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FINANCIAL FACELIFT: Can Brandon and Michelle achieve financial independence in six years’ time?

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Below you will find a real life case study of a couple who is 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 & Portfolio Manager, 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 6, 2022

Inspired by the FIRE movement, Brandon and Michelle – both in their mid-30s – have built a portfolio of income-producing properties and dividend-paying stocks they hope will free them soon from having to work. Characterized by extreme saving and investing, FIRE stands for “financial independence, retire early.” It helps if you earn a good income.

Brandon earns $127,000 a year plus bonus and employer pension plan contributions, while Michelle earns $92,000 a year. Their combined employment income totals $238,000.

Michelle has a defined benefit pension plan partly indexed to inflation. They have two children, ages one and three.

Their aspirational goal is to “become financially independent, non-reliant on employment income, before 40,” Brandon writes in an e-mail. Ideally, they could live off their dividends and rental income. Their more realistic goal, perhaps, is to have enough rental and dividend income to allow them to work part-time – “resulting in about 50 per cent of current pay” – in five years or so, Brandon writes.

Their retirement spending goal is $120,000 a year. Achieving it on half the salary will be a challenge.

“When can our passive income cover our expenses?” Brandon asks.

We asked Matthew Ardrey, a vice-president and portfolio manager at TriDelta Financial in Toronto, to look at Brandon and Michelle’s situation. Mr. Ardrey holds the certified financial planner (CFP), advanced registered financial planner (RFP) and chartered investment manager (CIM) designations.

What the expert says

Brandon and Michelle are looking to pull back from full-time work in mid-2028, Mr. Ardrey says. “Before engaging in what would seem like a pipe dream for many Canadians in their mid-30s, they want to ensure they are on secure financial footing,” the planner says.

In addition to their principal residence, they have four rental properties. They also rent out an apartment in their home. Their rental properties generate $1,100 a month, net of all expenses including mortgage payments, and the unit in their home another $1,600 a month. Brandon earns $400 a month for managing a relative’s rental property.

Dividend income from their non-registered accounts is about $2,500 a year, Mr. Ardrey says. Brandon’s $15,000 of employer-matched contributions is going to a defined contribution pension plan. As well, they maximize their tax-free savings accounts and contribute $2,500 per child to their registered education savings plans each year. They have no unused contribution room in their registered plans.

“After all of these savings and their spending, they still have a $50,000 a year surplus, which they put toward non-registered savings,” the planner says. He assumes they divide this surplus 50/50 to maximize tax efficiency. “This amount grows annually at a projected 4.9 per cent rate until they reach semi-retirement and have to use some of it to supplement their lower income,” Mr. Ardrey says. Inflation is projected at 3 per cent.

In mid-2028, he assumes Michelle and Brandon reduce their work by 50 per cent. Brandon will be 39, Michelle 41. Brandon’s bonus and employer contributions to his DC plan end. Michelle’s DB pension contributions drop by half. Brandon is assumed to maximize his RRSP each year based on 50 per cent of his current salary.

Adjusted for inflation, Brandon will be earning $78,000 a year and Michelle $56,000. They’ll have $3,000 in dividend income, $6,000 in property management income and gross rental income of $93,000.

At the same time, their spending is forecast to increase, the planner says. “They feel that in another five years’ time, things will be drastically more expensive. As well, less work will provide more leisure time and increased expenses. Thus, they have requested we estimate spending of $10,000 per month starting when they semi-retire in 2028 and continuing thereafter, adjusted for inflation.”

They will still be about 17 years away from full retirement. They continue working part time until Michelle is 58, when she can get an unreduced pension. “At this point we assume they move to full retirement,” Mr. Ardrey says. Michelle will be entitled to an estimated pension of $37,845. Her pension is indexed 60 per cent to inflation, or 1.8 per cent.

In their first full year of retirement, Michelle’s pension will have risen slightly to $38,526, property management income $10,000 and gross rental income $154,000. The mortgages will be paid off.

At age 65, they will start collecting Canada Pension Plan benefits (estimated at 70 per cent of the maximum) and full Old Age Security. “Under these assumptions, they meet their retirement spending goal of $120,000 a year after tax,” Mr. Ardrey says.

“However, when we stress test the scenario under the Monte Carlo simulator, their probability of success drops to 77 per cent, which is in the ‘somewhat likely’ range of retirement success,” he says. A Monte Carlo simulation introduces randomness to a number of factors, including returns, to test the success of a retirement plan. For a plan to be considered “likely to succeed” by the program, it must have at least a 90 per cent probability of success.

“Looking at their portfolio construction, it is great for accumulation, but the inherent volatility of an all-equity portfolio is less desirable for drawdowns,” Mr. Ardrey says. They have a portfolio of exchange-traded funds with a geographic breakdown of 55 per cent U.S., 25 per cent international and 20 per cent Canadian.

As they approach semi-retirement, Brandon and Michelle could benefit by diversifying their portfolio by adding some non-traditional, income-producing investments, such as private real estate investment trusts that invest in a large, diversified portfolio of residential properties, or perhaps in specific areas such as wireless network infrastructure, mainly in the United States, the planner says. Such investments are not affected by ups and downs in financial markets.

