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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

FINANCIAL FACELIFT: Can Richard and Jane afford an expensive renovation without infringing on Jane’s retirement plans?

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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 28, 2021

Richard is 59, retired and collecting a defined benefit pension, not indexed, of $39,660 a year. He also has substantial savings and investments. Jane is 53 and works in health care, earning about $80,000 a year. She has recently joined her pension plan at work and has the option of buying back some years of service. She wonders if it makes sense financially to do so. She hopes to retire from work at age 60.

They also wonder whether they can afford a major renovation to their small-town Ontario house without infringing on Jane’s retirement plans.

“Can we afford to indulge our interest in architecture with a major modern home renovation valued at $300,000 and still have Jane retire when she turns 60 years of age?” Richard asks in an e-mail. Their house is valued at $700,000 with a $215,000 mortgage that they took out some time ago to invest. As a result, the mortgage interest is tax-deductible. They have cash and short-term investments of about $139,000.

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

What the expert says

Jane is earning $73,320 a year, plus $6,800, which her employer contributes to her registered retirement savings plan, Mr. Ardrey says. Jane and Richard maximize their tax-free savings account contributions annually. Any surplus they earn is being saved for their renovation, planned for 2022.

With no buyback, Jane’s pension will be $9,360 a year at age 60 indexed to inflation plus a bridge benefit of $2,280 until age 65. If she purchases the buyback for $168,000, the pension increases to $18,840 at age 60 plus a bridge of $4,560.

To fund the buyback, Mr. Ardrey assumes Jane transfers her existing RRSP and locked-in retirement account, which together amount to $114,000, to her pension plan. The remainder would come from their $50,000 guaranteed investment certificate and $4,000 from the joint bank account. “Whether or not she chooses the buyback will impact the funding for the renovation, so we will look at each scenario independently,” Mr. Ardrey says.

The average rate of return for their investment portfolio is 5.16 per cent, with an average management expense ratio of 0.29 per cent – resulting in a net return of 4.87 per cent. The assumed rate of inflation is 2 per cent.

They estimate their Canada Pension Plan benefit will be $1,100 a month for Richard and $1,000 a month for Jane at age 65. The forecast assumes they take Old Age Security benefits at age 65 as well.

In the first scenario, Jane does not take the pension buyback. They take all of their cash savings, which amount to $150,000 by mid-2022, for the renovation, financing the rest of the work on their line of credit at a rate of prime plus 0.5 percentage points, or 2.95 per cent. The forecast assumes they pay this off over 10 years.

“Using the cash, which has a negative real rate of return after inflation and taxes, is a good place to start,” the planner says. For the remainder, using debt over cashing in investments is preferred. With a rate of interest of only 2.95 per cent, the “hurdle rate” to earn more than that on their investments is low.

“That being said, they certainly have the assets to pay off the entire renovation,” Mr. Ardrey says. If they were to pay for it all with investment proceeds and then borrow against the line of credit to re-establish those investments, the interest would be tax-deductible.

“They should watch interest rates,” the planner says. “If rates rise, the hurdle rate would become higher and it may be more beneficial to pay off the debt rather than reinvest it.”

In retirement, they plan to spend $65,000 a year after tax and adjusted for inflation. At Jane’s age 90, there will be an estate of $8.4-million (with inflation), including investments and real estate. “If instead of leaving a large estate, if they exhaust all of their investment assets, leaving only real estate, they can increase their spending in retirement by $48,000 per year,” Mr. Ardrey says.

In the second scenario, he looks at what happens if Jane takes the pension buyback. “As this impacts their cash savings for the renovation, they will need to borrow $210,000 from the line of credit,” he says. The result is surprisingly similar. “With the increased pension and larger loan, we would expect to see a difference, but in fact the two scenarios play out almost identically,” the planner says.

“The most likely reason is the rate of return used in the forecast and the discount rate for the pension plan are virtually the same,” Mr. Ardrey says. (The discount rate is the rate of return assumed by the actuaries when calculating the current value needed to fund a future pension.)

Since the quantitative factors are identical, Jane and Richard need to look at other factors when making the pension buyback decision. These would include Jane’s life expectancy, the expected rate of return on the portfolio, their willingness to assume the investment risk versus the certainty of receiving pension income, the need for financial flexibility and how much interest rates are expected to rise over time.

