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FINANCIAL FACELIFT: Should millennial savers Sid and Kamala hit pause on their plans to buy a house?

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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.

gam-masthead
Written by:
Special to The Globe and Mail
Published May 22, 2020

Fear of missing out has inspired millennials Sid and Kamala to save diligently in hopes of buying a house in the Greater Toronto Area. They also think they’re “bleeding money” by paying rent, Sid writes in an e-mail.

Sid is 34 and earns $55,000 a year in the hospitality industry. Kamala, who is 29, earns $35,000 a year in health services. The house they are eyeing is $880,000. For now, though, the house-hunting is on hold because Kamala and their toddler are stuck overseas, where they were visiting family.

“My question is whether to stay put in the rental market and focus on investing, or get into the housing market by depleting my savings,” Sid writes. “If we buy a house valued at $880,000, will we have any savings left for retirement?” They hope to retire from work when Sid is 60 with $48,000 a year after tax in spending.

In the meantime, they are planning a big trip. “Our dream is to go to Serengeti [National Park] in Africa to see the wildlife migrations one day,” Sid writes. They also want to help their son with postsecondary education.

“Is it feasible?” Sid asks.

We asked Matthew Ardrey, a vice-president and financial planner at TriDelta Financial in Toronto, to look at Sid and Kamala’s situation.

What the expert says

Mr. Ardrey explores how things might unfold financially if Sid and Kamala buy the house they want early in 2021 for $880,000. For the down payment and the estimated $15,000 in purchase costs (land transfer tax, moving costs, legal costs and furnishings), they have more than $200,000 in cash equivalents sitting in non-registered investment accounts, Mr. Ardrey says. The remaining $680,000 would be financed by a mortgage.

To help with their mortgage payments, they plan on renting out the basement for the first 10 years, Mr. Ardrey says. They expect to get about $1,400 a month. The planner assumes taxes, utilities, insurance and maintenance add another $1,500 a month over and above the $3,220 mortgage payment. One third of these costs – plus a third of the mortgage interest – will be tax deductible as long as they are renting it out.

Sid is expecting to inherit $50,000 in a few years. When he does, they plan to travel to Africa at a cost of $10,000, depositing the remaining $40,000 in their tax-free savings accounts.

“Based on these numbers, and assuming no large increases in their income, the house purchase is only viable with the renter in place” at least until the couple retires in 2046 rather than the 10 years they are planning for, Mr. Ardrey says.

As for the child’s education, their registered education savings plan contributions of $210 a month will fall short, the planner says. With food and housing, each year at university is estimated to cost $20,000, rising at double the rate of inflation, or 4 per cent a year. “With their savings, they will be able to cover about half these costs,” he says. The remainder will have to be covered by loans, grants “or other means.”

When they retire at Sid’s age 60, he is estimated to get 75 per cent of the maximum Canada Pension Plan benefit he would otherwise be entitled to and Kamala 50 per cent. By the age of 65, both will have 40-plus years of residency in Canada, allowing for full Old Age Security payments.

Their investments have a historical rate of return of 4.95 per cent a year, with an average management expense ratio of one percentage point, for a net return of 3.95 per cent. After subtracting inflation, estimated at 2 per cent a year, they will have a real return of 1.95 per cent, Mr. Ardrey says.

“Based on the above assumptions, they just break even with their $48,000-a-year spending goal,” the planner says, “with no room for unforeseen expenses or emergencies.”

To improve their circumstances, the couple could buy a less expensive home. It could be a smaller one in their desired neighbourhood or one farther afield, making their commute to work longer. Either way, they would not likely be able to command such a high rent from the lower-level apartment, the planner says.

Instead, they might want to consider one or more of the following:

Increase their annual savings now through a forced savings program, but “this would be difficult to do when they are already pushed to the edge of their budget,” Mr. Ardrey says. Or they could plan on renting out the apartment throughout their retirement years. “This would allow a non-investment asset – their home – to generate income for them,” the planner says. “They need to decide if they want to continue to have someone in their home and if so, for how long.”

Alternatively, they could sell the house and downsize after they have retired from work. Or they could work longer or spend less when they retire, “not a preferable choice,” the planner says.

The best alternative, Mr. Ardrey says, would be to improve their investment strategy. They have multiple accounts at several different financial institutions. They should consolidate at one financial institution and develop a diversified strategy using exchange-traded funds, he says.

