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financial facelift

Christopher Katsarov/The Globe and Mail

With six years to go to early retirement, Ben and Barbara know they have some planning to do. They are both 54.

It’s not that they will be short of money. Ben, a sales manager, earns $125,000 a year plus a substantial bonus that varies from year to year. Barbara earns $90,000 a year working for the municipal government. As well, their investment property in a small Ontario tourist town generates about $8,000 a year net of expenses but before tax.

Their actual retirement plans are still very much up in the air. When they retire from work, Barbara and Ben are not sure where they will live, what they will do or how much they will be able to spend. They think they might like to live abroad for half the year while they are still relatively young and healthy. They also want to give their three children – one of whom is still in school – $100,000 each to help them get established.

Barbara and Ben recently cut their ties with their financial adviser and are looking for a fee-based financial planning service, Ben writes in an e-mail. They’re hoping the planner will “do a financial assessment and start putting plans in place for retirement,” he adds. “Based on our current lifestyle, what should our after-tax retirement spending target be?” Ben asks.

We asked Stephanie Douglas, partner and portfolio manager at Harris Douglas Asset Management in Toronto, to look at Ben and Barbara’s situation.

What the expert says

“The next six years will be very important for Ben and Barbara if they plan to retire in 2025,” Ms. Douglas says. “They have a lot of moving pieces and uncertainty, so regular financial planning advice would help them gain more clarity.”

Because they are changing financial advisers, this would be a good time to review their investments. Barbara and Ben were not happy with their portfolio returns and high fees, Ms. Douglas says. (Their portfolio does not include Ben’s registered pension plan, which is managed by a pension fund manager.)

Their portfolio is 100-per-cent stocks and stock mutual funds, some of which have management fees as high as 2.3 per cent a year. “They should also take into consideration the additional fees they are paying above the management fee,” Ms. Douglas says – for example, transaction costs and trailer fees. Ben’s registered pension plan at work has only a small (5 per cent) allocation to fixed income.

While Ben is an aggressive investor, Barbara is much more conservative. One could argue that Barbara’s defined-benefit pension plan helps reduce their overall risk because it is guaranteed income. Barbara will be entitled to a pension of $51,000 a year, including a bridge benefit, starting at 60. This will drop to $39,500 at 65 when she is entitled to begin collecting Canada Pension Plan and Old Age Security benefits.

“Even so, having such high equity exposure in their investable assets could put them at risk once they retire and are drawing from these assets,” Ms. Douglas says. “I would suggest when they retire that they keep about five years of required withdrawals in fixed income,” the planner says.

Based on the first of the two options the planner analyzed, Ben and Barbara would be drawing about $40,000 a year from their investable assets for the first five years of retirement. “Drawing this money from fixed income assets ensures that if there is a pullback in the market, they would not be forced to sell securities in a down market to fund their lifestyle.”

Ben and Barbara have an investment loan of $316,000 that they are paying down at the rate of $1,025 a month. At that rate they’d still owe $188,000 at 95, the planner says. While the loan interest is tax deductible, “taking out loans for investment purposes is a risky proposition." She suggests they pay it off as soon as possible.

Sometime in the next decade, Ben and Barbara plan to sell one of their houses, but they have yet to decide which one. They may even decide to sell both and downsize to a condo in the city.

In the planner’s first option, where the couple retire as planned, stay in their Toronto house and sell the rental property in 10 years, they should have enough investable assets to last to the age of 95 if they spend no more than $108,000 a year after tax (in today’s dollars indexed to inflation), Ms. Douglas says. That assumes rent increases of 1.8 per cent a year, and a rate of return on investable assets of 4.5 per cent. At 95, they would still have their Toronto house, which by then would be worth about $3.8-million.

The analysis assumes Ben and Barbara allocate an additional $922 a month to pay off both mortgages before they retire in six years, focusing on paying down the mortgage on their principal residence first. The interest on the rental property is tax deductible. It also factors in the purchase of a new vehicle in 2023 at a cost of $35,000 and an inheritance of $100,000 that they expect to receive in the next five years.

The planner explores a second option in which Barbara and Ben sell the Toronto house and move to the rental, renovating it at a cost of $200,000. If they did this, and invested the remaining sale proceeds, they could raise their retirement spending target to $140,000 a year after tax, adjusted for inflation. At 95, they would still have their small-town house worth about $846,000 with inflation.

Naturally, giving $100,000 to each of their three children will limit their spending power. In the first option, where they stay in Toronto and sell the rental property, they would have to lower their spending target from $108,000 to $98,000 a year to cover the $300,000 gift, the planner says. In the second option, where they move to the rental property and sell the Toronto house, they’d have to lower their spending from $140,000 to $130,000, she says.

Client situation

The people: Ben and Barbara, both 54, and their three children

The problem: Can they retire at 60, give their children each $100,000 and maintain their current lifestyle?

The plan: Work toward getting their financial lives in order by lowering their investment cost and risk. Pay off investment loan. Get a clearer picture of where they would like to live and what they would like their ideal retirement to look like.

The payoff: Financial security.

Monthly net income: $15,745 (excluding his bonus)

Assets: Bank account $2,000; stocks $5,000; mutual funds $353,800; TFSAs $116,500; RRSPs $137,000; his RPP $415,000; RESP $52,000; principal residence $1.7-million; rental property $375,000; estimated present value of her DB pension $987,000. Total: $4.1-million

Monthly distributions: Mortgage $3,085; property tax $650; property insurance $190; water, sewer, garbage $155; electricity $280; heating $275; maintenance, garden $110; transportation, gas, car insurance, maintenance, parking $905; groceries $1,000; clothing $800; child care $400; dry cleaning $30; investment loan $1,025; gifting $100; charitable donations $200; vacation $1,000; entertainment, dining out, drinks $875; personal care $275; club memberships $170; pets $625; sports, hobbies $150; subscriptions $55; drugstore $20; life insurance $350; phones, TV, internet $390; RESP $250; TFSAs $750; pension-plan contributions $230. Total: $14,345

Liabilities: Mortgage residence $248,000; mortgage rental $46,000; investment loan $316,000. Total: $610,000

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