Below you will find a real life case study of a couple who are looking for financial advice on how best to arrange their financial affairs. Their names and details have been changed to protect their identity. 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.
Special to The Globe and Mail
Published January 10, 2020
People with ambitious financial goals are wise to start planning well in advance. So it is with Olivia and Larry, both 38, who hope to retire from work in their late 50s with substantially more discretionary spending power than they have now.
Larry brings in $125,500 a year plus bonus in a senior management job. Olivia earns $65,000 a year in education. They have a daughter, 4, whom they want to help get established financially when the time comes.
First, though, they plan to sell their Toronto-area house and move back to Montreal soon to be close to family and friends. Larry’s income is not expected to suffer in the move, but Olivia’s could be cut in half. Also, her defined benefit pension entitlement will be lower than if she stayed in her current job.
In 20 years or so, when they retire from work, Olivia and Larry hope to travel extensively, which partly explains why they have set their retirement spending goal so high: $120,000 a year.
“Can we retire early with an ideal income of $10,000 a month after tax?” Larry asks in an e-mail.
We asked Matthew Ardrey, a financial planner and vice-president at TriDelta Financial in Toronto, to look at Larry and Olivia’s situation.
What the expert says
Mr. Ardrey starts by reviewing the couple’s cash flow. According to Larry and Olivia, they spend everything they earn and sometimes have to dip into their tax-free savings accounts (TFSAs) to keep up with their car payments.
Yet when Mr. Ardrey runs the numbers, Larry and Olivia provided, he finds they actually have a surplus of $12,800 a year. (Income includes tax refunds from RRSP contributions.)
“This is a significant difference and does not even account for Larry’s variable bonus, which he requested to keep out of the projection,” the planner says. Because most people know what they earn and save, “we can assume the difference lies in the spending part of their budget,” Mr. Ardrey says. “Thus, a full review of their budget and spending is recommended.” In his analysis, the planner assumes they are spending the extra $12,800 a year on outlays not listed in their monthly expenditure form. That would include items such as household maintenance and repair, for example.
They are saving $650 a month to Larry’s RRSP, which his company matches 100 per cent, $160 to their child’s registered education savings plan (RESP) and $150 each to their respective TFSAs. Olivia contributes $600 a month to her work pension plan, an amount that is estimated to drop to $300 a month when she begins working in Montreal.
Some time in the next couple of years, Olivia and Larry would like to leave Ontario and return to Montreal. They would sell their house and purchase a smaller home in Montreal for about $600,000. “If we assume selling/moving costs of 10 per cent of the selling price, and that they pay off all their existing debts, they will need only a small mortgage of $30,000 for this transaction, which they can pay off in a few years at $1,000 a month,” Mr. Ardrey says.
The move to Montreal will affect their financial situation both positively and negatively, the planner says. Olivia’s income will drop about 50 per cent, which will also affect her DB pension. But their ability to save will increase because of the lower debt obligations. The planner assumes they direct these savings to their TFSAs and Larry’s RRSP. Any remaining surplus could go to a non-registered investment account.
The couple want to retire at the age of 57. Mr. Ardrey’s forecast assumes that at 65, Larry and Olivia will get 80 per cent and 60 per cent, respectively, of CPP/QPP (Quebec Pension Plan) benefits, and full Old Age Security benefits. Olivia’s pension estimate at age 57 is $27,182 a year in today’s dollars because of her reduced income. The couple’s baseline retirement spending target is $7,000 a month, plus $1,000 a month for five years to help their daughter, and another $2,000 a month for 25 years for travel.
Next, Mr. Ardrey looks at what Olivia and Larry can expect to earn from their investments. Their portfolio is 90-per-cent stocks and 10-per-cent fixed income, which produced a historical return of 6.1 per cent a year, he says. In retirement, he assumes their mix becomes more conservative (60-per-cent stocks/40-per-cent fixed income) and that they earn 4 per cent a year net of investing costs.
“Based on these assumptions, they fall short of their retirement goal,” Mr. Ardrey says. “They run out of savings in 2059 when they are 78.” (They would still have Olivia’s pension, their government benefits and their residence.)
If Olivia retired at 57 and Larry worked to 59, “they will reach the break-even point in their retirement spending,” the planner says. To have a surplus, they would have to work even longer, spend less or achieve a better rate of return.
To generate better returns, they could make some improvements to their investment strategy, he says. Larry’s group RRSP is well diversified, but their other investments are almost solely in five Canadian large-cap stocks. This lack of diversification “is adding significant risks,” the planner says.
As long as their portfolio is less than $500,000, they should consider broad-based exchange-traded funds, he says. ETFs offer low-cost diversification by company, asset class and geographic location. Once their portfolio passes the $500,000 threshold, they could consider hiring an investment counsellor or portfolio manager, Mr. Ardrey says. These firms charge a fee based on the size of the portfolio and have a fiduciary duty to act in their clients’ best interests. Investment counsellors tend to offer their clients investments that are not available on publicly traded markets – such as private debt and equity funds – designed to provide steady returns that are not subject to the ups and downs of financial markets.
The people: Larry and Olivia, both 38, and their daughter, 4
The problem: Can they afford to retire at the age of 57 and spend $10,000 a month even if Olivia’s income drops?
The plan: Olivia retires as planned, but Larry works another two years to 59. They take steps to diversify their holdings and improve their net returns.
The payoff: Goals achieved.
Monthly net income: $11,685
Assets: Cash $3,120; his TFSA $74,020; her TFSA $66,350; his RRSP $125,510; her RRSP $16,210; estimated present value of her DB pension $42,250; RESP $13,160; residence $1.1-million. Total: $1.44-million
Monthly outlays: Mortgage $3,165; property tax $505; home insurance $60; utilities $300; transportation $650; groceries $570; child care $510; clothing $265; car loan $660; gifts, charity $540; vacation, travel $415; dining, drinks, entertainment $660; personal care $145; other personal $145; life insurance $150; cellphones, internet $170; RRSP $650; RESP $160; TFSAs $300; her pension plan contribution $600. Total: $10,620 Surplus of $1,065 is spending unaccounted for.
Liabilities: Mortgage $526,640; line of credit $26,865. Total: $553,505
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Some details may be changed to protect the privacy of the persons profiled.