“By diversifying their portfolio, we estimate they could add at least one percentage point to their overall net return – taking it to 5.9 per cent – and significantly reduce the volatility risk of the portfolio.” In conclusion, Brandon and Michelle are on track to achieve something only most Canadians can dream of,” Mr. Ardrey says, “semi-retirement by their early 40s and full retirement before 60.”

Client situation

The people: Brandon, 33, Michelle, 35, and their two young children.

The problem: Can they achieve financial independence in six years’ time, allowing them to work part-time and still spend $120,000 a year?

The plan: Keep saving and investing. Go part-time in 2028 and retire fully at Michelle’s age 58, when she gets her pension. Add some non-traditional, income-producing assets to their investments as they approach retirement.

The payoff: Plenty of time off to reap the benefits of their hard work while they are still relatively young.

Monthly net income: $13,910

Assets: Cash $14,000; exchange-traded funds $100,000; his TFSA $153,000; her TFSA $127,000; his RRSP $154,000; her RRSP $44,000; market value of his DC pension $188,000; estimated present value of her defined contribution pension $125,000; registered education savings plan $46,000; rental units $915,000; residence $605,000. Total: $2.47-million

Monthly outlays: Residence mortgage $1,700; property tax $385; water, sewer, garbage $145; home insurance $70; electricity, heat $255; maintenance $200; transportation $435; groceries $900; child care $415; clothing $230; gifts, charity $375; vacation, travel $300; dining, drinks, entertainment $555; personal care $50; pets $80; sports, hobbies $30; health care $75; communications $130; his DC pension plan $1,000; RESP $415; TFSAs $1,000; her DB pension plan contributions $1,000. Total: $9,745. Surplus $4,165

Liabilities: Residence mortgage $428,000; rental property mortgages $707,000. Total: $1,135,000

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 & Portfolio Manager
matt@tridelta.ca
(416) 733-3292 x230

FINANCIAL FACELIFT: Plans for early retirement need a rethink

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Below you will find a real life case study of a couple who is 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 & Portfolio Manager, 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 March 4, 2022

Ted and Natalie have well-paying management jobs, Ted in the private sector and Natalie in government. He is age 52, she is 51. They have two children, 18 and 21. The younger one still lives at home.

Ted has earned good income over the past five years, averaging about $200,000 a year including commission. His base salary is $115,000. Natalie is making $118,000 a year, plus a bonus that ranges from $5,000 to $25,000.

Natalie and Ted bought a rental property not long ago with a small down payment; the property is barely breaking even.

Natalie recently joined her defined benefit pension plan and wonders whether she should use funds from her previous employer’s registered pension plan to “buy back” service in her new plan.

Ted, who had a recent health scare, is looking to the day they can both retire, travel extensively “while we can,” and winter in a warmer climate. Short term, they want to replace one of their cars and do some renovations to their house. Longer term, their goal is to retire from work in six years with a budget of $140,000 a year after tax.

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

What the expert says

Ted and Natalie have been able to pay off the mortgage on the family home, do some renovations and make other big-ticket purchases thanks to Ted’s substantial commission income and Natalie’s bonus, Mr. Ardrey says. Ted expects this extra income to fall markedly in future, averaging about $10,000 a year each.

“Unfortunately, with the reduction in this extra income, they may not be able to afford even their short-term spending in full,” the planner says. They have enough to pay for their yearly big trip ($10,000), but may not have enough for home renovations ($25,000) or a car purchase ($35,000). “If they want to proceed with these, they may either need to finance them or reduce spending in other areas.”

Ted saves 4 per cent of his salary each month in his defined contribution pension plan, which the company matches. Then he uses the remainder of his RRSP room to contribute to his group RRSP at work. He also makes a $100 contribution each month to his tax-free savings account. Natalie contributes $10,000 a year to her RRSP.

In addition to his DC pension, Ted also has a defined benefit pension that will pay him $26,400 a year when he retires at age 58, not indexed to inflation. Natalie has just joined her defined benefit plan and has the opportunity to buy back service, the planner says.

If Natalie uses the full $226,000 in her DC pension plan to buy back service with her new employer, her pension will increase from $1,000 a month to $2,500 a month, fully indexed, at her age 58. “We recommend she does this.”

Natalie and Ted recently bought a rental property worth $550,000 with a $500,000 mortgage on it. The property earns $2,700 a month gross and zero after fixed expenses. “This is concerning because at best, it is cash-flow neutral and if any ad hoc expenses come up, it will be cash flow negative,” Mr. Ardrey says. In preparing his forecast, he assumes they sell the rental property when they retire.

After all spending and saving are added up, the couple show a surplus that is not accounted for. They said they use the money for unexpected expenses such as car repairs. “Though that makes up some of the surplus, I feel that there is budget leakage in their spending,” the planner says. They should work on improving their budget so they will have a more accurate picture of their retirement needs.