“The main risk in each analysis is the asset mix of their investments,” Mr. Ardrey says. Their asset mix is 10 per cent cash, 3 per cent fixed income, 35 per cent preferred shares, 4 per cent in alternative investments and 48 per cent equities, of which about 80 per cent is in Canadian stocks or stock funds. “With about 75 per cent of their portfolio invested in Canadian stocks and preferred shares, some additional geographic diversification would be beneficial,” he says.

With preferred shares, an increase in interest rates can lead to a decline in value. As well, preferred shares can be more volatile than their traditional fixed-income counterparts such as corporate bonds, he adds.

Dividend income could also affect Old Age Security benefits. “Dividends are grossed up and an offsetting dividend tax credit is given to reduce the overall tax payable. The problem with this is that the grossed-up dividend is used in the OAS calculation, increasing the chances for the OAS clawback.”

To increase their diversification, Richard and Jane might consider adding some real estate investment trusts, private or publicly traded, to their investment mix, the planner says. “REITs that invest in a large, diversified residential portfolio or perhaps specific areas like wireless network infrastructure are preferable to one that has a large exposure to retail,” Mr. Ardrey says.

Client situation

The people: Richard, 59, and Jane, 53.

The problem: Can they afford an expensive renovation? Should Jane buy back some pension benefits?

The plan: The pension decision depends on considerations such as investment expectations, risk tolerance and their outlook for interest rates. Diversify their portfolio geographically.

The payoff: A clear view of their options.

Monthly net income: $8,820

Assets: Cash $89,000; GIC $50,000; his non-registered stocks $360,000; his private investment $60,000; his TFSA $100,000; her TFSA $88,000; his RRSP $510,000; her RRSP and locked-in retirement account $114,000; his defined contribution pension plan $100,000; estimated present value of his pension $700,000; his locked-in retirement account $52,000; residence $700,000. Total: $2.9-million

Monthly outlays: Mortgage $905; property tax $380; home insurance $50; utilities $180; maintenance, garden $320; transportation $755; groceries $670; clothing $135; gifts, charity $305; vacation, travel $670; dining, drinks, entertainment $630; personal care, club membership $55; pets $150; sports, hobbies, subscriptions $170; health care $115; disability insurance $70; communications $275; RRSP $565; TFSAs $1,000. Total: $7,400

Liabilities: Mortgage $215,000

 

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: Couple whose income has taken a big hit want to sell home and retire early by ‘leaning hard into dividends’

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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 12, 2021

A year ago, Frannie and Frank were earning a combined $100,000 a year after tax, Frannie in a restaurant, Frank in a bar. The value of their two-bedroom condo townhouse in Toronto was rising by the month.

Then the COVID-19 pandemic hit and they were out of work. Frannie is 37, Frank 31. They’ve managed to earn some money since then but they’re a long way from making ends meet.

“We are needing to make some huge and life-altering decisions,” Frannie writes in e-mail. Since they can’t foresee their income rebounding any time soon, they have decided to sell their townhouse. They plan to rent and invest the profit.

“Our thoughts are to lean hard into dividends,” Frannie adds. They’ve set their sights on one Canadian closed-end dividend income fund, attracted by its double-digit distribution. “How do we invest the dividends? Is this plan too high-risk? When can we retire? Can we retire?!?” Ideally, they’d like to hang up their hats at age 55 with $62,000 a year after tax to spend.

We asked Matthew Ardrey, a vice-president and portfolio manager at TriDelta Financial in Toronto, to look at Frannie and Frank’s situation. Mr. Ardrey also holds the certified financial planner and advanced registered financial planner designations.

What the expert says

“With the ultra-hot real estate market in the city, Frannie and Frank should have no problem selling their home and getting the price they want,” Mr. Ardrey says. They expect to get $950,000. They will pay off their mortgage of $377,500 and cover selling costs, estimated to be $66,500.

They plan to look for a smaller apartment for $2,000 plus $200 for utilities and parking. “This move will save them $650 per month in expenses.”

When the house closes, they plan to spend $7,000 on a vacation, leaving them with $499,000. They will both top up their tax-free savings accounts for a total of $120,000. “They may want to consider placing some funds aside for an emergency fund.”

Frank and Frannie plan to use the income from their investments to supplement their living expenses. They wonder whether their fund of choice is too risky.

