With retirement looming, Fred and Ethel are feeling uneasy. They have a home, a cottage and substantial savings. Yet they are concerned they do not yet have the $2-million in net worth they have come to believe they will need to retire.
Ethel, who is 50, plans to quit her job next year and work part-time in addition to volunteering at the hospital. Fred, who is 51, plans to semi-retire from his consulting business in five years or so. They came to Canada in the late 1980s and so will not be entitled to full Canada Pension Plan benefits.
In retirement, they figure they can get by on $60,000 a year after tax, including $10,000 a year for travel. They would like to spend some of the winter months in a warmer climate but they have no definite plans.
"Are we able to achieve a comfortable retirement?" Fred writes in an e-mail. Is Ethel "making the right decision to retire in 2012?" And because their income will come mainly from their investments, "should we move all our funds to risk-free investments from mutual funds?"
We asked Frank Wiginton, a certified financial planner and author of the newly released book, How to Eat An Elephant: One Day a Month to Financial Success (www.howtoeatanelephant.ca), to look at Fred and Ethel's situation.
What the expert says
Since they came to Canada in 1989, Fred and Ethel have done a good job of setting themselves up financially for a successful retirement, Mr. Wiginton says. Fred is running a successful consulting business, which gives him the opportunity to split income with Ethel. If they both continue to work part-time after they retire, as they plan, they should easily achieve their $60,000-a-year retirement goal without depleting their assets, the planner says.
Because they have substantial savings, Ethel's decision to retire soon need not be based on financial considerations but rather on quality of life. If she does quit her job, Fred could hire her as office manager to take care of the day-to-day operations of his consulting business, the planner says. As well as the income-splitting opportunity such an arrangement offers, Ethel could continue paying into the Canada Pension Plan and her RRSP.
In five years, when Fred semi-retires from full-time work, their combined income will drop to $69,000 a year before tax ($25,000 from his RRSP/RRIF, $24,000 from his part-time work and $20,000 from Ethel's RRSP/RRIF), or $56,525 after tax.
Meanwhile, their lifestyle expenses will have risen to $61,800. They will need another $1,692 for insurance premiums. As part of a tax-savings plan, the planner recommends they transfer an additional $5,600 each per year to their tax-free savings accounts, for a total annual cash requirement of $74,692. To cover this amount, they will need to draw the shortfall of $18,167 from their non-registered savings.
At Fred's age 60, he plans to quit working entirely. He will begin collecting Canada Pension Plan benefits of $6,921, while Ethel will get $6,678 a year later when she turns 60. At age 65, Old Age Security benefits will kick in for both of them. Their savings will carry them through comfortably to Fred's age 95, at which time they'll still have a substantial net worth.
Mr. Wiginton assumes a rate of return on investments of 3.5 per cent, an inflation rate of 3 per cent, and an investment income breakdown for tax purposes of 25-per-cent dividends, 50-per-cent interest and 25-per-cent capital gains.
Because they can achieve their retirement goals with a 3.5-per-cent average annual return, Fred and Ethel need not take too much risk with their investments, the planner says. On that basis, their investments will generate all the income they need to Fred's age 90 and still leave about $600,000. But the planner cautions them against investing their non-registered assets in interest-bearing investments because of the higher taxation.
"They would be wise to structure their investment portfolio to include a significant portion of ultraconservative dividend-paying common shares and preferred shares to generate tax-preferred dividend income."
At some point, Ethel and Fred plan to sell their cottage, but they do not need to do so to be comfortable financially, Mr. Wiginton says. Fred also wonders whether they would have to downsize their house to help make ends meet. "They never have to sell the house to meet financial needs," the planner says.
As for Fred's $2-million retirement target, "this goal ultimately will be reached, but their quality of life and security of not outliving their money override this priority," the planner says. Forty-five years from now, when they are in their mid-90s, their house could be valued at $2-million.
Fred, 51, and Ethel, 50
Do they have enough money saved for Ethel to retire this year and Fred in five years?
Once Fred retires, he will continue to work part-time for a few years at his consulting business. In the meantime, he might consider hiring Ethel to manage his office. Begin drawing on registered savings when Fred retires to offset expenses. Transfer $5,000 a year each to TFSAs.
Financial security and the peace of mind that comes from knowing they have more than enough money to last their lifetimes without any need to take big investment risks or sell their home.
Monthly net income
House $450,000; cottage $250,000; his RRSP $340,000; her RRSP $200,000; her defined-contribution pension plan $101,000; non-registered investments $186,000; TFSAs $30,000. Total: $1,557,000
Property taxes on house and cottage $460; utilities $225; property insurance $95; car insurance $170; gasoline $265; car maintenance $95; groceries $800; life, critical illness and disability insurance $268; phone, cable, Internet $180; home maintenance $110; clothing $45; gifts $170; vacation and travel $850; personal $165; club membership $50; entertainment $85; RRSP contributions $1,000; other savings $1,000; professional association $85. Total: $6,118
Special to The Globe and Mail
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