If they retire at Ted’s age 58, they will get reduced Canada Pension Plan benefits. The forecast assumes they start collecting CPP and Old Age Security at age 65. They will get 80 per cent of the maximum CPP benefit at age 65 as well as maximum Old Age Security benefits, subject to any clawback.

Their portfolio is 23-per-cent cash, 32-per-cent bonds and 45-per-cent stocks, Mr. Ardrey says. Of the stocks, 20 per cent are Canadian, 20 per cent U.S. and 5 per cent international. “With headwinds on the fixed-income side because of rising interest rates, the expected return on this portfolio is 3.04 per cent,” he says.

Inflation is now a larger concern for portfolios than it once was and this will likely last for a while, the planner says. “Thus, we are using a 3-per-cent inflation rate in this projection, meaning their investments are barely keeping pace with inflation.” Worse, the mutual funds they hold outside of their group plans have an average management expense ratio of 2.14 per cent. In comparison, the investments in the group plans would be at a relatively low cost.

Taking all of these variables into account, with their spending goal of $140,000 a year, they fall short very early in their projection, running out of savings just 10 years into retirement, in 2038,” the planner says. ”Given this drastic shortfall, we deem this scenario unviable.”

To improve their retirement plan, Mr. Ardrey recommends they hold less cash, add to their stock holdings, and add some income-producing, non-traditional investments such as private residential real estate investment trusts. “These investments provide uncorrelated and steady returns that are in excess of what we are expecting for fixed income today.”

With 55-per-cent cash and fixed income, their portfolio has embedded risk that they likely don’t recognize. “For the past 50 years or so, fixed income has been a safe haven for investing,” the planner says. “This is less so today.” An increase in interest rates leads to a decline in the price of existing bonds. Inflation also poses a risk to fixed-income securities. “If the current rate of inflation is stickier than predicted, the real rate of return on bonds will continue to be negative.”

Earning better returns improves Ted and Natalie’s retirement prospects but more is needed, he says. Mr. Ardrey puts his forecast through computer software known as a Monte Carlo simulation to gauge the likelihood of success given different variables. To improve their likelihood of success, Ted and Natalie will either have to cut their retirement spending by about a third, to $96,000 a year, or delay retiring for six additional years, from 2028 to 2034.

“Unfortunately, there is no magic bullet to retirement planning,” Mr. Ardrey says. “If you cannot achieve your goals, then it typically involves one or more of working longer, saving more, investing better, or spending less.” This is the situation Ted and Natalie must now manage through to meet their goals in the future. “Thankfully, they still have the time to do it.”

Client situation

The people: Ted, 52, Natalie, 51, and their children, 18 and 21

The problem: Can they afford to retire in six years with $140,000 in spending?

The plan: Take steps to improve investment returns, lower retirement spending expectations or plan to work much longer than anticipated.

The payoff: A clear picture of what needs to be done

Monthly net income: $15,100

Assets: Cash $2,000; his RRSP $410,000; her RRSP $235,000; his defined contribution pension $235,000; her DC pension $226,000; estimated value of his DB pension $634,000; estimated value of her DB pension $72,000; his TFSA $17,000; registered education savings plan $27,000; residence $820,000; rental property $550,000. Total: $3.2-million

Monthly outlays: Property tax $450; water, sewer, garbage $120; home insurance $170; heat, hydro $300; maintenance, garden $260; car insurance $235; fuel $700; maintenance $275; parking, transit $300; groceries $1,200; tutoring $400; clothing $250; gifts, charity $350; vacation, travel $1,000; other discretionary $600; dining, drinks, entertainment $1,300; personal care $200; club memberships $50; golf $25; pets $85; subscriptions $65; health care $100; communications $235; his RRSP and DC pension contributions $1,440; registered education savings plan $100; her DB pension plan $1,380; her RRSP $835; his TFSA $100. Total: $12,525.Surplus goes to occasional and unallocated expenses.

Liabilities: Mortgage on rental $501,590

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 & Portfolio Manager
matt@tridelta.ca
(416) 733-3292 x230

FINANCIAL FACELIFT: Have Margaret and Simon saved enough to meet their retirement spending goal?

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Below you will find a real life case study of a couple who is 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 & Portfolio Manager, 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 January 7, 2022

Margaret is age 61 and recently retired. Her husband Simon, who is 70, retired from work five years ago. Although neither has a pension, they have a home in the Greater Toronto Area, a cottage, and substantial savings.

“We are looking for advice on how to draw down our assets for the best tax advantage and longevity of our funds,” Margaret writes in an e-mail. Over the past year or so, they withdrew $100,000 from their savings to lend to their daughter to help with a down payment. As well, they bought a new truck.

Short term, they have some foundation work to do on their cottage and they’re planning a trip to Europe.

Simon is drawing $16,800 a year from his registered retirement income fund. He’s getting $12,170 in Canada Pension Plan benefits and $8,255 in Old Age Security. Margaret recently converted her registered retirement savings plan to a RRIF as well and is wondering how much she should draw. She also wonders when to begin collecting CPP and OAS benefits.