As their portfolio grows, they should look to move to an investment counselling firm that can offer private investments to supplement the couple’s diversified equity and fixed-income strategy. If all goes well, they should be able to increase their returns net of fees by about one percentage point, the planner says. This would give them more of a financial cushion without having to sacrifice their lifestyle.

One thing that could work in Sid and Kamala’s favour is the potential effect of COVID-19 on house prices. Canada Mortgage and Housing Corp. recently estimated that in a worst-case scenario, house prices could fall as much as 18 per cent over the next 12 months, which would knock $158,000 off the price of their desired home. “If that were to happen, it would certainly make their financial goals that much more achievable,” Mr. Ardrey says.

Client situation

The people: Sid, 34, Kamala, 29, and their toddler.

The problem: Can they afford to buy the house of their dreams?

The plan: Gain a solid understanding of the potential risks and trade-offs involved in buying the house they want.

The payoff: A greater potential for financial security.

Monthly net income: $5,900

Assets: Cash and cash equivalents $210,655; his RRSPs $45,425; his TFSAs $23,505; her RRSPs $3,760. Total: $283,345

Monthly outlays: Rent $1,900; home insurance $20; electricity $40; transportation $450; groceries $400; child care (grandparents are main caregivers) $100; clothing $25; charity $20; personal care $50; dining out $200; subscriptions $30; drugstore $20; cellphones $100; internet $45; RRSPs $700; RESP $210; TFSAs $425. Total: $4,735. Surplus of $1,165 goes to unallocated spending and saving for down payment.

Liabilities: None

Want a free financial facelift? E-mail finfacelift@gmail.com.

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

Matthew Ardrey
Presented By:
Matthew Ardrey
VP, Wealth Advisor
matt@tridelta.ca
(416) 733-3292 x230

TriDelta Webinar for Professional Corporations – May 14, 2020

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This Webinar is focused on those with a Professional Corporation. It will feature ideas and new opportunities that we see in 2020 and in a post COVID-19 world.

We will hear the best advice from a Lawyer, Accountant, Actuary and TriDelta Wealth and Planning specialists, all who work closely with Professional Corporations.

Learn about:

• How to best make use of current Government initiatives related to COVID-19
• Unique ways to draw funds out of Corporations tax free
• Unique ways to invest within your Corporation to reduce volatility and tax
• Post COVID-19 legal issues to watch out for
• Individual Pension plans (IPP) and why more Professional Corporations are using them today

Hear from these experts who all work closely with Professional Corporations:

Fraser Lang, CFP, CLU, CHS, Senior Vice President Sales & Business Development at GLB; is dedicated to strengthening the brand of GBL as a market leader in IPPs, RCAs, FMV of Insurance, and other strategies. Fraser has 20 plus years of experience in the financial services industry.

Greg Loskutov, CPA, CA, LPA principal at Omega Squared Professional Corporation; a full service accounting practice that focuses on providing accounting, taxation and advisory services to entrepreneurs and small businesses with a focus in medical professionals. Greg has 15 years of experience.

Michael E.B. Taing, BBA., LL.B is the managing lawyer for Healthcare Professionals and practices in the Corporate/Commercial and Real Estate divisions at Hummingbird Lawyers LLP.

Asher Tward, VP Estate Planning, TriDelta Financial. Asher runs the Estate Planning group at TriDelta, where he specializes in Planning and maximizing tax efficiencies across an individuals’ Corporation and Personal financial landscape.

Hosted by:
Ted Rechtshaffen, CFP, CIM, MBA, President and CEO, TriDelta Financial.

TriDelta Webinar: Estate Planning Decisions – May 7, 2020

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This Webinar will cover:

  • Making the biggest impact that you can to those you care about
  • How to sort through the tricky issues of stepfamilies and second marriages
  • The smartest ways to leave money to family and charity for the future
  • The smartest ways to leave money to family and charity this year
  • How to use Corporate assets most effectively
  • How to avoid creating family friction around the will and estate

Hear from:

Ted Rechtshaffen, President and CEO, TriDelta Financial
Asher Tward, VP Estate Planning, TriDelta Financial

 

TriDelta Financial Webinar: Real Estate Update – April 20, 2020

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In this Webinar, leaders in Canadian Real Estate and TriDelta Portfolio Managers will cover:

