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(Dave Chan For The Globe and Mail)
(Dave Chan For The Globe and Mail)

FINANCIAL FACELIFT

High mutual fund fees: The retirement sand trap Add to ...

Although he has a good executive job earning $115,000 a year, Ted, who is 54, is eager to retire in six years when he is 60 years old.

His wife, Tamara, a teacher, would like to quit her $95,000-a-year job at the earliest possible date under her union contract. That would be a year from now when she is 53. As well as their salaries, Ted earns $15,000 per year for sitting on boards of directors.

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Tamara has a fully indexed defined benefit pension plan but no RRSP. Ted has a registered retirement savings plan but no pension plan. Tamara’s pension plan would pay her $56,872 a year at age 53 and $61,136 if she works for two more years. Between Ted’s age 61 and 65, their income from pensions will be less than required to maintain their desired standard of living. Because of this, they wonder if they can afford to retire early.

Ted has $277,000 in an RRSP invested entirely in mutual funds.

When they retire from their jobs, they are mulling the prospect of selling their Ottawa house and buying or renting a condo. Avid golfers, they want to pay off the mortgage on their cottage and spend some time travelling. Their two children, who are in their mid-20s, are financially independent.

“Will we be able to retire when I turn 60 and my wife is 58?” Ted writes in an e-mail. “Should Tamara work past her eligible retirement age of 53?”

We asked Warren MacKenzie, founder of Weigh House Investor Services in Toronto, to look at Ted and Tamara’s situation.

What the expert says

Using conservative assumptions, Tamara and Ted’s financial plan shows that they can afford to retire when Ted is 60 and Tamara is 53, Mr. MacKenzie says.

“However, if maintaining the target level of spending of $70,000 (in current dollars) is critically important, it would be wise to have a larger cushion that they could fall back on if things don’t go exactly as planned,” he adds.

“They need to think carefully about how they want to live their lives in retirement.” Some people spend less, others more, especially if they plan to travel.

Ted’s RRSP portfolio of mutual funds carries an average management expense ratio (MER) of 2.4 per cent, Mr. MacKenzie notes. “These mutual funds have consistently underperformed. He could save more than 2 per cent a year by moving from high-fee, underperforming mutual funds to low-fee exchange-traded funds, the planner says. Doing so would cut the expenses in his RRSP by $5,500 a year.

Moving away from these high-fee mutual funds into low-cost ETFs would be more beneficial long-term than Tamara working two years longer in a job she finds stressful, Mr. MacKenzie says.

Actuarial tables show a 40-per-cent probability that at least one of them “will be alive and needing an income 40 years from now,” he says. If the current portfolio’s underperformance continues for 30 years, the loss would be “over $400,000,” Mr. MacKenzie says.

The planner’s calculations assume a 5.5-per-cent average annual rate of return after subtracting fees. As it stands, Ted would be left with only 3.3 per cent. Simply lowering the fees Ted is paying on his mutual funds would compare favourably with the benefit of Tamara working longer (two years of income plus $4,200 per year for 30 years of additional pension). If they sell their home and invest that money too, the long-term savings from using low-cost investment products would approach $1-million.

Tamara and Ted wonder whether they should focus on savings or paying down the mortgage on their cottage. The planner suggests they pay down the mortgage first. Being mortgage-free is equivalent to earning a guaranteed return of 3.5 per cent (the mortgage rate), “and they can’t get that in an RRSP.”

As for renting or buying a condo, they can afford to do whichever they prefer, the planner says.

Mr. MacKenzie recommends that Ted turn his RRSP into a registered retirement income fund in his first year of retirement (rather than waiting until he is 72) and begin withdrawing about $20,000 a year. Because income is lower in the years before his government benefits kick in, the RRIF withdrawals will attract tax at a lower rate than if the RRIF continued to grow in value and he was forced to make higher minimum withdrawals on top of his Canada Pension Plan and Old Age Security benefits.

This is a case of people not realizing how well off they are, Mr. MacKenzie says. To enjoy peace of mind, they need a third party to confirm that they are financially secure.

Client Situation

The people

Tamara, 52, and Ted, 54

The problem

Figuring out whether they can afford to retire early, pay off their cottage mortgage and travel a bit without sacrificing long-term financial security.

The plan

Tamara quits work next year and Ted works to age 60 then begins drawing on his registered savings to make up the income shortfall. Ted shifts his savings from high-cost mutual funds to low-cost investments such as exchange-traded funds and saves a bundle in fees.

The payoff

Confidence they should be able to live comfortably for the rest of their lives.

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Monthly net income

$12,210

Assets

His RRSP $277,000; her DB pension plan (estimated present value) $1.4-million; residence $500,000; cottage $300,000. Total $2,477,000

Monthly expenditures

Mortgage $1,770; property taxes $560; property insurance $175; utilities $605; security $30; car lease $1,030; fuel $400; auto insurance $145; maintenance $100; groceries $1,000; clothing $200; gifts $200; charitable $200; golf $1,000; grooming $100; dining out, entertainment $300; pet expenses $100; other personal discretionary $330; drugstore, life insurance $150; TV $165; telecom, Internet $260; group benefits $305; professional dues $105. Total: $9,230

Liabilities

Mortgage on cottage $295,529

 

Special to The Globe and Mail

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