Their retirement spending goal is $8,000 a month, or $96,000 a year, after tax. Have they saved enough?

We asked Matthew Ardrey, a vice-president and portfolio manager at TriDelta Financial in Toronto, to look at Simon and Margaret’s situation.

What the expert says

Margaret and Simon want to take stock of their situation and ensure they will have enough to enjoy their retirement, Mr. Ardrey says. They have investment assets of $800,000 ($76,000 in their tax-free savings accounts and the remainder in RRIFs) plus real estate assets of $2.1-million, which include their home and cottage. The cottage has about $400,000 in imbedded capital gains.

“They are willing to sell the cottage to make their retirement work, “but they want to keep their house. “I would agree with their thinking,” the planner says. “With rising costs of long-term care, I believe in keeping the house aside as insurance against these costs and as a financial buffer in a retirement plan.”

Aside from these assets, they have lent their daughter $100,000 toward a home down payment that she is repaying at 1-per-cent interest over 10 years. As well, they recently bought a truck using funds from their TFSAs. While there are no tax implications from this withdrawal, they might have been better off borrowing the funds, he says. “If they could have financed at a low rate, then they would have been better off doing that than using portfolio assets.”

Simon’s income consists of withdrawals from his RRIF and government benefits, for a total of $37,225 a year. The forecast assumes Margaret begins taking CPP and OAS at the age of 65 because the penalties for taking the benefits earlier are “very punitive and are generally not recommended,” Mr. Ardrey says. “We assume 75 per cent of the maximum CPP and full OAS for Margaret,” which will add another $24,865 a year in future dollars.

They want to spend $8,000 a month starting this year. “Based on the above assumptions, they are not able to meet their objectives,” the planner says.

“The goal of the projection is to have enough to cover their spending until Margaret’s age 90, leaving the principal residence intact to cover off any future health care costs,” he says. To avoid the punitive losses of taking CPP early, they must make additional withdrawals from their RRIFs, which are all taxable.

“They run out of investment assets in 2034, when Simon is 83 and Margaret is 74, where we assume they sell the cottage,” Mr. Ardrey says. Even then, they run out of investment assets a second time in 2047. Margaret, who would be 87, would be forced to sell the house at this time to fund her expenses for the remainder of her life.

“This adds the risk of failure to this projection because she would no longer have the financial cushion,” he says. “Although it could work under ideal conditions, life is not always ideal.”

Although the projection works if she sells the house, “things look worse if the projection is stress-tested using a Monte Carlo simulation,” Mr. Ardrey says.

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 500 iterations with the financial planning software to get the results,” he says. For a plan to be considered “likely to succeed” by the program, it must have at least a 90-per-cent success rate, meaning at least 450 trials out of 500 succeed. If it is below 70 per cent, then it is considered unlikely.

“Even if Margaret sells the house in 2047, the probability of success in this plan is only 51 per cent,” Mr. Ardrey says. “To achieve 100 per cent success with their current portfolio construction, they would need to reduce their spending by almost 20 per cent to $6,500 per month.”

Their current portfolio has an expected future return of 2.82 per cent a year on average, the planner says. This is owing to the 60 per cent weight in fixed income. “By changing their portfolio mix to achieve a 5 per cent return (a 3 per cent real rate of return above 2 per cent inflation), the probability of success jumps to 92 per cent,” he says. In his forecast, Mr. Ardrey uses an asset mix of 60 per cent stocks, 20 per cent non-traditional investments and 20 per cent fixed income. “If in addition they lower their expenses by $500 a month to $7,500, the likelihood of success increases to 100 per cent and removes the need to sell their home.”

For the past 40 years or so, fixed income has been a safe haven for investing, the planner says. “This is less so today.” Fixed income faces risks of rising interest rates. An increase in interest rates leads to a decline in the price of existing bonds. Additionally, it has inflation risk. “If the current rate of inflation is stickier than predicted, the real rate of return on bonds will be negative.” In short, Simon and Margaret need to consider taking on more stock market risk and less interest rate and inflation risk, the planner says.

Client situation

The people: Simon, 70, and Margaret, 61.

The problem: How should they draw on their assets to meet their retirement spending goal? Have they saved enough?

The plan: Strive to cut spending. Plan on selling the cottage and investing the proceeds. Consider professional money management to boost investment returns. Margaret may have to sell the family home at some point.

The payoff: The realization they will have to temper their aspirations.

Monthly net income: $8,070

Assets: Cash in bank $50,000; combined TFSAs $76,000; combined RRIFs $724,000; mortgage to daughter $100,000; grandchild’s education savings plan $23,370; cottage $900,000; residence $1.2-million. Total: $3.07-million.

Monthly outlays: Property taxes $1,000; water, sewer, garbage $80; property insurance $290; electricity, heating $390; maintenance, garden $585; transportation $880; grocery store $895; clothing $40; gifts, charity $525; vacation, travel $350; other discretionary $200; dining, drinks, entertainment $865; personal care $25; club membership $20; pets $600; sports, hobbies $175; subscriptions $140; other personal $25; health care $350; communications $475; grandchild’s registered education savings plan $165. Total: $8,075.

