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.
Special to The Globe and Mail
Published February 17, 2023
Ed and Patti are both 58 and itching to retire from their well-paying jobs. Ed works in education and Patti at a government agency, and their combined salaries total $204,000. Both have pensions indexed to inflation.
“I plan to retire on my 60th birthday in 2024,” Patti writes in an e-mail. Ed hopes to quit in 2027 when he turns 63. However, they plan to work part-time until they begin getting government benefits at age 65, although they’d prefer not to. Their short-term goal is to travel, heading to Europe in the fall and to a hot climate in winter.
They want to stay in their Maritime home as long as they can – then leave it to their two children, now in their late 20s. Their retirement spending goal is $80,000 a year after tax.
We asked Matthew Ardrey, a financial planner and portfolio manager at TriDelta Financial in Toronto, to look at Ed and Patti’s situation. Mr. Ardrey holds the certified financial planner (CFP) and the advanced registered financial planner (RFP) designations.
What the expert says
“Patti and Ed are within striking distance of their retirement, but before they finalize their decision, they want to ensure that they will have the necessary resources in place to make their dreams a reality,” Mr. Ardrey says. Their defined-benefit pension plans are “a luxury today,” the planner says. Many employers no longer offer DB plans, turning instead to defined-contribution plans, he notes. Patti will receive a pension of $27,600 per year, plus a bridge benefit – a payment provided from date of retirement until 65 – of $7,150 per year. Ed will receive a pension of $18,750 per year. All pension figures will be indexed to inflation.
After Ed retires at 63 and Patti at 60, they will work part-time till they turn 65, earning $12,000 per year each.
Their Canada Pension Plan benefits will be about 75 per cent of the maximum. When they are fully retired, they will start taking CPP along with maximum Old Age Security (subject to any OAS clawback). Inflation is assumed to be 3 per cent a year and their life expectancy is assumed to be age 90.
Patti and Ed have two low-interest mortgages, one of which comes due in 2025 and the other in 2026. At the current rate of payment, mortgage one will be retired in 2028 and mortgage two in 2031.
A major concern is the current budget, the planner says. Patti and Ed say they earn $9,745 per month net, but their net income is actually much higher – $12,430 a month. “There is nearly $2,700 each month that is not accounted for. This is a substantial difference.”
Using simple math, from the information they provided, their gross income is $17,008 a month. Subtracting income tax, CPP and EI contributions of $4,635 leaves net income of $12,373 a month. Their spending and savings total $9,745 a month, leaving a surplus of $2,619 a month unaccounted for, the planner says.
“With retirement planned right around the corner, when the ability to earn income becomes fixed, understanding their budget will be imperative for their future financial success,” Mr. Ardrey says. “Without this in place, there is no way to accurately predict their future spending.”
Despite the budget shortcomings, he has used their retirement spending target of $80,000 per year for his projection. That is in addition to the cost of debt repayments.
Their investment portfolio is 97 per cent stocks and 3 per cent cash and bonds, for which the historic rate of return is 5.62 per cent, the planner says. Such a high proportion of stocks is too risky given how close they are to retiring. “They should already be reducing their risk to avoid a potential portfolio decline with a limited time horizon for recovery,” he says.
In retirement, Mr. Ardrey assumes they will move to a balanced portfolio of 60 per cent stocks and 40 per cent fixed income. This reduces the projected return to 4.55 per cent. As most of their portfolio is self-managed, no fees were assumed, the planner says.
“Under these circumstances, Ed and Patti are unable to meet their retirement goal, running out of [investment assets] at age 88,” Mr. Ardrey says. “When the Monte Carlo analysis was used, it showed only a 41 per cent probability of success.” A Monte Carlo simulation introduces randomness to a number of factors, including returns, to stress test the success of a retirement plan, he says.
“To increase the probability of success, they could work longer, spend less, save more or, the ever-unpopular die earlier,” the planner says. For example, Patti could work another three years, to age 63, retiring at the same time as Ed. In addition, they could review their budget and increase their savings by $1,000 per month each from now to the time they retire, he says. They would contribute the extra money to their tax-free savings accounts.
“These two changes have a significant impact on the Monte Carlo simulation, increasing their probability of success to 93 per cent,” Mr. Ardrey says.
“Patti and Ed need to make some tough choices to make their retirement dream a reality,” the planner says. “They first need to get a good hold of their budget and spending so they will have more to spend in retirement.” Second, they need to work longer to increase the time they have to save. “Over all, having defined-benefit, indexed pensions will give them a good base, but they need some extra savings to enjoy some of the sweet things in life.”
The people: Ed and Patti, both 58, and their two children.
The problem: Can they afford to retire early and spend $80,000 a year?
The plan: Track their spending a little more closely to see where the money is going. Plan to increase their savings by $1,000 a month. Patti could consider working three more years so they both retire at the same time.
The payoff: The lifestyle to which they aspire.
Monthly net income: $12,373.
Assets: Cash $6,900; her TFSA $28,700; his TFSA $2,105; her RRSP $45,085; his RRSP $175,770; residence $775,000; estimated present value of her defined-benefit pension $684,865; estimated present value of his DB pension $402,865 (based on 3 per cent inflation and a 5-per-cent discount rate). Total: $2.1-million
Monthly outlays: Mortgages $2,095; property tax $455; water, sewer, garage $65; home insurance $75; electricity $110; heating $250; security $40; maintenance, garden $110; transportation $436; groceries $800; clothing $180; gifts, charity $475; vacation, travel $600; dining, drinks, entertainment $350; personal care $120; club memberships $40; sports, hobbies $50; miscellaneous personal $300; drugstore $10; life insurance $380; cellphones $275; TV $50; internet $130; RRSPs $800; TFSAs 0; pension plan contributions $1,545. Total: $9,745. Unallocated surplus $2,619.
Liabilities: $87,420 at 1.99 per cent due 2025 and $64,140 at 1.92 per cent due 2026.
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Some details may be changed to protect the privacy of the persons profiled.