  • The short term and long term impacts of COVID-19 on Real Estate
  • How did real estate react in 2008 and will it be different this time?
  • Opportunities for your investment portfolio, your home and/or investment property
  • Broader stock, bond and preferred share – Investment market update, what are we doing today

Hear from:

Corrado Russo, CFA, MBA, Senior Managing Director, Investments & Global Head of Securities, Timbercreek – The firm manages $2 billion in Global Real Estate Securities
Nick Kyprianou, Director,President and CEO, RiverRock Mortgage Investment Corporation – 30 years’ experience as a Canadian Leader in the Mortgage Industry
Cam Winser, CFA, SVP, Equities, TriDelta Financial
Paul Simon, CFA, VP, Fixed Income, TriDelta Financial

Hosted by Ted Rechtshaffen, CFP, CIM, MBA, President and CEO, TriDelta Financial

Real Estate Update

The coronavirus has created a tremendous financial opportunity for workers with a pension

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Unique opportunities sometimes come in extreme times.

The one detailed below on commuting the value of your pension won’t be an option for many, but for those with the ability to take advantage, it could meaningfully improve their retirement finances for years to come.

This opportunity is based on three fundamental facts.

First, the current or commuted value of your pension is much higher when interest rates on 5 Year Canadian Bonds are low. The five-year bond is trading near historic lows, at 0.57 per cent at the time of writing.

Secondly, you can use the paid-out pension money to buy some very solid long-term Canadian investments with dividend yields of six per cent or more.

Finally, the effective marginal tax rate on Canadian dividends is very low. In Ontario, British Columbia and Alberta, you don’t pay any tax on such dividends at $40,000 of taxable income, and only 7.6 per cent at $70,000 of taxable income.

Let’s take a look at each of these facts.

Why low interest rates make your pension worth more today

Canadian money and Why low interest rates make your pension worth more today.This only relates to the one-time value of defined-benefit (DB) pension plans, since defined-contribution plans go up or down in value each month based on the investment value of your account.

Low interest rates can be great for DB plans because they are valued on a specific date — usually monthly. This value is essentially meant to compensate you for what the pension would need to set aside to cover your pension payouts.

Let’s say you needed to get $50,000 a year from a guaranteed investment certificate. If interest rates are 10 per cent, you would need $500,000 invested to generate the $50,000. If interest rates are one per cent, you need $5 million to generate the same amount. Today, the pension plan needs to set aside much more money to ensure it can meet the fixed needs of your lifetime pension.

The value of your pension is made up of several factors. Needing $5 million to generate $50,000 is a very generic example, but the difference could mean getting $250,000 or more on a full mid-level pension if you retire today compared to if you retire when rates are two percentage points higher.

Of particular interest is that pension plan managers do not want you to take the commuted value. They don’t want to lose assets at the best of times, but especially not at the most expensive times when interest rates are low. If they wanted you to take out the cash, they would provide more education to make your decision easier. In our experience, you often have to push hard to get answers to key questions that might help you make better informed decisions.

Keep in mind, too, that with some plans you can make the decision to take the cash instead of the pension right before you retire. With other plans, you have to make the decision to take the commuted value of a pension as early as age 50 or 55. This is an important question to ask your manager.

What to do with a cash payment

One of the keys to making such decisions is to understand that this isn’t play money. This is your retirement pension. You want to invest wisely and lean conservative. If a portfolio won’t do as well as your pension, then you should keep the pension.

We often analyze pensions for clients to determine the break-even point if someone was to live to be 90. This point will depend on whether a pension is fully indexed to inflation, and must account for any other health benefits that might be included.

Having said that, because of the low interest rates at this time, the rate of return required to do better than a pension payout is generally in the range of 2.75 per cent to four per cent today. If the pension funds are invested at, say, a three-per-cent annual return until age 90, and funds are drawn out exactly the same as they would be in a pension, the investments will be worth zero at age 90, the same as they would be for the pension if you pass away at 90 with no survivors.

Over the long term, three per cent is a pretty low hurdle to clear. It is much easier now. As an example, we put together three investments with a combined yield of more than seven per cent that could help you achieve this return.

George Weston Preferred Share – Series D: The current dividend yield on this fixed-rate or perpetual-preferred share is 6.2 per cent (at the time of writing). The share price is still down almost 15 per cent from March, but we believe that you will see some decent price recovery in addition to the dividend.