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 & Portfolio Manager
matt@tridelta.ca
(416) 733-3292 x230

FINANCIAL FACELIFT: Can Owen and Emily afford to retire next year and spend winters overseas?

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Below you will find a real life case study of a couple who is 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 & Portfolio Manager, 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 November 5, 2021

Owen and Emily – freelancers in their early 60s – amassed $1.7-million in financial assets the old-fashioned way. No inheritance or real estate windfall helped them. They raised two children, now 22 and 29, and their house in small-town Ontario is fully paid for.

They each draw a salary of $36,000 a year from their corporation, which bills about $130,000 a year.

“The lower cost of living here might have played a small role, but we always spent less than we earned,” Owen writes in an e-mail. “We paid for our house after eight years and we have invested our savings in passive investments, mostly exchange-traded funds, on a buy and hold basis,” he writes.

Emily and Owen are hoping to hang up their hats next year and travel, spending Canadian winters overseas. They wonder whether they can contribute $25,000 a year for a few years for their younger child’s overseas studies. Their retirement spending goal is $70,000 a year, much more than they are spending now.

“What is our best strategy to withdraw our investment money to support our lifestyle?” Owen asks.

We asked Matthew Ardrey, a vice-president, portfolio manager and financial planner at TriDelta Financial in Toronto, to look at Owen and Emily’s situation.

What the expert says

Owen and Emily are looking to retire next summer after years working at a successful business, Mr. Ardrey says. “Before they do, they want to ensure that they have accumulated enough assets to make the switch from earning a living to enjoying retirement.”

They are saving the maximum to their tax-free savings accounts. Any other surpluses are being held in their personal and corporate bank accounts, the planner says. The higher spending they anticipate will be for travelling and “focusing more on enjoying life,” the planner says. Their current spending has likely been constrained by the COVID pandemic, he adds.

Emily and Owen would like to support their son for the next five years while he is overseas by giving him $25,000 a year, Mr. Ardrey says. “If this is not feasible, it’s not necessary, but it’s certainly something they would do if they could.”

Part of what they would like to understand is how to draw down or “decumulate” the assets they hold in their corporation, their registered retirement savings plans and their TFSAs, “not to mention a sizable balance in their cash accounts,” the planner says.

He suggests a fixed draw on the corporate assets to create a steady income stream much like a pension. Spreading out the income they receive also will help keep their tax bill down, he says. “This would provide them with $2,000 per month (total) starting in retirement, indexed to inflation.”

Mr. Ardrey recommends they “melt down” their RRSP assets before they take Canada Pension Plan and Old Age Security benefits. They could take withdrawals of $20,000 each a year, which would create a level income stream until they start collecting government benefits at age 65. The forecast assumes they will get 70 per cent of the maximum CPP benefit.

Before analyzing their retirement cash flow, the planner says he must first analyze their portfolio construction. “If we ignore the large cash balances, which will likely be used to pay for their son’s living costs overseas, they have a portfolio that is about 87-per-cent stocks and 13-per-cent fixed income,” Mr. Ardrey says. “Though that mix is great for accumulation, it has considerable volatility risk inherent in it, which is not appropriate for decumulation,” the planner says.

“On top of the volatility risk, there is significant company-specific risk, with one stock making up 32 per cent of the entire portfolio.” This stock has a huge imbedded capital gain, he notes. “The only saving grace is it is in the corporation, so selling the stock will increase the capital dividend account, allowing for tax-free withdrawal of part of the gain.”

The capital dividend account is funded by the non-taxable portion of a capital gain in a corporation, currently 50 per cent. This account permits tax-free withdrawals from the corporation by the shareholders.

In preparing his forecast, the planner assumes Emily and Owen reduce their stock exposure to 60 per cent in retirement and allocate the remainder to bonds. He assumes a rate of return on investments of 3.84 per cent (historical) and an inflation rate of 2 per cent. “Though adding bonds limits the volatility risk, it lowers the return they can earn, and also adds risks from inflation and interest rate increases,” he says. Even so, running the projection under these conditions allows them to meet their retirement spending goal and help their son with his expenses, Mr. Ardrey says.

“Things change if we stress-test the projection using a Monte Carlo simulation.”

A Monte Carlo simulation is a computer program that introduces randomness to a number of factors, including returns. “In this plan, we have run 500 iterations with the financial planning software,” the planner says. For a plan to be considered likely to succeed, it must have at least a 90-per-cent success rate. If it is below 70 per cent, then it is considered unlikely.

“In the case of Owen and Emily, they achieved a success rate of 89 per cent, so they are just under the likely marker,” he says.

“Owen and Emily’s diligent saving has made it possible for their retirement dream to be realized,” Mr. Ardrey says, “although with their portfolio in its current form, there are certainly some risks they need to address.” By addressing these concerns, he says, “they can improve the likelihood they will achieve all of their financial goals.”

Client situation

The people: Owen, 61, Emily, 62, and their two children, 22 and 29.

