Luther earns $237,000 a year as a manager in the private sector and Bethany earns $200,000 as a health care executive.Amanda Erickson/The Globe and Mail
Luther and Bethany would like to retire comfortably in five years and still leave a sizable inheritance for their two children.
He is 52 and earns $237,000 a year as a manager in the private sector. She is 49 and earns $200,000 as a health care executive. Their children, both living at home, are 17 and 19.
In the short term, their goals are to pay off their mortgage, buy two new vehicles and devise a tax-efficient investment strategy. Their retirement spending target is $105,000 a year after tax, rising with inflation.
Bethany has a defined-benefit pension plan partly indexed to inflation. “We have always maxed out our contributions to RRSPs and TFSAs,” Bethany writes in an e-mail.
“I think we have ample money to retire in five to 10 years but my husband worries about money.”
One of Bethany’s questions is whether they should be contributing less to their RRSPs to avoid future taxation.
We asked Matthew Ardrey, portfolio manager and senior financial planner at TriDelta Private Wealth in Toronto, to look at Luther and Bethany’s situation.
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What the expert says
Before they make the transition to the next stage of their lives, Luther and Bethany want to make sure they will be financially independent, Mr. Ardrey says.
They have a mortgage of $225,000 on their Alberta house valued at $1.6-million. They have been putting funds aside in GICs to retire this debt when it comes up for renewal in November, the planner says. “This is a cornerstone of financial independence, being debt-free. It will free up their assets and pensions to be used for their lifestyle spending.”
In preparing his forecast, the planner assumes that they buy two vehicles worth $75,000 each once the mortgage is paid off. These will be paid off over the next five years by redirecting the cash flow freed up by paying off the mortgage.
They have almost $3.6-million in investment assets and are continuing to save to these accounts in the following amounts: Bethany’s RRSP, $600 a month; Bethany’s pension plan contribution of $1,375 a month; Bethany’s TFSA, maximum annual amount; Luther’s spousal RRSP, $1,000 a month; Luther’s work RRSP, $750 a month, plus $1,125 employer matching; Luther’s company share purchase plan, $1,500 a month, plus $525 employer matching; and Luther’s TFSA, maximum annual amount.
The planner assumes all savings stop at retirement except the TFSAs, which continue to be funded from the non-registered portfolio.
Luther and Bethany should continue to make their maximum RRSP contributions each month, Mr. Ardrey says. They have high incomes and thus high marginal tax rates. “In retirement, there will be opportunities to withdraw these contributions at much lower marginal tax rates.”
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Bethany has a defined-benefit pension plan that will pay her $3,390 a month at the age of 55 that is 60 per cent indexed to inflation. Based on the Canada Pension Plan estimates provided, Luther will get 65 per cent and Bethany 60 per cent of maximum CPP; both will receive full Old Age Security benefits, subject to clawbacks.
“Ignoring the funds set aside to pay off the mortgage and Luther’s company shares, the remaining $3.06-million portfolio has an asset mix of 70 per cent equities and 30 per cent fixed income,” Mr. Ardrey says. The majority of the equity exposure is to Canada and the United States. This asset allocation has an expected future rate of return of 5.55 per cent, with inflation assumed to be 3 per cent.
Luther’s company shares add another $398,000 to the portfolio assets. This represents about 11 per cent of their total investment assets.
In retirement they plan to spend $105,000 a year in today’s dollars, rising with inflation every year. This is very close to their current budget once savings and debt repayments are removed.
Based on these assumptions, they can meet their retirement goal, Mr. Ardrey says.
“To truly understand the risk in this plan, we need to move beyond the straight-line projection, as we know that life and investments rarely ever move in a straight line. To ensure the viability of this plan, we stress test it by using a Monte Carlo simulation. A Monte Carlo simulation introduces randomness to a number of factors, including returns, to stress test the success of a retirement plan.”
“In this plan, we have run 1,000 iterations with the financial planning software to get the results. We look at the 75-per-cent and 50-per-cent levels to determine where risk due to return rate variance may affect the success of the plan.”
In their volatility stress test, the results are positive with a 100-per-cent success rate, the planner says.
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Besides having enough to meet their retirement income goals, they wanted to ensure that they have enough to leave at least $2-million to each child upon their death. If they want this amount on an inflation-adjusted basis in 2072 when Bethany is 95, then it would be equivalent to about $7.8-million for each child in future dollars, the planner says.
In 2072, they would have a projected $17.8-million in investment assets, plus the value of the home. As most of the investment assets will be in TFSAs and non-registered investments, this should be sufficient to meet their secondary goal of providing an inheritance for their children.
When they retire and begin their decumulation, they want to be as tax-efficient as possible. In the early years of retirement, the withdrawals are focused on the registered accounts. “We recommend unlocking Bethany’s locked-in retirement account and taking LIF payments. We will then balance out the income between each of them each year to minimize the overall taxes payable,” Mr. Ardrey says. When CPP and OAS start at 65, non-registered funds will be added to the withdrawal strategy.
The other side of the tax-efficiency strategy is to preserve their TFSAs. If they need money for large ad hoc expenses, this can be taken out tax-free and will not affect OAS payments. If it’s not needed, it will provide a tax-free distribution to their children.
“Though the forecast shows that they can meet all of their goals, it is important to remember that a financial plan is not a one-time exercise, but rather a starting point,” Mr. Ardrey says. Luther and Bethany’s plan is built on today’s assumptions about markets, tax rules and their own goals, and each of these will shift over time, he says.
“We recommend they revisit their plan regularly, at least annually, to test it against what has actually happened, adjust for any changes in their income, spending or family circumstances, and confirm they remain on track,” Mr. Ardrey says. “Financial planning is best thought of not as a document to be filed away, but as an ongoing, dynamic process that evolves alongside their life.”
How should Faye, 68, and Ava, 60, draw down their RRSPs given their $108,000 spending target?
Client situation
(Income, expenses, assets and liabilities provided by the applicants.)
The people: Luther, 52; Bethany, 49; and their two children, 17 and 19.
The problem: Can they retire soon and still leave their children a substantial inheritance?
The plan: Continue contributing to their RRSPs and TFSAs. When they retire, tap Bethany’s LIRA first. Update their plan as they go along.
The payoff: All their financial goals achieved.
Monthly after-tax income: $25,365.
Assets: GICs $220,000; her LIRA $331,000; her RRSP $411,000; spousal RRSP $402,000; her TFSA $311,000; his RRSP $131,000; his group RRSP $1,159,000; his TFSA $319,000; his company shares $390,000; registered education savings plan $198,000; residence $1,600,000; cottage $300,000. Total: $5.77-million
Estimated present value of Bethany’s DB pension: $751,000. This is what someone with no pension would have to save to generate the same retirement income.
Monthly outlays: Mortgage $4,000; property tax $1,550; water, sewer, garbage $180; home insurance $200; heating $30; maintenance, garden $230; transportation $720; groceries $2,000; clothing $300; miscellaneous living expenses $750; gifts $100; charity $500, vacation, travel $1,500; dining, drinks, entertainment $400; personal care $150; pets $50; sports, hobbies $300; subscriptions $50; health care $50; cellphones, TV, internet $340; RRSPs $2,800; TFSAs $1,165; pension plan contributions $1,375; company shares $1,500. Total: $20,240
Liabilities: Mortgage $225,000 at 2.14 per cent.
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Some details may be changed to protect the privacy of the people profiled.