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Retirement Can these retirees protect their portfolio while maintaining their comfortable lifestyle?

Can Aaron, 68, and Linda, 63, keep spending $120,000 a year and still have enough money left to pay for a comfortable retirement home if they eventually need one?

The Globe and Mail

Linda and Aaron are approaching their seventh year of early retirement and feel “it’s now time to re-evaluate our retirement plans and consider making some adjustments,” Aaron writes in an e-mail. They’re concerned about drawing too heavily on their savings.

He is 68, she is 63. They have no children.

They both have defined benefit pension plans that are not indexed to inflation, substantial savings and a mortgage-free house in the Niagara area. They are spending roughly $10,000 a month after tax.

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Their income from work pensions and government benefits totals $100,385. In addition, they draw $53,310 from their non-registered portfolio. Over the next few years, they plan to spend $40,000 on fixing up their house and buying a new car.

“We have been drawing down on the principal amount [from our non-registered account] in addition to the dividend income,” Aaron writes. They want to preserve enough capital so they can afford “a comfortable retirement facility for one or both of us if needed.” They also wonder whether their investment portfolio is structured properly.

We asked Trevor Van Nest, a certified financial planner and owner of Niagara Region Money Coaches in St. Catharines, Ont., to look at Linda and Aaron’s situation.

What the expert says

Aaron and Linda are in great shape financially, Mr. Van Nest says. For the next few years, though, they will need to draw about $55,000 a year from their non-registered portfolios to pay for their “very comfortable” lifestyle. They want to continue travelling, golfing and doing all the other things they enjoy as long as their health allows it.

At the age of 72, after they have converted their registered retirement savings plans (RRSPs) to registered retirement income funds (RRIFs) and begun making minimum withdrawals, their shortfall will drop to about $45,000 a year, the planner says. Once their non-registered portfolios are depleted, they can draw from their tax-free savings accounts (TFSAs). They only run out of financial assets at the age of 100, at which point they would still own a fully paid-off home worth $2.3-million in future dollars.

In drawing up his plan, Mr. Van Nest assumed a rate of return on investments of 5 per cent and an inflation rate of 2 per cent.

There are two significant challenges that Aaron and Linda should reflect on, Mr. Van Nest says. First, their pensions are not indexed for inflation, meaning the buying power of their pensions could be cut in half over time.

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“This will put increasing pressure on draw-downs from the $1-million in current investments,” the planner says. They’re concerned about drawing on their principal (in addition to interest, dividends and capital gains), but they will need to if they are to maintain their current lifestyle, Mr. Van Nest says.

Second, their investments are held 100 per cent in equities (mostly individual stocks and a few exchange-traded funds). “As self-directed investors with risk profiles that put them in the conservative (her) and moderate (him) categories, this is not appropriate,” the planner says.

Their focus on dividend-paying stocks is hiding the fact that a portfolio of stocks could lose 20 per cent to 30 per cent of its value during a downturn, he points out. “Given we’ve all been enjoying a 10-year bull market since 2009, a significant drop is likely at some point,” he adds.

If they were to lose 20 per cent of the value of their stocks in the next year – the ‘sequence of returns’ challenge early retirees should be concerned about – it would result in their needing to sell their home when Aaron’s 92, the planner says. Their estate value would be $340,000 lower when he is 100, albeit still an impressive $1.9-million, if this were to occur and the market did not bounce back.

This doesn’t imply they should try to time the market, but rather make sure their asset allocation is appropriate for them, Mr. Van Nest says. He recommends a mix of low-cost, globally diversified stock ETFs for 40 per cent of their holdings, and a bond ETF for the remaining 60 per cent. “An asset allocation ETF could also work well, where they would buy a single ETF (with the same 40-per-cent equities/60-per-cent bonds mix) with a management expense ratio in the 0.2-per-cent range.”

Linda and Aaron should maximize contributions to their tax-free savings accounts while their non-registered accounts still have balances and split their RRIF and pension income to share the tax burden, the planner says. Average tax rates for each spouse would be in the 13-per-cent to 16-per-cent range throughout retirement.

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Client situation

The people: Aaron, 68, and Linda, 63.

The problem: Can they keep spending $120,000 a year and still have enough money left to pay for a comfortable retirement home if they eventually need one?

The plan: Review their all-stock portfolio to bring it more in line with their risk tolerance and the fact they are no longer working. Because pensions are not indexed, keep 40 per cent in globally diversified stocks to guard against inflation.

The payoff: Financial security without ever having to sell their home to pay for their living costs unless and until they decide to do so.

Monthly net income: $9,850.

Assets: Her non-registered $259,000; her TFSA $119,000; her RRSP $214,000; commuted value of her pension plan $487,000; his non-registered $518,000; his TFSA $200,000; his RRSP $268,000; commuted value of his pension plan $750,000; residence $1,200,000. Total: $4-million.

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Monthly outlays: Property tax $550; home insurance $100; utilities $380; maintenance $250; transportation $550; groceries $1,230; clothing $265; line of credit $100; charity $620; vacation, travel $3,350; other discretionary (art) $1,100; dining, drinks, entertainment $1,025; club membership $20; sports, recreation $650; doctors, dentists $130; phones, TV, internet $320. Total: $10,640. Shortfall comes from non-registered portfolio.

Liabilities: Line of credit $15,100.

Want a free financial facelift? E-mail finfacelift@gmail.com.

Some details may be changed to protect the privacy of the persons profiled.

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