The problem: Can they afford to retire next year with a budget of $70,000 a year after tax while still helping their younger child with overseas living expenses? What is the best way to draw down their savings?

The plan: Treat the corporate savings like a pension, making regular monthly withdrawals that rise with inflation. Melt down their RRSPs as much as possible before taking government benefits.

The payoff: A secure retirement with enough money to travel and winter overseas.

Monthly net income: $5,655

Assets: Cash in bank $135,000; cash in corporate account $89,000; stocks in corporate account $766,000; his TFSA $77,800; her TFSA $77,500; his RRSP $280,500; her RRSP $310,450; remainder of registered education savings plan $12,600; residence $700,000. Total: $2.4-million

Monthly outlays: Property tax $380; water, sewer, garbage $115; home insurance $50; electricity, heat $165; maintenance, garden $190; transportation $350; groceries $550; clothing $30; gifts, charity $35; vacation, travel $600; other discretionary $200; dining, drinks, entertainment $215; personal care $10; pets $20; club membership $15; health care $140; communications $95; TFSAs $1,000. Total: $4,160. Surplus of $1,495 goes to unallocated spending and saving.

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 & Portfolio Manager
matt@tridelta.ca
(416) 733-3292 x230

FINANCIAL FACELIFT: Can Sébastien and Sofia afford a new cottage on top of their other financial goals?

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Below you will find a real life case study of a couple who is 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 & Portfolio Manager, 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 September 24, 2021

Sébastien and Sofia are in their late 30s with three children, ages 10, 7 and 5. Sébastien works in education, Sofia has gone back to university to get an advanced degree. Their family income is about $200,000 a year. It will rise once Sofia begins full-time work.

“Thus far, Sofia and I have been very careful with our money,” Sébastien writes in an e-mail. “We have avoided debt and we have done well with our investments,” he says. “Our decisions are rarely based on money and almost always on our values, life goals, and what kind of education we want to offer our kids.” The Montreal couple are planning to move to a larger apartment in the next few years to make more room for their family. They want to give their children the option of attending a private high school if they choose. Private schools in Quebec cost about $7,000 a year. They also want to help with their higher education.

An unexpected opportunity has landed amid these well-ordered plans: Sébastien and his brother have been asked whether they’d like to buy the family cottage, a small, three-season place that requires extensive rebuilding. “It’s been in the family for three generations,” Sébastien writes. After the renovation, each family would spend some time at the cottage, and rent it out when they’re not there to help cover expenses.

Can they do it without jeopardizing their other goals? Sébastien asks. If so, how should they finance the purchase and renovation?

“We are not too worried about retirement, but we are more concerned about the period when the kids will go to high school,” he writes.

We asked Matthew Ardrey, a vice-president, portfolio manager and financial planner at TriDelta Financial in Toronto, to look at Sébastien and Sofia’s situation.

What the expert says

If they decide to buy and renovate the family cottage, Sébastien and Sofia will be sharing the cost with Sébastien’s brother 50/50 and expect the total amount to be $550,000, of which Sébastien and Sofia would pay $275,000, Mr. Ardrey says. To pay for the purchase and rebuilding, they have three options: Sébastien and Sofia could sell some securities and pay cash for their portion; together the partners could get a mortgage on the cottage at 2.39 per cent; or Sébastien’s brother could borrow against his condo at 1.05 per cent, with both partners being responsible for the loan.

“Selling securities will result in capital gains and a loss of investment income,” Mr. Ardrey says. “This would only make sense if they could set it up as a Smith Manoeuvre, making the loan interest tax-deductible,” he says. (If they sell some securities to pay for the cottage and then reborrow to reinstate the investments, the interest on the debt would then be tax-deductible.) They would need to compare the cost of taxes on capital gains against tax savings from deductible interest payments.

Financing with a mortgage is most likely the best option, the planner says. “The cost of debt today is very low, and as long as they can exceed the cost of debt with their investment returns, it is the preferable choice.” Their mortgage payments would be about $11,680 a year.

Though the rate of interest would be lower borrowing against the brother’s condo, they should try to avoid mixing business with family, Mr. Ardrey says. “If for any reason their financial circumstances change for the worse, their brother should not pay the consequences.”

In his forecast, Mr. Ardrey assumes they can get a mortgage for 80 per cent of the value. The remaining capital will come from Sofia’s portfolio because her income is lower and the tax consequences from the capital gains will be less.

Aside from the cost of the mortgage, Sébastien and Sofia expect the net effect on their budget will be an increase in spending of about $1,200 a year because they plan to rent the cottage out part-time to cover some of the costs. As well, having it will lower other vacation costs.

The forecast assumes Sébastien and Sofia move to a larger apartment in 2023, increasing their rent from about $1,500 to $3,000 a month.

Their single largest spending year shows an increase of $26,500 with higher rent, private high school and cottage mortgage payments, Mr. Ardrey says. “That being said, with Sofia’s increased income, their annual surplus savings remain in the $25,000 to $30,000 range,” the planner says. “So there is a significant amount of cushion to deal with these added expenses.”