“Aside from the risk of putting all their eggs in one basket, a deeper review of this fund has revealed a number of concerns,” Mr. Ardrey says. It boasts a yield of 10.97 per cent. “With a yield that high, how the distributions are generated is of utmost importance,” he says. “The fund does not hold anything that would generate that high a yield.” Instead, it generates its returns mainly through capital gains and return of capital; that is, giving investors some of their own money back.

When return of capital to unitholders becomes substantial, it can depress the value of the fund, Mr. Ardrey says. The fund’s return on capital has been around 47 per cent a year for the past four years – with the exception of 2019, when it was 88 per cent. Typically, fund distributions come from dividends and capital gains. In 2019, those accounted for only 12 per cent of the distribution. “For the rest, they had to encroach on capital.” The balance of the distribution for the past four years came mainly from capital gains – “not very typical of an income fund.”

The question is how long the fund company can sustain such high distributions, he adds. “What would happen if markets went through a prolonged downturn? It would likely be an unsustainable distribution.”

Finally, this fund locks in their investments, Mr. Ardrey says. Frank and Frannie would be able to redeem only once a year and when they do, they will get only 95 per cent of the value. “This is not an investment I would recommend they undertake.”

Instead, Mr. Ardrey looks at how the couple would fare with a diversified portfolio of 75 per cent equities and 25 per cent fixed income, and a historical rate of return of 4.78 per cent. If they invest with an online portfolio manager, they would pay 0.65 per cent in fees, leaving them with 4.13 per cent.

Frannie’s income is $19,000 a year, which she expects to remain static post-COVID, the planner says. Frank expects his income to rise from $44,000 back to its historical average of $56,000. The investment income alone will not be sufficient to meet the couple’s ongoing needs. They would need to start drawing down $4,000 a year of capital in 2022, increasing by $2,000 every few years, he says. “As time goes on, the frequency of these increases will rise as the capital pool diminishes.” By the time Frannie reaches age 55, the annual capital withdrawal would be $12,000 a year.

If they retire that early, Frannie will be entitled to 30 per cent of the maximum Canada Pension Plan benefit at age 65 and Frank 60 per cent, he estimates. The inflation rate is forecast at 2 per cent a year. “Based on these assumptions, they will run out of capital by 2051, when Frannie is 68 and Frank is 61.”

What if they worked another decade to age 65 and invested in the same portfolio? Working longer would have the effect of increasing their CPP benefits to 40 per cent of the maximum for Frannie and 75 per cent for Frank. “However, it would also add to the length of time they would need to be making pre-retirement withdrawals.” By the time Frannie retired at age 65, they would be withdrawing $22,000 a year.

“Leaving all other assumptions the same, they would still not be able to achieve their retirement spending goal,” Mr. Ardrey says. They would run out of capital by 2072, when Frank is 82 and Frannie is 89.

To improve their return, he recommends they hire an investment counselling firm and invest in a diversified portfolio of stocks, bonds and alternative income funds. Good-quality private income funds have returned 7 per cent to 9 per cent over the past few years with virtually no correlation to stock markets, he says. Private funds do have liquidity risk because they are subject to redemption periods.

“A portfolio like the one described above should be able to earn them 5 per cent net of investment costs or 6.5 per cent before,” the planner says. “With this change, they will reduce the amount needed from the portfolio pre-retirement,” he adds. They would start with $1,000 in 2026 and end with withdrawals of $14,000 when they retire. “So the improved returns delay the withdrawals by four years and reduce the amount needed at retirement by 36 per cent.”

These changes would be enough to put Frank and Frannie on the positive side of the ledger, but “the margin for error is very small.” They would be left with $575,000 at Frank’s age 90.

“So in addition to delaying retirement and improving their investment return, they must find a way to earn more income or reduce their expenses further,” the planner says. Because Frannie is in a lower tax bracket, the ideal would be for her to earn at least another $10,000 gross a year, he says.

Client situation

The people: Frank, 31, and Frannie, 37.

The problem: How should they invest the proceeds of their house sale? When can they afford to retire?

The plan: Invest in a diversified and balanced portfolio. Plan on working to age 65. Strive to make at least another $10,000 a year.

The payoff: A realistic assessment of what they need to do to achieve their goals.

