Keeping it real?

Hey there, time traveller!
This article was published 19/09/2015 (3819 days ago), so information in it may no longer be current.

Shelby and Derrick have had a lot of good times with their investments. That’s because most of their retirement finances are riding on their home, a cottage and a U.S. property.

“It’s great that we have all these investments that we actually use rather than looking at a bank balance every month, but how do we get out of it?” says Derrick, who is in his mid-60s.

The combined value of their properties exceeds $1 million, but they still owe $120,000 on the line of credit they used to purchase the U.S. vacation home, which is worth $200,000.

“I put $2,000 a month on it, which is four times as much as required,” says Shelby, also in her mid-60s, adding they hope to have it paid off in five years.

Yet their focus on real estate has come at the expense of their other investments. Their combined savings are about $273,000, with most of the money in GICs and savings accounts.

“We got our butts kicked in the market, and as soon as the market recovered back to where we had recouped our original investment plus modest growth, we went back to cash,” Derrick says. “We know that’s not the best strategy, but that’s why we’re here asking for the help now.”

Another challenge is they have no work pensions — both are self-employed — so they recognize they cannot fund their current costs — about $7,000 a month — on government pensions and savings alone.

To make up for the shortfall, they plan to sell one of their properties — likely the cabin.

The proceeds will help fund retirement — one that includes spending about four months of the year enjoying their U.S. property, which they plan to sell once they are in the late 70s or early 80s.

While they believe their retirement vision is doable, they’re worried they could be suffering from financial myopia and missing the big picture, Derrick says.

“It could be a case where we’re too attached to our investments.”

Certified financial planner Jan Fraser says the couple’s aversion to risk may put a cramp in their retirement lifestyle.

“They may not like the markets, but I believe they’re exposing themselves to quite a bit of risk with the way their current finances are set up,” says the financial adviser with Fraser and Partners in Winnipeg.

The biggest red flag Fraser sees is that most of their wealth is invested in cash, putting it at risk of being eroded by inflation. Their money is earning about 1.5 per cent per year, but inflation is about two per cent a year. That amounts to a 0.5 per cent loss annually. Over 20 years, $1,000 in savings would be more like $600.

This means their money isn’t likely to last.

If they were to retire at the start of 2017, for example, Fraser estimates their savings — even if they have the proceeds from the cabin to invest — would not last much longer than a decade.

Here’s how the numbers add up: including their monthly payments on the line of credit, it’s likely their monthly expenses in retirement, at least until the U.S. property is paid in full in about five years, will be about $7,000. Afterward, it will drop to more like $5,000 a month.

With the proceeds of their cabin — about $290,000, conservatively — invested in cash and GICs for a return of 1.5 per cent per year, their RRSPs and profits from the sale would last nine years and a few months based on an inflation rate of three per cent.

They’d still have about $50,000 in TFSAs and general savings, but that money could easily be spent on other needs prior to that point. And even if these funds are available, the money would only cover costs for about another year.

One option to extend the life of their money would be taking on a little more risk by adding dividend stocks to their portfolio to provide an additional return of 2.5 per cent to increase the total yield from their investments to four per cent a year.

This small step would make their savings last about four more years, bringing them close to their goal of hanging on to their U.S. property until age 80.

At that stage, they could use the proceeds from its sale to provide them with income for another five to six years.

Fraser points out she has used very conservative projections regarding investment returns as well as a higher-than-usual rate of inflation to create a “worst-case scenario.” Lower inflation would obviously increase the longevity of their funds, as would higher market returns. They could also make their money last longer by delaying retirement a couple of years, reducing their spending or continuing to work part time once they retire.

“If they’re uncomfortable with stock market risk, they also might consider as a compromise a prescribed annuity or segregated funds for their unregistered money so they could comfortably earn at least four per cent. “

In exchange for guarantees on income an annuity would provide, or protection of capital offered by segregated mutual funds, both options involve higher fees than a typical mutual fund strategy, and consequently, could actually have a negative effect on how long their money will last.

In addition, a prescribed annuity, which provides income from a mix of capital and profit, might only make sense for another year or so because the Canada Revenue Agency is expected to change taxation rules regarding annuities. Still, they may find the assurance provided by these types of investments is worth the fees and potential taxes. “A prescribed annuity would be beneficial mainly because the taxable portion of each payment remains the same for the life of the contract,” she says.

“They might find that useful because it’s crystal clear what they would get each year, and it would improve their cash flow a little bit.”

Another consideration is stopping payments on principal for their U.S. property, which would eliminate about $1,500 a month in expenses for the first five years of retirement.

But it would increase their costs later on as they’d still have to make interest payments, and it would also reduce the proceeds they’d receive from its eventual sale.

“They could also get a reverse mortgage on their home,” Fraser says, adding many financial institutions offer products that act as a savings account, line of credit and mortgage all rolled into one package.

“They could set it up against their home never expecting to use it, but if they do need some immediate cash flow, they have it.”

Ultimately, Fraser says Derrick and Shelby’s success in achieving their retirement vision will largely involve balancing their core goals — such as wintering in the U.S. for a few months every year — with their appetite for risk.

She adds it’s likely something will have to give.

Fortunately, they have time and choices to find a solution.

“It really comes down to having clarity on what’s most important to them.”

joelschles@gmail.com