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financial facelift

Leon and Lydia both enjoy professional careers in education, bringing in a combined $245,000 a year.Alex Filipe/The Globe and Mail

At age 40, Leon and Lydia “enjoy a good life – dinners out, good-quality groceries, a wine collection, travel, a personal trainer,” Lydia writes in an e-mail. A couple of years ago, they bought a century house in southeastern Ontario. “We have no debt other than our mortgage and can always pay the bills,” she adds.

They both enjoy professional careers in education, bringing in a combined $245,000 a year. They both contribute to defined-benefit pension plans, partly indexed to inflation, as well as to registered retirement savings plans and tax-free savings accounts. “We would love to know if there are extra things we should be doing to set ourselves up for a successful retirement in 15 to 20 years,” Lydia writes. “Is our spending reasonable given this scenario, or should we try to cut back on some luxuries?”

Short term, they plan to take a vacation costing $15,000 and to redo their back courtyard for $30,000. Longer term, they plan to buy an electric car. They hope to maintain their historical home at a cost of $25,000 every five years until they are 75. Their retirement spending goal is $130,000 a year after tax.

“Can we retire comfortably by age 60 or even sooner?” Lydia asks.

We asked Stephanie Douglas, partner and portfolio manager at Harris Douglas Asset Management in Toronto, to look at Leon and Lydia’s situation. Ms. Douglas holds both the chartered investment manager (CIM) and certified financial planner (CFP) designations.

What the expert says

While much can change given the long time horizon, if they stay on their current path, Lydia and Leon should be able to retire at age 60 and meet their spending goal, Ms. Douglas says. Her forecast assumes they live to age 95 and earn 5 per cent a year on their investments.

At age 95, they would they still have roughly $1.4-million in investable assets along with the equity in their home. If they want to deplete their savings, they could increase their retirement spending to $136,000 a year – even more if they decided to sell their house and downsize.

“They would be able to stay in their current home, or a home of similar value, for as long as they would like, and any equity from the property could be used for long-term care if required,” Ms. Douglas says.

If they decided instead to retire at age 55, they would run out of savings and would have to use the equity in their home to maintain their desired spending goal, the planner says. “This would happen very early in retirement, at age 62.” That’s because of the impact of retiring early on their pension entitlement, particularly for Lydia because she would have a pension penalty. Leon works for a different institution and so has a pension plan with different terms.

Retiring before age 60 may still be achievable, but it would require either saving more, lowering their retirement spending goal, achieving higher returns on their investable assets, or a combination of all three.

Lydia and Leon show an annual surplus of about $30,000 after all expenses, taxes and savings are accounted for. “I would suggest they track their expenses closely to see where these extra funds are going,” Ms. Douglas says. Their income may fluctuate because of some additional consulting work by Lydia. “They should aim to save some of this surplus for their short‐term spending goals to avoid depleting their TFSAs,” she says. Any funds remaining could be used to pay down their mortgage if they want to retire earlier.

Lydia and Leon invest on their own using an online broker because they were dissatisfied with their investment adviser, to whom they paid a 1 per cent fee. Their portfolio consists mainly of large cap, dividend-paying companies, exchange-traded funds and mutual funds, the planner says.

“They should be mindful that the mutual funds and ETFs also charge fees that are embedded in the funds,” Ms. Douglas says. The amount they pay will be listed as the management expense ratio, or MER. For example, one of their mutual funds has a 1.06 per cent MER. “They should review the fees to ensure they are comfortable with them.”

Lydia and Leon’s 100 per cent allocation to stocks and stock funds is not unsuitable given their long time horizon and the fact that they both have pension plans, Ms. Douglas says.

To avoid having to sell stocks in a down market, “I suggest that they set up an account specifically for their short‐term goals, anything less than five years,” she says. These funds can be invested in guaranteed investment certificates to ensure the funds are there when they need them.

“They should also regularly revisit their asset allocation to ensure that it continues to be in line with their risk tolerance and their goals,” she says. This will be particularly important after they have retired and begun drawing from their savings. “At that point, I would suggest they have between three and five years’ worth of withdrawal requirements in a lower volatility asset class to draw from.”

She also suggests they apply for a home-equity line of credit while they are both still employed, in case of unexpected cash needs later on. “If a large amount was needed and the market was down at that point, they could wait for the market to recover before selling stocks to pay down the line of credit.”

As they near retirement, the planner suggests Lydia and Leon seek advice on “decumulation,” or the drawing down of their savings. They will likely have an opportunity early on to draw down their RRSPs before they start getting government benefits or making minimum withdrawals from their registered retirement income funds, “all of which will push them into a higher tax bracket,” she says. ”This can help spread out some of the tax implications.”

Twenty years from now, in the first full year of retirement, Lydia would have pension income of about $125,000 a year and Leon about $100,000. This is based on their pensions increasing at 66.67 per cent of the inflation rate. Their spending needs would have risen in line with inflation; they would withdraw funds from their RRSPs to make up the shortfall. Because their pensions are only partly indexed, they should review their financial plan regularly to account for any changes, Ms. Douglas says.

Finally, she suggests the couple maximize their TFSAs so they will have funds available that are not taxable income.

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Client situation

The people: Lydia and Leon, both 40

The problem: Can they accomplish their goals without cutting back on the luxuries they enjoy? Will they be able to retire at age 60 or even earlier?

The plan: Continue working and saving, taking full advantage of TFSAs. Keep an eye on investment fees and target a minimum 5 per cent rate of return. Retiring earlier than age 60 will involve trade-offs.

The payoff: A plan that can be adjusted as they go along and their goals and needs change.

Monthly net income: $15,565

Assets: Bank accounts $36,000; her TFSA $42,000; his TFSA $60,000; her RRSP $290,000; his RRSP $61,000; estimated present value of her DB pension $60,310; estimated present value of his DB pension $271,300; house $1.3-million. Total: $2.1-million

Monthly distributions: Mortgage $3,445; Property tax $710; water, sewer, garbage $100; home insurance $135; electricity, heating $175; maintenance $200; garden $50; transportation $270; groceries $1,000; clothing $300; gifting $100; vacations $500; dining out, drinks, entertainment $1,600; personal care $250; sports, hobbies $150; subscriptions $100; doctors, dentists, drugstore $310; life insurance $100; disability and critical illness $100; cellphones $145; internet $85; cable or satellite $60; RRSPs $1,215; savings account $100; pension plans $1,870. Total: $13,070. Surplus of $2,495 goes to TFSAs, provision for ongoing major expenditures on their house, and unallocated spending.

Liabilities: Mortgage $671,000

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