Monthly net income (budgeted): $4,360

Assets: Bank $13,710; non-registered $17,020; her TFSA $10,105; his TFSA $1,520; residence $950,000. Total: $992,355

Monthly outlays: Mortgage $1,775; condo fee $475; property tax $250; utilities $240; home insurance $90; maintenance $25; transportation $600; groceries $720; clothing $100; gifts, charity $35; vacation, travel $0; dining, drinks, entertainment $0; personal care $50; sports, hobbies $65; pets $205; subscriptions $30; other personal $100; health care $30; phones, TV, internet $225. Total $5,015. Shortfall comes from savings. (Discretionary spending on travel, dining out, entertainment has been suspended.)

Liabilities: Home mortgage $377,500

 

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: B.C. couple want to achieve a ‘working optional’ lifestyle

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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 22, 2021

Benjamin has worked hard over the years building a successful – and valuable – professional practice. Now he’s wondering whether he should sell his half-interest in the business or simply lean back and collect dividends. He’s getting $135,000 pre-tax in dividend income. Benjamin and his artist wife Esther are 57 with two adult children.

Benjamin’s goal is to achieve a “working optional” lifestyle by the time he is 60. His plan is to work one day a week. He and Esther have a house in British Columbia valued at $950,000 with a mortgage of $580,000. Their retirement spending goal is $96,000 a year after tax.

Benjamin estimates the value of his practice at anywhere from $1.5-million to $4-million. “I don’t need to sell at this time,” Benjamin writes in an e-mail. As long as the business is profitable, “I could just hang on and collect dividends.” What he’s trying to figure out is how much he would have to sell his practice for to match or surpass his dividend income. “Could I do better by investing the proceeds elsewhere?” he asks.

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

What the expert says

“The key question for Benjamin and Esther is to determine how much they need to sell the practice for in order to break even with the future stream of dividends from Benjamin’s business,” Mr. Ardrey says. He assumes the dividends continue to be $135,000 a year, growing at the rate of inflation.

Benjamin feels that at a minimum he would be able to sell his half of the practice for $1.54-million, the planner says. “According to conversations with his accountant, he would be able to shelter almost the entire amount with his remaining capital gains exemption, only having to pay $41,000 through alternative minimum tax,” he says. “Thus for purposes of this comparison, we will assume that Benjamin receives a payment of $1.5-million after-tax in 2023.”

Benjamin and Esther estimate they are spending $7,840 a month, which includes their mortgage payments of $2,425 a month. Once the mortgage payments, the savings to Benjamin’s registered retirement savings plan and to Esther’s tax-free savings account are subtracted, this leaves spending of $4,515 a month.

“Benjamin confirmed that anything not being saved is being spent,” Mr. Ardrey says. “When I ran a budget analysis for them, this amounted to $3,500 per month unaccounted for,” he adds. “This is a significant difference because it almost doubles their post-mortgage expected lifestyle expenses.”

Because of this significant discrepancy, the first thing that Esther and Benjamin need to review is their budgeting, the planner says. “If they are going to retire with a specific amount of spending in mind, they should understand where those dollars are going now so they can plan for their future,” he says. “With that in mind, I have included the additional $3,500 a month in their spending budget” both now and after they retire.

Next, to determine a breakeven amount required from the sale of the practice versus the dividend income stream, the planner estimates a rate of return on the couple’s investment portfolio. “Benjamin feels that returns of 10 per cent are the minimum he would expect,” Mr. Ardrey says. That’s based on Benjamin’s experience as a self-directed investor over the past decade. “That assumes they are fully invested in equities in a portfolio focused on value and dividend income throughout the remainder of their lives,” the planner says.

“When I entered an asset mix of all equities, ignoring the 25 per cent Benjamin is holding in cash today, the historical rate of return that the program produced is 5.67 per cent,” the planner says. He assumes this will all be direct stock investment with no management fees. “I used 5.67 per cent in all the projections, feeling that the 10 per cent figure was too high,” Mr. Ardrey says, “especially because they would have to draw on this portfolio and would need to have some diversification away from equities in the future.”

In the first scenario, Benjamin retires but maintains the dividend income stream, never selling his interest in the practice. As additional cash becomes available from registered retirement income fund (RRIF) withdrawals, and then from paying off their mortgage, Esther and Benjamin use the surplus cash flow to maximize their TFSAs, where they have unused contribution room.

At their age 90, they have a net worth in future dollars of $7.3-million, of which $4.7-million is tied up in their home and Benjamin’s practice, Mr. Ardrey says.

