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(PAUL DARROW FOR THE GLOBE AND MAIL)
(PAUL DARROW FOR THE GLOBE AND MAIL)

FINANCIAL FACELIFT

Couple eye early retirement but risk running out of capital Add to ...

Gerry is more than ready to reap the rewards of the five years he and Sheila spent teaching in the United Arab Emirates. They returned to Canada a year ago last December, bank accounts bulging with cash.

Since then, Gerry, who is 56, has been living off his severance pay and employment insurance. Sheila, who is 46, got a job with a provincial government agency earning $75,000 a year. She hopes to hang up her hat in four years.

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With little in the way of company pensions, they’ll be leaning heavily on the $1-million or so they have invested mainly in the Canadian stock market. They have a house in Nova Scotia valued at about $450,000 and both their children are grown.

“We feel that we have amassed a decent retirement nest egg, but the question is how and when do we turn this into a better income-generator to fund our retirement?” Gerry writes in an e-mail. Will it be enough?

We asked Matthew Ardrey and Warren Baldwin of T.E. Wealth in Toronto to take a look at Sheila and Gerry’s situation. Mr. Ardrey is manager of financial planning, Mr. Baldwin is regional vice-president.

What the experts say

At first glance, Gerry and Sheila would seem to have no trouble funding their retirement, the planners say. By retiring so early, though, they run the risk of running out of capital.

The planners assume Sheila retires in four years and that the couple earn an average of 5 per cent a year on current and future savings, and inflation averages 2 per cent a year. Because Gerry effectively retired in December, the planners begin their calculations this month. They assume lifestyle expenses of $51,000 a year plus a travel budget of $10,000 a year starting at Gerry’s age 60 through to his age 80.

Sheila should contribute $5,500 to each of their tax-free savings accounts over the next four years. If she has any RRSP room left after contributions to her company pension are taken into account, she should take advantage of it.

Their retirement income will come from Canada Pension Plan benefits (reduced because they take them at age 60), Old Age Security (age 67 for Sheila, 65 for Gerry), and Sheila’s work pension of $7,500 a year, which according to the terms of the plan is indexed at 1.25 per cent. The rest of their income will have to come from their savings. The planners assume the couple live to age 90.

Based on these assumptions, Sheila and Gerry will run out of capital when she is 87. Sheila will still have their house to fall back on and it will be worth substantially more thanks to inflation.

“If Sheila sold her home the year after Gerry’s death in 2047 (at age 90), she could have $882,000 before expenses,” the planners calculate. She could take $200,000 to cover her living expenses and still have more than $600,000 to buy a condo if she wanted to.

The real risk, the planners say, is “sustaining their wealth over the long term.” By retiring so early, they have to provide for themselves for 40 years or more.

“If an ill-timed market event similar to 2008 were to occur at or near the beginning of their retirement, it could have a devastating effect on a portfolio that is heavily weighted in equities,” the planners note. The flip side is that they need equity exposure to sustain their portfolio’s growth.

Over the next four or five years, Gerry and Sheila should shift gradually to a more diversified portfolio, lowering the growth component of their combined portfolios to 50 per cent of their holdings, with 10 per cent in Canada, 20 per cent in the United States and 20 per cent internationally. This could be accomplished through low-cost exchange-traded funds that track major stock indexes.

On the income-producing side, they could complement fixed-income holdings such as bonds and guaranteed investment certificates with some dividend-paying blue-chip stocks and alternative investments such as real estate investment trusts (REITs) and mortgage investment corporations (MICs), which tend to have higher returns. They could put 10 per cent in Canadian dividend payers, 10 per cent combined in REITs and MICs, and 30 per cent in traditional fixed income.

If the dividend yield was 4 per cent, the REITs and MICs 7 per cent, and bonds and GICs 2 per cent, then the growth side of their portfolio (the other 50 per cent) would need to generate 6.6 per cent a year (dividend income and capital gains) to achieve an overall return of 5 per cent a year.

Client Situation

The People

Gerry, 56, and Sheila, 46

The Problem

Is it financially possible for Gerry to retire now and Sheila in four years given that they have 40 or so years to plan for? Can they generate enough income from their investment portfolio?

The Plan

Sheila works for another four years, adding to both of their TFSAs and contributing to her own RRSP to the extent possible. They gradually shift their portfolio to a more balanced one, designed to generate an average annual return of 5 per cent a year.

The Payoff

All of their goals are achieved without sacrificing financial security in their old age.

Monthly income (salary and investments)

$7,000

Assets

Short term deposits $97,000; non-registered investments $285,600; TFSAs $43,600; RRSPs $579,050; residence $450,000. Total: $1,455,250

Monthly disbursements

Property tax $350; heating $250; other housing $395; transportation $465; groceries $700; clothing, dry cleaning $160; gifts $125; charitable, other $100; vacation, travel $650; personal discretionary $550; dentists, drugstore, life and disability insurance $300; telecom, TV $205; RRSPs $1,000; TFSAs $835; other saving $500; group benefits $210. Total: $6,795

Liabilities

None

 

Special to The Globe and Mail

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