Sébastien and Sofia save $625 a month in a registered education savings plan toward their children’s higher education. Assuming a cost of $15,000 a year, including living expenses, for postsecondary education (lower due to Quebec’s lower tuition fees), they would be able to cover undergraduate degrees in full for their first two children and two-thirds of the cost for their third child. He assumes any shortfall is covered by Sébastien and Sofia from their personal investments.

Sofia and Sébastien make their annual maximum contributions to their tax-free savings accounts and save another $6,000 a year to Sofia’s registered retirement savings plan. Sébastien also contributes $920 a month to his defined benefit pension plan at work. “They note a surplus of around $49,500 a year in their questionnaire,” Mr. Ardrey says. They have already saved $27,000 as of the end of August. Thus any surplus is assumed to be saved.

“As their income increases and expenses like private school end, their surplus grows substantially and so we assume their annual savings do as well,” the planner says.

Sébastien and Sofia plan to retire at age 65, when they will get full Canada Pension Plan and Old Age Security benefits. Sébastien’s pension will pay him $60,280 a year, indexed to inflation. Their retirement spending goal is $80,000 a year after tax.

Their current asset mix is 4 per cent cash, 4 per cent fixed income, 11 per cent preferred shares and 81 per cent equities, which in turn are divided 47 per cent Canada, 41 per cent U.S. and 12 per cent international and emerging markets. This portfolio has had a historical return of 5.03 per cent. They are investing using stocks and exchange-traded funds, which keep costs down, so the planner assumes an average investing cost of 0.25 per cent.

“In retirement we assume that they need to make their portfolio more conservative to avoid the inherent volatility in their current mix,” Mr. Ardrey says. “We assume they move to a 60/40 equity/fixed income portfolio, which lowers their returns to a historical 3.84 per cent.”

Sébastien and Sofia can make their retirement goal with ease, the planner says. “In fact they could more than double their spending and still have funds left over.”

Client situation

The people: Sébastien, 38; Sofia, 39; and their three children.

The problem: Can they afford to buy and renovate the family cottage in partnership with Sébastien’s brother without jeopardizing their other goals? How should they finance it?

The plan: Take out a mortgage to finance 80 per cent of their share of the cottage, selling securities from Sofia’s portfolio to pay for the rest. Continue saving their substantial surplus.

The payoff: All goals achieved.

Monthly net income: $12,600

Assets: Cash $14,500; his stocks $401,455; her stocks $146,000; his TFSA $130,765; her TFSA $135,670; his RRSP $120,345; her RRSP $96,990; estimated present value of his DB pension $157,500; RESP $85,000. Total: $1.29-million

Monthly outlays: Rent $1,540; home insurance $40; electricity $30; car rental $200; other transportation $140; groceries $900; child care $420; clothing $200; gifts, charity $200; vacation, travel $500; dining, drinks, entertainment $380; personal care $20; sports, hobbies $500; subscriptions $20; dentists, drugstore $20; health, dental insurance $70; life, disability $90; communications $145; RRSPs $500; RESP $625; TFSAs $1,000; his pension plan $920. Total: $8,460. Surplus of $4,140 goes to non-registered savings account.

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 & Portfolio Manager
matt@tridelta.ca
(416) 733-3292 x230

FINANCIAL FACELIFT: Can Ben and Lucy retire in their 40s on just one income?

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Below you will find a real life case study of a couple who is 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 & Portfolio Manager, 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 July 9, 2021

Ben and Lucy are in their early 40s with two children, no company pensions and a burning desire to retire very early. Lucy earns $59,000 a year, Ben $79,000 a year. Both have mid-level management jobs.

They own a $1.4-million house in Toronto – their former home – that they rent out for $3,600 a month. Last fall, they moved to a smaller community not far from the city, where they bought a house valued at $850,000. They have about $1.2-million of debt.

“What we would like to know is the best path to achieve a retirement with $55,000 a year income after tax,” Ben writes in an e-mail. “My wife is planning to quit her job soon.” Once Lucy stops working, Ben wonders how much longer he will have to work to achieve their spending target. “Should we sell the house in Toronto as soon as possible and pay off the mortgages and the home equity line of credit?” Ben asks. They would invest the net proceeds. Ben is anticipating a $400,000 inheritance in about 10 years.

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

What the expert says

Lucy plans to stop working by month end, just before she turns 45, Mr. Ardrey says. Working from home during the pandemic led her to conclude she needed to spend more time with the children. Ben plans to retire in about 10 years, if possible, when he is 51.

They have an investment portfolio of about $770,000 in various accounts, invested in geographically diversified equities. The one exception is the leveraged investment account worth $447,000, which is all invested in the iShares S&P/TSX Composite High Dividend Index ETF. In addition to their investment portfolio, they own their home worth $850,000 and a rental property valued at $1.4-million.

Against these investments, they have a $473,000 mortgage on their principal residence, a mortgage and line of credit totalling $371,000 against their rental property and a loan of $385,000 against their investment portfolio, the planner says. These loans, other than the line of credit, come up for renewal in the next three or four years.

