Stress and health issues have Melanie contemplating some big changes.
She’s 54 and earns $74,000 a year working for a large health care facility. “After working in health care for more than 30 years, I want to retire at 55,” Melanie writes in an e-mail. Her defined benefit pension will be reduced if she leaves early.
She and her partner have one child, age 16, and a jointly owned house – mortgage free – in the Greater Toronto Area. They share household expenses but keep their savings and investments separate. They contribute to a registered education savings plan for their daughter.
“I don’t want to rely on my partner’s income in case we’re not together in the future,” Melanie writes. She wonders whether her own income would be enough to live on. She also wonders which account to draw on first to supplement her work pension. “If I retire early, is it more beneficial to take out RRSP funds first or use my non-registered account?” she asks.
Because her skills are in strong demand, Melanie knows she could easily find part-time work if she wanted to – after she’s had time to relax and do some travelling.
We asked Warren MacKenzie, a fee-only certified financial planner (CFP) in Toronto, to look at Melanie’s situation. Mr. MacKenzie also holds the chartered professional accountant (CPA) designation.
What the Expert Says
Melanie wants to be sure that if she retires at the age of 55, she can achieve her basic lifestyle spending goal of $40,000 a year after tax, Mr. MacKenzie says. In addition, she would like to spend $7,000 a year on travel.
“Melanie has wisely concluded that her first step is to decide whether the contemplated changes are feasible financially,” Mr. MacKenzie says.
Because of her health concerns, Melanie thinks she may not live beyond the age of 80. That’s why she is willing to take a reduced work pension and start reduced Canada Pension Plan benefits at the age of 60. “She would like to have a few additional years to travel and enjoy life while her health permits,” the planner says.
“To be on the safe side, though, she should have sufficient funds to maintain her lifestyle until at least age 90,” Mr. MacKenzie says.
Melanie is weighing a number of different options. For his analysis, the planner looked at the most financially challenging one, in which Melanie retires at the age of 55 and she and her partner go their separate ways. The planner assumes the townhouse is sold and Melanie invests her share of the net proceeds at a 5-per-cent rate of return. Once she’s on her own, Melanie estimates her cost of living – including rent and $7,000 a year for travel for 15 years – will bring her total spending to $65,000 a year.
If she chooses to retire at the age of 55, her monthly pension benefit, including the bridge of $995, will be $3,015, or about $36,000 a year. Her net pension income will be about $33,000. The shortfall would come from her RRSP, which would last about eight years. After that she would draw from her non-registered account, which would be bolstered by the income from the house sale.
With the house sold, Melanie’s investment portfolio will consist of her existing investments of about $480,000 plus about $530,000 net from the sale of the property.
If Melanie’s main goal is to retire at the age of 55, she can afford to do so, Mr. MacKenzie says. Her pensions will be adjusted for inflation. “Ignoring inflation, if she retires at age 55, by age 60 when she starts to collect CPP, her income will be $46,000 year, which will provide about $42,000 after tax,” the planner says. At 65 she would begin collecting Old Age Security benefits, increasing her income even further.
Melanie and her partner have contributed more than $65,000 to their daughter’s RESP. “She should also open a First Home Savings Account and contribute the maximum of $8,000 per year for her daughter,” Mr. MacKenzie says. The lifetime limit is $40,000.
There is one potential contradiction in Melanie’s goals. In the planner’s questionnaire, Melanie said she would like to leave her only child a substantial inheritance. That would change things considerably: Melanie would have to work to at least the age of 60.
“In the five years from age 55 to 60, her salary income would be about $75,000 per year, and after deductions she would clear about $60,000,” the planner says. This would mean a net cash flow substantially higher than if she retired at the age of 55. In addition, by working and contributing to CPP and her defined benefit pension plan for an extra five years or so, she would increase her future pension income. She would get a work pension of $3,855 a month if she retired at the age of 60. “This would increase her net worth and ultimately the amount she leaves to her daughter.”
As an alternative to leaving her child a large lump-sum inheritance, Melanie could consider giving inheritance advances when she has some extra money. “This way her daughter can learn about investing and make her mistakes with relatively small amounts,” the planner says. By giving inheritance advances, Melanie would be able to see whether the money is being used wisely, he adds.
Melanie manages her portfolio herself and it is almost entirely invested in exchange-traded funds. Her asset mix is 80 per cent stocks and alternative investments and 20 per cent fixed income. Because she can achieve her retirement goal with a five-per-cent rate of return – reasonable for a lower-risk portfolio – Melanie is taking more risk than necessary, Mr. MacKenzie says.
“It would make sense to reduce her exposure to stock-market risk and move to a goals-based asset mix in which she has only as much exposure to equities as is necessary to achieve her goals,” he says. As well, she should continue to use funds from her non-registered account to maximize contributions to her TSFA each year.
The person: Melanie, 54, and her daughter, 16.
The problem: Can she afford to retire early without having to depend on her partner’s income?
The plan: Melanie can afford to retire at the age of 55. She should draw from her RRSP first to supplement her work pension. Consider shifting her portfolio to a more balanced asset allocation.
The payoff: The information she needs to navigate the future.
Monthly net income: $5,195.
Assets: Share of joint cash account $5,200; her savings account $21,500; guaranteed investment certificate $5,105; TFSAs $94,290; non-registered investment account $167,645; RRSP $198,540; half ownership of residence $560,000. Total: $1,052,280.
Estimated present value of her DB pension $460,000 (discount rate of five per cent). This is what a person with no pension would have to save to generate an income stream equal to Melanie’s pension.
Monthly outlays: Condo fee $505; property tax $215; home insurance $65; electricity $65; heating $105; maintenance, garden $235; car insurance $195; fuel $200; other transportation $90; groceries $500; child care $170; clothing $20; gifts $80; charity $35; vacation, travel $585; personal care $10; club membership $15; dining, drinks, entertainment $400; sports, hobbies $10; subscriptions $25; other personal $15; health care $230; life insurance $25; communications $205; RRSP $170; TFSA $540; pension plan contribution $485. Total: $5,195.
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