Canadian Imperial Bank of Commerce common shares: The current dividend yield is 7.5 per cent. No Big 5 Canadian bank has cut its dividend since the 1930s. It is possible they would, but very unlikely. The stock is still trading almost 30 per cent lower than it was in mid-February, but even if the stock price never goes up, and the dividend never rises, 7.5 per cent a year is a decent return. The good news is that both the stock price and dividend are very likely to meaningfully rise during your retirement years.

Bridging Income Fund: Bridging Income is a well-run firm that offers secured private lending and factoring. The fund has delivered consistent annual returns of eight per cent or more, with little correlation to stock markets. It has also provided positive returns for the past 70-plus months without a single negative month. We have worked with the fund since its inception seven years ago, and this has provided investment benefits to our clients.

The above three are clearly not meant to be an investment portfolio, but they represent a sample of what can be purchased today, often at higher yields than normal because of the decline in markets.

Tax and dividend considerations

Usually, the commuted value of a pension is paid out in two forms. The first would be funds that are tax sheltered and paid out into a registered retirement savings plan or similar account. You don’t pay tax on the transfer, but you will pay full income tax on the funds when they are ultimately withdrawn from the account.

The second form usually comes out as a taxable lump sum. There is a maximum transfer value for a pension, with anything above this amount considered taxable income. The general rule is that the larger your annual income as an employee, the higher percentage of your pension payout will likely be taxable. There are some strategies to lower the tax payment, but it is important to fully factor in the tax bill when determining what pension option makes sense.

In the three investments mentioned above, the George Weston and CIBC investments pay out eligible Canadian dividends, while the Bridging Income payout is considered interest income.

For a pension payout, we would hold Bridging Income in a tax-sheltered account. For the Canadian dividends, we are very comfortable holding them in a taxable investment account, because of the low tax rates on this income. Even for someone who has a total taxable income of $90,000, the tax rate on Canadian eligible dividends is just 12.2 per cent in Ontario and 7.6 per cent in B.C. and Alberta.

One of the negatives of a pension is that you don’t have control of the cash flow. It comes in every month, fully taxed, whether you need the cash or not. If you take the commuted value of your pension, you have much more control over cash flow and income, and this can be very valuable over time, as shown by the Canadian dividend income example.

The bottom line is that historically low interest rates along with higher-yielding investments can be a very rare opportunity that comes out of unfortunate circumstances. If your company or organization is strong and you are very risk averse, then keep your pension as is. If you don’t fall into that group, you should at least explore your options, especially now.

Reproduced from the National Post newspaper article 14th April 2020.

Ted Rechtshaffen
Written By:
Ted Rechtshaffen, MBA, CFP
President and CEO
tedr@tridelta.ca
(416) 733-3292 x 221

FINANCIAL FACELIFT: Can this couple still retire in three years after their investments took a major hit?

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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.

gam-masthead
Written by:
Special to The Globe and Mail
Published April 10, 2020

Robert and Rachel have worked hard, raised three children and – thanks to high income and frugal living – amassed an impressive portfolio of dividend-paying stocks, which they manage themselves. When they approached Financial Facelift in February, their combined investments were worth about $2.7-million.

After the coronavirus tore through financial markets last month, their holdings tumbled to a little more than $1.8-million by late March, a drop of roughly $900,000, or 33 per cent. Markets have since bounced but are still well below their February highs.

“The recent market downturn caught us by surprise,” Robert acknowledges in an e-mail, “but we are hoping we can weather the storm.”

Robert, a self-employed consultant, is 57. Rachel, who works in management, is 52. Together they brought in about $285,000 last year, although Robert’s income prospects for this year are uncertain. They have three children, ranging in age from 9 to 19.

“We feel burned out,” Robert writes, “but we have no company pensions or other safety blankets. Can we retire now?”

Leading up to retirement, the couple want to do some renovations costing $100,000 and take up recreational flying, which they estimate will cost about $150,000. Their goal is to quit working in three years with a budget of $100,000 a year after tax. Can they still do it?

We asked Matthew Ardrey, a vice-president and financial planner at TriDelta Financial in Toronto, to look at Robert and Rachel’s situation.

What the expert says

“The rapid decline and subsequent volatility of their investments is a result of how they are investing,” Mr. Ardrey says. Their portfolio is 85 per cent common stocks and 15 per cent preferred shares, the planner notes. “Of the common stock, about 90 per cent is Canadian. This lack of diversification in their investment strategy will affect their retirement plans.”

