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financial facelift

Can Wayne afford to quit his high-paying consulting work in the New Year, meet his financial obligations and still have enough to live on?Jennifer Roberts/The Globe and Mail

Wayne's corporation grosses more than $200,000 a year on average (he pays himself a salary of $133,000), yet he'd like nothing more than to let his contracts expire at year end and quit. He'd look for "something less stressful" in the new year – at Home Depot, perhaps, or some other retailer. He'd take a big cut in pay.

Wayne is 60, single again and living in Toronto with his daughter, 22, who is in her final year of university. His condo is mortgage-free and he has a house in a nearby town – currently rented – where he intends to retire eventually.

His plan is to work at the less stressful job until he is 65 and then retire completely, finding some new hobbies and just hanging out.

"I am pretty much a homebody," Wayne writes in an e-mail – "Squash, walks with my dogs, bicycle riding, reading, movies and TV. I don't have any expensive hobbies."

He figures his personal spending will be $47,800 after tax when he finally retires. He has some big obligations: support payments to his ex-wife of $58,057 a year, falling to $20,640 in 2021. As well, his corporation will pay a premium of $30,100 a year for the next 10 years for a whole life insurance policy.

While Wayne has substantial investments, he wonders whether he has saved enough to cover his living expenses for the next 30 years.

We asked Warren MacKenzie, a principal of investment counsellor HighView Financial Inc. in Toronto, to look at Wayne's situation.

What the expert says

Wayne has investment assets of $1.5-million owned almost entirely by his holding and operating companies, Mr. MacKenzie says. In planning his retirement, Wayne seems to have underestimated the tax he will have to pay to get this money out of the corporations and into his hands to spend.

To some degree, he is relying on a strategy whereby in 2025 he will use the cash value of the corporate-owned life insurance as collateral for a bank loan and thereby avoid the tax on removing between $300,000 and $400,000 from the corporation, Mr. MacKenzie says. This strategy would make good sense if the corporation had a surplus of interest-bearing investments. However, in Wayne's case, where there is not going to be a surplus, and where the investments are earning capital gains and dividends rather than interest, the tax-exempt insurance strategy is less effective, he says.

"Given that Wayne is divorced, and that most of us eventually need some form of assistance when we grow old, an insurance policy that provided for long-term care might have been a better choice than the corporate-owned insurance," the planner says.

As well, Wayne faces a key risk that could derail his retirement plans: He is exposed to a higher than normal "sequence of returns" risk, because in the first five years of retirement he needs to withdraw about $550,000 from his portfolio to cover support and insurance payments – even if it has fallen in value. If he retires from his consulting business at age 60, during the first five years of retirement he would need to withdraw $47,800 a year for living expenses, $58,057 in spousal support, and $14,000 for income tax. As well, his corporation needs to pay a $30,100 insurance premium. Offsetting this would be an estimated – and perhaps optimistic – $40,000 a year in income Wayne would earn from his less-demanding job.

Wayne's investment portfolio is 95-per-cent equities and alternative strategies, Mr. MacKenzie notes. If the stock market were to drop 30 per cent to 35 per cent and stay low for five years soon after Wayne retired, "his $1.5-million in investment assets would fall in value to about $950,000." If cash of $550,000 was needed during the first five years, "his portfolio would be reduced to $400,000, which would not be enough to support his lifestyle."

Wayne's main concern is running out of money, the planner notes. To ensure he doesn't, Wayne has to do two things: He has to work for a few more years at his consulting business, and he has to reduce his investment risk by diversifying his holdings, at least until his support payments drop and his insurance policy becomes self-funding, Mr. MacKenzie says. If Wayne works three more years at his consulting business, he would then need to earn only an average of 4 per cent a year in order to achieve his financial goals and maintain his lifestyle until age 100.

He should be able to achieve this rate of return with a well-diversified, medium-risk portfolio, "which would have lower 'sequence of returns' risk because it would not be expected to drop by more than about 15 per cent" in a severe bear market, the planner says.

While Wayne has done well, he doesn't have enough to cover big investment losses or to withstand long-term market underperformance, Mr. MacKenzie says. Wayne pays a fee of 2.5 per cent to his investment counsellor, so "it is not a surprise to see that he has underperformed the S&P/TSX composite index by 1.4 percentage points, or about $20,000, a year."



The person: Wayne, 60

The problem: Can he afford to quit his high-paying consulting work in the New Year, meet his financial obligations and still have enough to live on?

The plan: Work a few more years and lower the risk in his investment portfolio

The payoff: A secure, albeit modest, retirement lifestyle

Monthly net income: (Salary and rent, variable, after support payment): $12,125

Assets: Corporate investments $663,800; insurance policy $30,000; shareholder loan $40,716; personal cash $4,404; mutual funds $6,143; TFSA $48,333; Individual Pension Plan (IPP) $724,123; RESP $9,258; residence $410,000; second home $240,000. Total: $2.2-million.

Monthly disbursements: (Corporate and personal, and excluding support payments): Mortgage $715; condo fees $226; property tax $466; insurance $113; electricity $143; heat $66; maintenance $127; garden $36; transportation $413; grocery store $567; clothing $58; car loan $361; shareholder loan $100; gifts, charitable $161; drinks, dining, entertainment $325; grooming $19; sports, hobbies $22; subscriptions $14; other personal $500; doctors, dentists $75; drugstore $120; vitamins, supplements $12; telecom, TV, Internet $200; IPP contributions $3,333; TFSA $833; accounting $342; investment fees $83. Total: $9,430. Unattached surplus $2,695 (goes to savings and investments).

Liabilities: Mortgage on second home $183,000 at 2.39 per cent; car loan $19,113; shareholder loan $40,716. Total: $242,829.

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