In the second scenario, Benjamin sells his practice for $1.5-million and Esther and Benjamin maximize their TFSAs upon the sale. Benjamin asked whether he should pay off his mortgage. With rates as low as they are today, they are better off investing than paying down debt, the planner says. This second option leaves them with a net worth of $5.6-million at the age of 90.

“To reach an equal number at age 90, Benjamin would need to increase the selling price by $275,000 to $1,775,000, assuming the additional amount was taxed as a capital gain upon receipt,” Mr. Ardrey says.

“Out of interest, I ran a third scenario in which the rate of return was 4.67 per cent rather than 5.67 per cent,” the planner says. If that were to occur, Benjamin would have to sell his practice for more than double – $3.05-million – to reach the same outcome as the first scenario, he says. “So the rate of return and its consistency is very important.”

Maintaining a 100-per-cent equity portfolio throughout retirement is risky. Esther and Benjamin should diversify their portfolio to help smooth out the volatility, the planner says. This becomes increasingly important as they draw on the portfolio. “Withdrawing money in down markets crystalizes losses,” he says.

Benjamin and Esther can look at traditional diversifiers such as fixed-income securities, which often do not move in correlation with stocks and so can be drawn upon when stock prices are down. But what they would gain in liquidity they would give up in returns, he says. “The prospect of yields beyond 2 per cent to 3 per cent in this asset class would not be expected.”

To increase their diversification and, one hopes, improve returns, Esther and Benjamin could consider alternative investments such as private income funds, Mr. Ardrey says. Not only have these investments offered solid returns, they have virtually no correlation to stock markets, he adds. “So as markets go up or down, the returns on these investments remain consistent.” Mind you, private debt funds do have liquidity risk and may be subject to set redemption periods, the planner says.

Client situation

The people: Benjamin and Esther, both 57, and their children.

The problem: Should Benjamin sell his practice or hold on to it and continue collecting dividends from the business?

The plan: First, get a firm handle on spending. Benjamin should temper his rate of return expectations. Consider adding some private debt funds to their portfolio.

The payoff: A better understanding of how to make optimal financial choices as they arise.

Monthly net income (budgeted): $11,845

Assets: Cash in bank $8,000; non-registered stocks $100,000; his TFSA $9,000; her TFSA $7,000; his RRSP $120,000; her RRSP $155,000; residence $950,000; Benjamin’s business $1,500,000. Total: $2.8-million

Monthly outlays: Mortgage $2,425; condo fee $160; property tax $150; water, sewer, garbage $175; home insurance $90; electricity, heat $140; maintenance, garden $250; transportation $535; groceries $600; clothing $200; gifts, charity $175; vacation, travel $500; other discretionary $100; dining, drinks, entertainment $400; personal care $75; club membership $25; pets $50; sports, hobbies $250; subscriptions, other $150; health care $220; life insurance $195; phones, TV, internet $75; RRSP $500; TFSA $400. Total: $7,840. (Does not include unallocated surplus spending of $3,500.)

Liabilities: Home mortgage $580,000

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: Can Ted retire at year end and spend $150,000 a year?

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Below you will find a real life case study of an individual 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, 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 20, 2020

A retirement activity for Ted, fishing.

Ted wants to retire from work as a self-employed consultant at year end when his current contract expires. He is 58 and single with no dependants.

Years of running a successful business have left Ted with more than $2-million in his corporate investment account. He also has a mortgage-free house in Toronto and a defined benefit pension from a previous employer that will pay him $24,000 a year, indexed to inflation, starting at the age of 65.

“If I retire now, how much could I safely draw per year from my investments and in what order?” Ted asks. “What would be the most tax-efficient way to draw down the corporate funds?” His investments comprise a mix of dividend-paying exchange-traded funds and index funds. “What return should I expect and what asset mix would you recommend?” he asks. “Do you see any gaps and what would be your suggestions to correct them?”

Longer term, Ted might exchange his house for a condo in Toronto and a villa someplace where the winters are warm. His retirement spending goal is $150,000 a year after tax, up from spending of about $70,000 now. The increase would cover travel and leisure expenses.

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

What the expert says

Ted will be relying largely on his corporate investment portfolio for retirement income, Mr. Ardrey says. Ted has $55,000 in his tax-free savings account, $120,000 in his RRSP and $2.08-million in his corporation.

