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Cliff and Karen.

Glenn Lowson/The Globe and Mail

Although he’s only 60, Cliff has decided to take his employer’s early-retirement offer.

“I am a long-serving faculty member at an Ontario university,” Cliff writes in an e-mail. The university is looking for savings in the wake of the provincial government’s 10-per-cent tuition cut. The offer would pay him two years’ salary as a retirement allowance.

Cliff is concerned because he and his wife, Karen, also 60, still have a mortgage, which was taken out when they moved to a large house a few years back. Karen is no longer working. “How can we use this deal to at least semi-retire early?” Cliff asks. “We don’t want to make any big mistakes.”

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He wonders whether to take the retirement allowance of $253,000 over two years or five. He will get $10,000 more if he spreads it over five years. He wonders, too, whether to leave his defined contribution pension money with the current pension administrator – a big insurance company – or take it to one of the big investment dealers.

The couple has three adult children, all financially independent.

We asked Warren MacKenzie, head of financial planning at Optimize Wealth Management in Toronto, to look at Cliff and Karen’s situation.

What the expert says

Cliff was planning to work for another five years, by which time they would mortgage-free, Mr. MacKenzie says. With another five years of pension plan contributions from Cliff and his employer, plus annual portfolio growth, he expected his pension would be worth about $1.3-million by then. Instead, it is about $900,000 currently.

For his retirement allowance, Cliff has the option of taking the $253,000 over two years or $52,600 a year for five years. By spreading it out, he will get $10,000 more and will be in a lower tax bracket than if he had taken it over two years, the planner says.

“At the end of five years, the net advantage to spreading it out is about $26,000,” Mr. MacKenzie says. Because of this, he recommends taking it over five years.

By splitting their pension income, Cliff and Karen will be able to maintain their lifestyle with no fear of running out of money, Mr. MacKenzie says. His financial plan shows that with an average rate of return of 5 per cent a year, spending of $70,000 a year (plus income tax) and an inflation rate of 2 per cent, at the age of 90 their net worth still would be about $1.5-million ($800,000 in today’s purchasing power), including their house. These numbers assume they start taking Canada Pension Plan benefits at the age of 70 rather than at 65, and Old Age Security at 65.

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In 2020, Cliff’s first full year of retirement, he will get $52,600 in retirement allowance and an estimated $64,000 from his pension plan. The actual amount will depend on the value of his locked-in retirement account (LIRA) at year end. His pension will become a LIRA as soon as he retires and a life income fund (LIF) at the point he starts to draw out an income.

With his pension, Cliff can shift money around within the insurance company’s fund family. “Cliff was brilliant, or lucky, in that near the bottom of the market in 2009, he decided to move about 80 per cent of the portfolio into equities,” Mr. MacKenzie says. In anticipation of another market correction, he now has about 60-per-cent bonds and 40-per-cent equities.

He may not always be so lucky. Instead, Mr. MacKenzie recommends a goals-based asset mix in which Cliff takes only as much risk as necessary to achieve his goals. “Based on reasonable assumptions, an asset mix of 60-per-cent equities and 40-per-cent fixed income would do the trick.”

The first step would be to draw up an investment policy statement that sets out the acceptable ranges for each asset class. “This should be his guide as to when to rebalance the portfolio.”

Trying to time the ups and downs of the market – and enduring future market corrections – will become more stressful when Cliff no longer has a salary to fall back on and is drawing cash from his portfolio to cover their living expenses, the planner says. The investment policy statement will help keep him from reacting emotionally to a market drop.

Cliff wonders whether he should move the funds to an investment adviser at one of the large brokerage firms.

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“His insurance company uses professional money managers, the management fee is less than 0.4 per cent and he can rebalance the portfolio with almost zero cost,” Mr. MacKenzie says. “If he leaves the money where it is and starts to manage his investments in a disciplined way, it is unlikely that a typical financial adviser would add anything except an additional cost.”

If, in the future, they are worried about running out of savings, Cliff and Karen could consider using some of their life income fund to buy a new type of annuity called an advanced life deferred annuity, or ALDA, Mr. MacKenzie says. The advantages of the ALDA are guaranteed income for life, higher payments than from a traditional annuity because the start date has been deferred and lower taxes because the LIF withdrawals will be lower than they would have been if funds had not been taken out to buy the annuity. ALDA can be deferred to the age of 85.

Client situation

The people: Cliff and Karen, both age 60

The problem: How to financially navigate an unexpected early retirement.

The plan: Spread the retirement allowance over five years to reduce tax, split pension income and set the pension portfolio on a more even and sustainable keel. Leave it with the insurance company. Later in life, consider a deferred payment annuity.

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The payoff: Peace of mind

Monthly net income: $7,730

Assets: Cash $10,000; his TFSA $4,900; her TFSA $2,800; his RRSP $900; her RRSP $43,000; his defined contribution pension plan $908,000; residence $480,000. Total: $1.4-million

Monthly outlays: Mortgage $1,500; property tax $325; utilities $330; home insurance $90; transportation $290; groceries $800; clothing $250; line of credit $50; gifts $350; charity $275; vacation, travel $400, dining, drinks, entertainment $310; personal care $25; sports, hobbies, subscriptions $100; health care $140; phones, internet $185; RRSPs $1,000; TFSAs $350; his pension plan contributions $745. Total: $7,515

Liabilities: Mortgage $153,800; line of credit $14,000. Total: $167,800

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

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