit of this strategy is they would be unifying their assets under one manager, who could tactically invest their money.
Certainly, working a little longer will improve their retirement income picture quite a bit, especially if they hold off until age 65. By then their mortgage will be paid on their Winnipeg home, and they will owe less on the mortgage on their B.C. home. Furthermore, they will have saved considerably more in their RRSPs and TFSAs.
Yet if retiring sooner is important to them, Jack and Diane must get a firm handle on their spending numbers. If they are spending as little as indicated, they are likely in good shape to retire.
Either way, Madams says Jack and Diane should enlist the help of a professional advisory team that can provide them with a comprehensive retirement plan and investment strategy -- at a reasonable cost -- to help them enjoy the retirement they envision.
Republished from the Winnipeg Free Press print edition March 29, 2014 B10
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