For the first quarter, major stock markets were down more than 20 per cent, he says. “The fixed-income universe in Canada was up 1.56 per cent for the quarter.” Having some fixed-income securities “would have mitigated the couple’s losses.”

In preparing his forecast, Mr. Ardrey weighs some different situations. He assumes their investment returns from this point forward equal the long-term average for this type of portfolio of 6.25 per cent. This rate of return continues until they retire from work in three-and-a-half years.

When Robert and Rachel retire, the planner assumes they reduce their exposure to stocks and switch to a balanced portfolio of 60 per cent stocks and 40 per cent bonds. This would give them a return of 4.5 per cent. “From there we can compare how much impact this market decline had on their portfolio.”

Their original $2.7-million would have given them a net worth at Rachel’s age 90 of $10-million, adjusted for inflation, including their residence and rental property valued at $5.4-million, Mr. Ardrey says. If they chose to spend all of their investments, leaving the real estate for their children, they could have increased their spending from $100,000 a year to $136,000, adjusted for inflation, giving them a comfortable buffer.

With their current portfolio – about $2.2-million as of April 6 – they would have a net worth of $8.4-million at Rachel’s age 90, including $5.4-million in real estate. They would have the option of increasing their spending to $118,000 a year. “This is half of their former buffer, which is a significant difference,” Mr. Ardrey says.

Even if the markets returned double the couple’s historical rate of return, or 12.5 per cent, from now until they retire, “it would still not make up all of the difference of what they have lost,” the planner says. Their net worth at Rachel’s age 90 would be $9.5-million and they could increase their spending to $130,000.

This market downturn speaks to the value of a balanced, diversified portfolio and professional money management, Mr. Ardrey says. “In so many cases, people try to invest on their own without truly understanding their ability to tolerate risk, or without a financial plan in place” to help them understand the implications of market returns on their retirement.

He recommends Robert and Rachel gradually shift to a professionally managed portfolio that includes both large-capitalization stocks with strong dividends, diversified geographically, and a fixed-income component comprising corporate and government bonds. This strategy could be supplemented with some private income funds – which do not trade on financial markets – to stabilize their returns and potentially enhance their income.

By making this change, they could increase their rate of return in retirement from 4.5 per cent to 5.5 per cent, giving them an additional financial cushion of $12,000 a year. “This would be especially beneficial if markets take a long time to return to their former highs,” Mr. Ardrey says.

The plan assumes Robert will get 85 per cent of Canada Pension Plan benefits and Rachel 75 per cent, starting at age 65. They will both get full Old Age Security benefits.

Fortunately, this couple have ample resources, including real estate, that they can use to insulate themselves against unexpected expenses, Mr. Ardrey says. Many other Canadians who have been investing in the same manner do not. Worse, many investors may have other financial stresses such as a lost job or mounting debts that could force them to liquidate their portfolio at an inopportune time, the planner says.

“What the past month has shown is that there are significant risks to do-it-yourself investing and not having a proper asset mix in place – especially as you approach retirement.”

Client situation

The people: Robert, 57, Rachel, 52, and their three children.

The problem: Can they retire in about three years without jeopardizing their financial security?

The plan: Retire as planned but take steps to draw up a proper financial plan that includes a more balanced investment strategy.

The payoff: Lowering potential investment risk to better achieve goals.

Monthly net income: $16,720

Assets: Cash $32,875; stocks $589,775; capital in his small business corporation $157,080; her TFSA $82,220; his TFSA $57,035; her RRSP $446,145; his RRSP $621,755; her locked-in retirement account from previous employer $76,405; his LIRA from previous employer $184,825; registered education savings plan $81,260; residence $1,800,000; recreational property $650,000. Total: $4.78-million

Monthly outlays: (including recreational property): Property tax $1,215; home insurance $125; utilities $495; maintenance $240; transportation $650; groceries $1,105; clothing $435; gifts $215; vacation, travel $325; dining out, entertainment $385; pets $45; sports, hobbies $625; piano lessons $160; other personal $415; doctors, dentists $200; prescriptions $70; phones, TV, internet $140; RRSPs $1,830; RESP $630; TFSA $915; savings to taxable accounts $7,460. Total: $17,680.

Liabilities: None

Want a free financial facelift? E-mail finfacelift@gmail.com.

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

Matthew Ardrey
Presented By:
Matthew Ardrey
VP, Wealth Advisor
matt@tridelta.ca
(416) 733-3292 x230
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