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financial facelift

’I have been following a budget for some time,′ says Louise, 59.Globe and Mail

Louise is 59, divorced with no children. She’s collecting long-term disability insurance benefits and could well continue doing so until she retires at age 65. She also gets a Canada Pension Plan disability benefit, bringing her total income before tax to $48,445 a year.

“I have been following a budget for some time,” Louise writes in an e-mail. “My TFSA [tax-free savings account] is full, and I have some money in my RRSP [registered retirement savings plan] which is minimal due to my company’s defined-benefit pension plan.”

Louise has a work pension plan that will pay her about $45,120 a year, at age 65.

“I’m currently able to save a minimum of $1,250 a month to invest in a non-registered account,” she adds. Over the past few years, though, the amount she actually spent was considerably more than budgeted as one thing or another made demands on her funds, she admits. One year it was dental work, another a new bicycle.

She is looking for “tax-efficient investments” for her non-registered savings account “with a reasonable MER [management expense ratio] and easy to self-direct for a conservative to moderate investor,” she writes. “I am willing to invest in a medium-risk fund for growth.”

Her big question: “Am I on target to have a $50,000 net income when I retire?”

We asked Heather Franklin, an independent Toronto fee-for-service financial planner, to look at Louise’s situation.

What the expert says

First, Ms. Franklin suggests Louise track her actual spending because she is probably understating it in her monthly budget (see sidebar).

“Louise is determined to save a specific amount each month,” the planner says. “The result is she is leaving her cash management too tight.” Over the past few years, Louise has had to raid her savings to compensate, Ms. Franklin says. Rather than continue this way, Louise should loosen the purse strings a bit, even if it means targeting a little less for savings.

“Tracking her expenditures will assist Louise with her cash management as well as offering insights into her spending,” the planner says. “At present, the [budgeted] expenditures are unrealistically low.” Drawing up a more realistic budget will improve Louise’s sense of financial well-being.

Next, Ms. Franklin looks at how Louise has invested her registered and non-registered savings. She holds mostly mutual funds with a 60-per-cent fixed-income allocation, and some guaranteed investment certificates.

“Saving money is great, but if the money is not invested for growth, inflationary pressures will overwhelm fixed-income investments and bank savings accounts,” the planner says. “If Louise wants to make meaningful advances with her investments, she will have to alter her investment strategy.” Louise has indicated she is willing to do so.

Adding to her position in conservative, dividend-paying equities would not only potentially improve Louise’s returns but would also be more tax-efficient for her non-registered savings because of the dividend tax credit, the planner says.

To keep costs low, she suggests using exchange-traded funds or low-cost mutual funds that hold dividend-paying stocks.

Louise is fortunate to have a defined-benefit pension plan, which could be viewed as a type of guaranteed income or fixed-income investment, Ms. Franklin notes. “This is another compelling reason for Louise to consider holding more equities.”

Louise has the money in her TFSA invested in a GIC and a fund tilted heavily toward fixed income. “These are not working to the maximum to provide growth,” the planner says. She suggests that by switching to investments that provide dividend income and also have some growth potential, Louise can take full advantage of the TFSA’s tax-sheltered growth.

“The benefits are realized through the tax-free income generated by the investments.”

Will Louise achieve her retirement spending goal of $50,000 a year after tax?

Louise will get about $45,120 a year before tax from her company pension. Though Louise has the option to take the lump-sum, commuted value of her pension instead, Ms. Franklin does not recommend doing so. She is doubtful Louise could do a better job managing the pension than a plan administrator.

In addition, Louise will get about $420 a month in Canada Pension Plan benefits at age 65 and another $575 a month or so from Old Age Security benefits, for total income before tax of $57,060 annually. After-tax, she’ll be left with about $47,000. If she invests in good quality, dividend-paying stocks, her dividend income should make up the balance, lifting her to the $50,000 mark, Ms. Franklin says.

Client situation

The person: Louise, age 59

The problem: Arranging her financial affairs for retirement at age 65.

The plan: Track spending to come up with a more realistic budget and shift her investments to a greater allocation of dividend-paying stocks with solid growth potential.

The payoff: Retirement spending goal achieved.

Monthly net income: $4,040

Assets: TFSAs $63,085; RRSP $25,145; non-registered $87,000; commuted value of pension $601,980. Total: $777,210

Monthly outlays: Rent $1,375; insurance $20; transit $20; groceries $180; clothing $100; gifts, charity $100; vacation, travel $55; other discretionary $55; dining, drinks, entertainment $85; personal care $100; subscriptions, other personal $60; dentist, supplements $65; phone, TV, Internet $70. Total: $2,285

Liabilities: None

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