Below you will find a real life case study of a couple who are looking for financial advice on when they can retire and how best to arrange their financial affairs. The names and details of their personal lives have been changed to protect their identities. The Globe and Mail often seeks the advice of our VP, Wealth Advisor, Matthew Ardrey, to review and analyze the situation and then provide his solutions to the participants.
Written by: DIANNE MALEY
Special to The Globe and Mail
Published Friday, August 25, 2017
When he retires this fall, Chuck hopes to enjoy that magical combination of time and money that proves so elusive for people while they are still working. He and his wife, Charlene, hope she can hang up her hat at the same time.
He is 59, she is 51. They have two children, ages 17 and 23. The younger lives at home.
Chuck makes more than $160,000 a year working for an auto maker, while Charlene is self-employed and earning $143,000. Chuck has a defined-benefit pension plan, Charlene has none.
As a widow and widower in their second marriage, each collects a Canada Pension Plan survivor benefit. Charlene also gets a portion of her late spouse’s work pension, so they will have various income sources when they retire. They also have substantial investments.
But will this be enough to allow them to retire with $120,000 a year after tax, their goal? Should Chuck take the lump-sum value of his pension or the monthly cheque? Is Chuck right in calling Charlene’s investment fees “ridiculous, especially with the low return?”
We asked Matthew Ardrey, a vice-president and certified financial planner at TriDelta Financial in Toronto, to look at Chuck and Charlene’s situation.
What the expert says
Mr. Ardrey starts by totting up the couple’s future income. When he retires in October, Chuck will get 22 months of severance pay ending in July, 2019. They get a combined $6,926 in CPP survivors’ benefit, while Charlene gets $20,000 a year (not indexed to inflation) from her late husband’s employer. They have a sideline that will generate $3,000 a year until mid-2030.
If Chuck opts for the pension, he will choose a 100-per-cent survivor benefit for Charlene, giving him $39,357 a year, plus a CPP supplement to the age of 65 of $4,864 a year. Neither is indexed. In drawing up his plan, Mr. Ardrey assumes they will begin collecting (full) CPP and Old Age Security benefits at 65 and live to 90.
In addition to their $120,000 goal, Charlene and Chuck plan on spending another $12,000 a year on travel until Chuck is 80 years old. They plan on buying two new vehicles soon for $30,000 apiece.
The key to achieving their goal lies in their investment returns. Given their current holdings, Mr. Ardrey projects a rate of return of 4.15 per cent – the historical average of the underlying asset classes they are invested in – with a 1.65-per-cent management expense ratio. “By the time we account for the 2 per cent assumed inflation rate, the real rate of return on their portfolio is almost zero,” the planner says. “Based on these assumptions, they will not be able to achieve their retirement goal.”
Either Charlene would have to work for another five years or they would have to pare their spending by $11,000 a year to $109,000.
What if they were able to earn more on their investments with lower fees?
By shifting from retail mutual funds to an investment counsellor, the couple may well be able to raise their return to 6.5 per cent on average and lower their fees to 1.5 per cent a year, for a net return of 5 per cent. This way, they would not only meet their spending target but surpass it by $15,000 a year. “The shift is $26,000 per year in after-tax, inflation-adjusting spending.”
They have 53 per cent of their investments in cash and fixed income, which is “definitely placing a drag on their returns,” the planner says. More than half of their equity exposure is to Canada. Mr. Ardrey recommends 50-per-cent equities, divided among Canadian, U.S. and international stocks; 30-per-cent fixed income; and 20-per-cent in alternative investments, which tend to have a low correlation to the stock market and potentially higher returns than fixed income.
Next, the planner looks at whether Chuck should take a lump sum or a pension. “If he took the lump sum, $515,000 could be transferred to a locked-in retirement account, while the remaining $390,000 would be taxable,” he says. “Using the 5-per-cent net rate of return [assumed above], the difference between the two would be almost nil.” They would be able to increase their spending by $17,000 a year rather than $15,000.
In making this decision, Chuck should consider the following points: Does he believe the pension is secure? Does he feel comfortable investing the money? Would he prefer if the money was available for his children in the event both he and Charlene died in an accident? Does choosing a lump sum result in the loss of other company benefits such as health care?
The people: Chuck, 59, and Charlene, 51
The problem: Can they both retire this fall without compromising their retirement spending goals? Should Chuck take the cash or the pension?
The plan: Either scale back spending expectations, work longer or take steps to improve investment returns.
The payoff: All their financial goals realized.
Monthly net income (past year): $20,660
Assets: Cash in bank $25,000; GICs $75,000; his taxable portfolio $180,000; her taxable portfolio $726,000; his TFSA $64,200; her TFSA $57,500; his RRSP $100,000; her RRSP $839,000; commuted value of his DB pension plan $979,000; estimated PV of her survivor pension $340,000; RESP $70,000; residence $1,000,000; her cottage $500,000. Total: $5-million
Monthly disbursements: Property tax $600; water, sewer $100; property insurance $325; electricity, hydro $250; maintenance, garden $500; auto lease $800; fuel $350; parking, transit $400; grocery store $1,000; clothing $200; gifts $200; charity $550; vacation, travel $1,000; dining, drinks, entertainment $720; grooming $75; club memberships $150; pets $200; sports, hobbies $335; subscriptions $25; drugstore $20; life insurance $70; disability insurance $80; telephone, cellphones, internet $340; RRSPs $2,690; investment account $5,000; TFSAs $915; his pension plan $305. Total $17,200. Surplus: $3,460 (had been going to savings and investments)
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Some details may be changed to protect the privacy of the persons profiled.