Because the bulk of his assets are in his corporation, Ted must consider the tax consequences of each withdrawal and take full advantage of available tools to minimize tax, the planner says. This includes using the capital dividend account, or CDA. With this, the non-taxable half of a capital gain from a stock sale is added to the CDA and can be distributed as a tax-free dividend to the shareholder.

“In terms of how we see the drawdown of Ted’s accounts, he will focus on using his corporate assets exclusively at a rate of $150,000 per year, plus any available CDA distribution,” Mr. Ardrey says. “As the assets are depleted, the amount of the CDA distribution declines from $43,700 in year one to $4,800 by the time Ted is 83 in 25 years’ time.”

Once Ted turns 65, he will have pension income of $24,000 a year plus Canada Pension Plan benefits of $8,254 a year. The CPP benefits are less than maximum because Ted has been drawing dividends rather than salary from his corporation. The planner assumes Ted’s Old Age Security benefits will be clawed back because his income is high. “This [extra income] will allow him to reduce the amount of his withdrawals from the corporation to $110,000 per year.”

Next Mr. Ardrey looks at Ted’s investment strategy – and finds it wanting. If Ted is to live off the income from his investments, he will have to find a way to keep stock price volatility low and “create a consistent stream of income for his future,” the planner says.

“Currently, Ted’s portfolio is 63 per cent in cash, and aside from one small stock position, the remainder is in a financial services ETF and an income fund,” Mr. Ardrey says. Ted’s cash position is so high because he sold three substantial holdings – a real estate investment trust (REIT), a Nasdaq index ETF and half his income fund – when the markets pulled back in September. This nervousness does not augur well for someone who wants to invest solely in stocks, the planner says.

Ted plans to invest 50 per cent of his corporate portfolio in dividend-paying stocks and 50 per cent in stocks that focus on capital appreciation, Mr. Ardrey says. As well, Ted would like to focus on investments with return of capital distributions (like some REITs and income funds) to minimize tax. (Income tax is deferred on return of capital distributions until the security is sold.) With this strategy, Ted expects to earn $10,000 to $12,000 a month in dividends, the planner says.

Historically, a well diversified, 100-per-cent stock portfolio with allocations to all geographic regions could earn a total return (dividend yield plus capital appreciation) of 6 per cent, net of investment costs, Mr. Ardrey says. If Ted gets $10,000 a month in dividends, this would be a yield of 5.77 per cent. Dividends of $12,000 a month would mean a 6.92-per-cent yield. “Though it’s not impossible to achieve,” such high yields will likely require more concentration in securities (such as REITs and income funds) and sectors (such as financial services and utilities) than would be prudent, the planner says.

Even if Ted can resist the urge to sell when markets are jittery, he will need more than just dividends to achieve his spending goal, Mr. Ardrey says. He will need to draw on his capital as well, selling his holdings over time. If he has to sell when “there is a prolonged market contraction, he risks permanent losses.”

Given the size of his portfolio and how dependent he will be on it for retirement income, Ted should consider hiring a professional portfolio manager or investment counselling firm, Mr. Ardrey says. Such firms are required by law to act in the best interests of their clients. They can also offer investments that do not trade on public markets, including private income or debt funds; for example, fund managers who offer mezzanine or bridge financing to corporations.

So can Ted retire at year end and achieve his spending goal? “Unfortunately, the answer is no,” Mr. Ardrey says. By the age of 82, Ted would run out of investment assets, but he’d still have his real estate. Selling his property at that point and investing the proceeds would carry him to age 90. This assumes Ted is able to achieve that 6-per-cent return.

Having to sell his real estate would leave Ted with little in the way of a financial cushion, the planner says, “something that I would not recommend.” There is a simple solution. Ted can keep his property cushion by cutting his target spending from $150,000 a year to $120,000, still well above the $70,000 he is spending now, Mr. Ardrey says.

Client situation

The people: Ted, age 58.

The problem: Can he retire at year end and spend $150,000 a year? How should he draw down his corporate investments?

The plan: Cut spending target to $120,000. Consider hiring a professional money manager to design his portfolio to lower risk and provide steady and potentially higher returns.

The payoff: A worry-free retirement.

