Katherine has a good job, a mortgage-free home, a rental property, a pension and a fat portfolio. Now, at 39, her thoughts are turning to what she doesn’t have: a child. She’s thinking of having one soon and wondering how that will affect her most ambitious goal – to retire at the age of 45 with $40,000 to $45,000 a year in after-tax income.
Before she hangs up her work hat, Katherine wants to replace her car ($40,000), pay off the remaining mortgage on her rental unit ($150,000) and increase her investable assets to $1-million.
“I think I’m currently on track to retire at 45 (five or six years away) but am wondering if adding a baby to the mix would throw a wrench in my plans,” Katherine writes in an e-mail.
She seems to have given quite a bit of thought to her postwork life, wondering what sort of savings withdrawal rate would be “safe,” how much having a baby might delay her retirement, when to begin collecting government benefits and what to do with the rental property.
We asked Stephanie Douglas, partner and portfolio manager at Harris Douglas Asset Management of Toronto, to look at Katherine’s situation.
What the expert says
Katherine has a rental property that she plans to sell in the next five years if the Calgary real estate market recovers, Ms. Douglas says. Katherine wonders whether she would be better off keeping it. She also wonders if she should be investing in the stock market rather than aggressively paying down the mortgage.
If Katherine decides to retire at the age of 45 and sells her rental apartment, she would run out of investable assets in 2071 at the age of 92, Ms. Douglas says. That assumes spending of $40,000 a year, an inflation rate of 2 per cent and a rate of return on investments of 5 per cent. She would still have her home, which would be worth roughly $1.4-million.
The planner assumes that Katherine will qualify for 50 per cent of Canada Pension Plan benefits beginning at the age of 65.
Katherine plans to take the commuted value of her pension at 45.
The analysis assumes Katherine replaces her vehicle in three years, with the funds coming from her tax-free savings account. Any surplus funds she has after paying off her mortgage will go to savings.
If Katherine decides instead to keep the rental property, she would run out of investable assets in 2070 at the age of 91. At that point she could sell the rental property, which would be worth roughly $850,000. “After paying capital gains on the property, she would have enough funds to live off the proceeds until age 95 without having to sell her primary residence,” Ms. Douglas says. She would still have investable assets of roughly $450,000 at 95. The analysis assumes Katherine raises the rent by the rate of inflation, or 2 per cent a year.
If Katherine decides to have a baby in the next three years, the situation would look different. Her annual expenses would increase by $13,000, adjusted for inflation, until her child reaches the age of 18. She would also be making registered education savings plan contributions of $2,500 annually to receive the maximum government grant of $500 a year.
In this case, even if she sells the rental unit, she would have a shortfall in 2051 at the age of 72. If she keeps the rental property, she would have a shortfall in 2046, at which point she could sell the rental. “However, the funds would only last until 2060, when she would be 81,” Ms. Douglas says.
Katherine would still have her principal residence, which would be worth about $1.1-million.
The planner’s analysis takes into consideration a 12-month maternity leave with Katherine receiving the maximum maternity benefits and drawing from her investable assets to cover the gap. The initial cost of having or adopting a child has not been factored in.
“There are a few things that Katherine could do to help get closer to her goals without having to sell her primary residence,” the planner says. She could look at reducing the investment fees she pays. “Even reducing her fees to 1.2 per cent [a year] would extend her portfolio by an extra 10 years.”
The majority of Katherine’s portfolio is in mutual funds with fees of roughly 2 per cent a year. Many of these are large funds that are similar to the index.
“If she would like to continue managing the funds herself, she could consider buying an exchange-traded fund that tracks the index,” the planner says.
Another option would be to decrease her spending goal, although this would be difficult. If she spent only $32,000 annually, adjusted for inflation, she would have enough investable assets to last until the age of 95, the planner says.
“Alternatively, Katherine could consider working instead until age 49 while continuing to save.”
Katherine’s investments are all in stocks and stock funds. Ms. Douglas suggests she consider adding some fixed-income exposure. This would allow her to draw the funds to live on from the fixed-income portion of her portfolio. “That way, she would not have to sell securities from the equity portion of her portfolio if there was a pullback in the market,” the planner says, giving the equity portion of her portfolio time to recover.
The person: Katherine, 39
The problem: Can she retire at 45 with a retirement income of $40,000 to $45,000 a year if she decides to have a baby?
The plan: Take a closer look at the fees she is paying on her investments. Consider working longer or lowering her spending goal.
The payoff: Having a baby and retiring early
Monthly net income: $10,307 (including rental income)
Assets: House $519,000; rental property $310,000; commuted value of pension $186,000; stocks $120,162; TFSA $57,000; RRSP $332,563; cash $6,700. Total: $1.5-million
Monthly distributions: Condo fees $664; property tax $284; home insurance $49; electricity $45; maintenance $54; transportation $223; groceries $110; clothing $28; vacation $200; gifts, charity $200; entertainment, dining out, alcohol, hobbies, personal care $255; club memberships $50; health-care expenses $300; phone, internet $95; RRSP $1,125; TFSA $500; pension plan contributions $1,500. Total: $5,682.Surplus of $4,625 goes to pay down rental property mortgage plus condo fees and property tax of $625 a month.
Liabilities: Rental mortgage $150,000
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