“With $1.23-million of debt, the risks associated with rising interest rates are considerable, especially when mixed with a reduction in family income,” Mr. Ardrey says.

Ben and Lucy are not setting aside money for retirement at the moment, but Ben is expecting a large inheritance. “Typically, I would exclude an inheritance from any financial projection unless it is quite certain, which in this case Ben feels it is.”

One of the main questions Lucy and Ben ask is whether they should sell their rental property or keep it. Mr. Ardrey prepared two scenarios. In the first, they keep the rental property. It earns them $3,600 a month gross, less expenses of $1,195 and debt repayment costs of about $1,330.

Ben and Lucy have been living frugally, spending about $43,000 a year excluding debt repayment, rental costs and savings. They want to loosen the purse strings a bit in a few years, increasing their spending to $55,000 a year to cover home repairs, a new car, children’s activities and more travel. Without Lucy’s income, they will need to draw about $3,000 a year from their investments, increasing to about $15,000 a year once they hike their spending.

Their current rate of return on their portfolio is 6.14 per cent, less an average management expense ratio of 0.29 per cent, for a net return of 5.85 per cent. “To maintain their asset mix at 100 per cent equities once Ben stops working would be very risky,” Mr. Ardrey says. So in preparing his forecast, he assumes they move to a balanced asset mix of 60 per cent stocks and 40 per cent bonds at Ben’s retirement. This lowers the rate of return to 4.1 per cent gross and 3.81 per cent net of MERs. When Ben receives the inheritance, the planner assumes they catch up with their contributions to their tax-free savings accounts and make their annual maximum contribution thereafter.

“In the first scenario, they can achieve their retirement goal, though with very little financial cushion if the rental property is never sold,” Mr. Ardrey says. Though there is a net worth of $7.7-million at Ben’s age 90, it is almost entirely real estate.

In the second scenario, they sell the rental property in 2022 and retire all of the associated debts. Based on a cost base of $790,000 there is a capital gain of $660,000. This capital gain is reduced by estimated selling costs of 5 per cent, or $72,500, making the net gain $587,500. The same investment drawdown and rate of return figures apply in this scenario. The one change is they fund their TFSAs earlier using the proceeds of the rental sale.

“In the second scenario, they can also achieve their retirement goal and have more financial cushion when doing so,” Mr. Ardrey says. Their net worth is $6.8-million at Ben’s age 90, but they are able to spend $24,000 more than their target each year – or $79,000 – from Ben’s retirement to his age 90, adding much more financial flexibility.

“Looking at these scenarios, it is apparent that there are some major risks to their retirement success,” the planner says. The first is future interest rates. “With so much debt, a rise in interest rates could have a significant impact on their monthly costs,” the planner says. The second risk is rates of return. Given the more than 50-year time horizon, Mr. Ardrey used what is called a Monte Carlo simulation – a software program – to stress-test the success of the couple’s retirement plan. For a plan to be considered “likely” to succeed, it must have at least a 90-per-cent success rate. Less than 70 per cent is considered “unlikely.”

Both the first and second scenarios fall into the “somewhat likely” category, with success rates of 75 per cent and 86 per cent, respectively. Because this is below the 90 per cent threshold, Mr. Ardrey suggests some changes to their portfolio allocation, replacing a portion with private investments such as real estate investment trusts or mortgage investment corporations.

To invest in these asset types, they will need to access them through an investment counsellor who could charge 1.5 per cent a year, tax deductible on non-registered accounts, he says. Such investments carry risks, but may lessen the reliance on traditional fixed-income securities on which yields are historically low.

Client situation

The people: Ben, 41, Lucy, 44, and their children, 7 and 9.

The problem: After Lucy quits this month, how much longer will Ben have to work to achieve a retirement spending target of $55,000 a year? Should they sell their rental property to pay off debt?

The plan: The scenario in which they sell the rental and pay off their debts offers a greater degree of security and allows them to spend even more if they choose to. Consider diversifying the investment portfolio into private, income-producing assets such as REITs.

The payoff: The path forward they are asking for.

Monthly net income: $14,030

Assets: Cash $19,000; ETFs $447,470; his TFSA $170; his RRSP $132,490; her RRSP $127,365; RESP $62,190; residence $850,000; rental property $1.45-million. Total: $3.09-million

Monthly outlays: Home mortgage $1,725; property tax $370; home insurance $100; utilities $385; transportation $180; groceries $950; clothing $50; line of credit $400; other loans $2,570; gifts, charity $120; rental property fees, tax, maintenance $1,195; dining, drinks, entertainment $250; pets $40; sports, hobbies $600; subscriptions $20; children’s activities $240; life, disability insurance $80; phones, TV, internet $190; RESP $165. Total: $9,630

Liabilities: Residence mortgage $472,915; rental mortgage $182,475; HELOC $188,430; investment loan $385,155. Total: $1.23-million

 

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 & Portfolio Manager
matt@tridelta.ca
(416) 733-3292 x230
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