Single again and with her 50th birthday nearing, Rhonda wonders whether she should take the commuted value of her pension to spend more time with her 12-year-old child, who has special needs. Or should she continue working until she is 55, at which point she will be entitled to a pension of $55,000 a year?
Rhonda works in the education field, earning $120,000 a year. In addition to her own condo in Southern Ontario, she owns two investment condos. One is used by family, the other is rented out. She has substantial non-registered savings, mainly in mutual funds.
"I have been saving for years to ensure, I hope, that we will both be secure once I retire," Rhonda writes in an e-mail. "I have been thinking about commuting my pension and retiring early because I am finding it hard to balance work and support my child," she writes. "I have tried to make good financial decisions with the help of an adviser over the years and would love to have a fresh pair of eyes take a look at where things stand for me financially before I turn 50."
Rhonda gets $300 a month in child support, which will continue until her child is age 21.
We asked Warren MacKenzie, a principal at HighView Financial Group, an investment counselling firm, to look at Rhonda's situation.
What the expert says
Because Rhonda would like to spend more time at home, she is considering retiring from her job at age 50, Mr. MacKenzie says. "Although she wants to spend more time with her child, she will take early retirement only if she is confident that she will still be able to leave a substantial inheritance. The child will be able to work and live independently, but career options and salary potential will be limited.
Rhonda's financial plan shows that with reasonable assumptions – if she retires at age 50, takes the commuted value of her pension, earns an average rate of return on her investments of 5 per cent a year, net of fees, and lives to the age of 90 – she will die leaving her child an estate of about $2.7-million (in dollars with today's purchasing power).
If she works for an additional five years, she will qualify for an indexed pension of $55,000 a year. In that case, her estate is projected to be about $3.4-million. Either way, she and her child will be set financially. If Rhonda chooses to take the pension, when she dies her child will be entitled to half Rhonda's pension for life, provided the child is still disabled.
"Rhonda will have to ask herself how important it is for her to be at home for an additional five years," Mr. MacKenzie says. The choice is quite simple – she can spend more time with her child or she can leave her a larger estate.
If Rhonda retires at the age of 50 and takes a lump sum, part of the money will go to a locked-in retirement account (LIRA). During the years before she starts collecting Canada Pension Plan and Old Age Security benefits, she should create taxable income each year by withdrawing funds from her registered savings (RRSP and LIRA) so that the total of her rental income, investment income and income from withdrawals from the registered accounts generates about $42,000 of taxable income to take advantage of the lower tax rate on the first $42,000 of income.
With eligibility for the federal disability tax credit, Rhonda's child can also be the beneficiary of a Registered Disability Savings Program (RDSP). If she takes advantage of this program, Rhonda is eligible to make a lump sum contribution of $200,000 on her child's behalf. RDSP contributions are not deductible for tax purposes, but the investment income accrues tax-free.
"A better approach might be to create a strategy that makes annual contributions to the RDSP rather than a lump sum," the planner says. This way, her child would be entitled to receive the Canada Disability Savings Grant, where the government contributes a maximum of $3,500 a year to the RDSP.
As part of her estate planning process, Rhonda should also consider setting up a Henson trust, which, among other things, will ensure that her child is entitled to support payments from the Ontario Disability Support Program even after receiving the inheritance, Mr. MacKenzie says. (A Henson trust is a discretionary trust for a person receiving social assistance or disability payments designed to top-up that person's income without making them ineligible for those benefits.)
"There is one area where Rhonda can and should make some changes to generate a higher income," Mr. MacKenzie says. "With almost $1-million in investments, she can do better than high-fee mutual funds."
Her investment portfolio is complicated and there is no evidence that she is following a disciplined investment process, the planner says. "With 19 mutual funds, she is overdiversified, and her holdings are too heavily concentrated in Canadian equities," he adds. "Because she is paying an average MER (management expense ratio) of 2.3 per cent, she should expect to underperform her funding target of 5 per cent a year [after fees] by at least two percentage points per annum." She is not getting a proper performance report, so she does not know how her portfolio is performing relative to the appropriate benchmark.
At a time when her net worth was very low Rhonda wisely purchased term life insurance on her own life to ensure that that would be an estate for her child. She also pays for a whole life policy on her child's life. The value of this policy is increasing on a tax-free basis and will eventually be a nest egg that her child may borrow against at some time in the future.
The people: Rhonda, age 50, and her child, 12
The problem: Deciding whether to commute her pension now, taking a lump sum, or work another five years and take the monthly amount.
The plan: Either way, they are well fixed financially, but there are non-financial considerations as well. Consider a Henson trust to provide for her child after she is gone.
The payoff: A clear road map to a secure future.
Monthly net income: $6,230
Assets: Bank accounts $70,000; investment account (mutual funds) $762,800; investment trust account $66,000; TFSA $58,800; RRSP $95,800; estimated present value of DB pension plan $1.1-million; RESP $48,000; residence $350,000; two investment condos $600,000. Total: $3,151,400
Monthly disbursements: Condo fees, residence $690; property tax $350; home insurance $75; electricity $160; maintenance $100; transportation $370; groceries $700; child care $800; clothing $50; charity $80; vacation, travel $150; dining, entertainment $400; grooming $30; pets $30; sports, hobbies $50; other $25; dentists, drugstore $60; life insurance $530; Internet $100; TFSA $460; pension plan contributions $1,240. Total: $6,450
Liabilities: Mortgages on rental condos $224,000 at 1.95 per cent
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