Monthly net income (budgeted): $5,870

Assets: Bank $25,000; corporate cash $130,000; corporate investment portfolio $1.95-million; TFSA $55,000; RRSP $120,000; estimated present value of DB pension $444,670; residence $1.25-million. Total: $3.97-million

Monthly outlays (forecast): Property tax $600; home insurance $105; utilities $235; maintenance $335; transportation $390; groceries $415; clothing $85; gifts, charity $170; vacation, travel $1,665; dining, drinks, entertainment $1,165; health care $85; phone, TV, internet $120; TFSA $500. Total: $5,870

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

FINANCIAL FACELIFT: How can this couple save for their son’s higher education and their own retirement?

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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, 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 25, 2020

Since coming to Canada from India in 2016, Sanjay and Maya have found well-paying jobs, bought a large condo in Toronto and had a child. He is age 35, she is 32.

Both are professionals, bringing in a combined $300,000-plus a year in salary. Sanjay earns another $15,000 a year in income from his business, which he hopes to expand.

“We have assets across Canada and in India, spanning equities, bonds and real estate,” Sanjay writes in an e-mail. While they are both well educated, “financially, we believe there’s so much more we can and should do,” he writes. “The last few years were so unpredictable in the stock market that most of the time we spent on the sidelines.”

Their questions: “What should be our portfolio structure to achieve our goals?” Sanjay asks. Their long-term goals include saving for their son’s higher education and for their own retirement. Their retirement spending target is $6,500 a month or $78,000 a year. “How much should we be saving on a monthly basis?” As well, “what products are we missing that are unique to Canada and which can give us some tax benefits?”

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

What the expert says

Now that they are settled, Sanjay and Maya would like to take stock of their lives and ensure they are on the right path for their financial future, Mr. Ardrey says.

“Sanjay’s goal is to work at his own business full-time once his income from it is sufficient, which he figures will take another two years.” In preparing his forecast, Mr. Ardrey assumes that for the next two years (2021-22) Sanjay will earn $15,000 a year from his business and in 2023 will start working there full-time, earning $150,000 a year.

After communicating with the couple and analyzing their income and expenditures, the planner discovered some holes in their budget. They appear to have a larger surplus than their numbers indicated, he said. Although some of the difference can be attributed to RRSP refunds, “Sanjay and Maya need to review their budget thoroughly,” Mr. Ardrey says.

The next step is for Sanjay and Maya to open a registered education savings plan for their son, who was born in 2018, to take advantage of the Canada Education Savings Grant, the planner says. The grant adds 20 per cent to the first $2,500 in contributions made to an RESP each year up to a maximum of $7,200. “To maximize the grant, they should look at contributing $5,000 for this year and next (to catch up with missed contributions) and then $2,500 a year afterwards,” he adds.

The savings will not be enough to cover the expected future cost of postsecondary education, estimated at $20,000 a year for a student living away from home, Mr. Ardrey says. Including investment returns, they would be able to cover off about 55 per cent of the expected costs. The remainder would have to come from the child’s work income, student loans or other family savings or current income.

In addition to their above-mentioned savings, Maya will be enrolled in a defined contribution pension plan by the end of the year, the planner says. Starting in 2021, she will contribute 6 per cent of her salary, matched by her employer. In addition, Maya makes the maximum contribution to her RRSP annually. Mr. Ardrey assumes that after he leaves his job to run his own business, Sanjay will maximize his RRSP contribution room each year as well.

Next, the planner looks at the couple’s investment portfolio, which has an asset mix of 95 per cent equities and 5 per cent fixed income, with most of the stock portion in U.S. and international markets. Aside from bank accounts, all of the non-registered investments remain in investment accounts in India, with the bulk in mutual funds, he says. The historical return for a portfolio with this asset mix is 5.6 per cent a year, with an average investment cost of 1.25 per cent, Mr. Ardrey says. When they retire, his analysis assumes their rate of return is reduced by one percentage point as they add more conservative investments to their asset mix.

Both Sanjay and Maya plan to retire at the age of 65. Based on their time in Canada, they would get 85 per cent and 93 per cent of Old Age Security benefits, respectively. If they continue to work at their current income levels, then they would get 87 per cent and 95 per cent of Canada Pension Plan benefits, respectively.

“Based on the above assumptions, Maya and Sanjay can meet their retirement goals with ease,” Mr. Ardrey says. At Maya’s age 90, they would have $3-million in investment assets, largely in RRSPs or other registered accounts, and $4-million in real estate value, he says. If they decided to spend that investment value, they could increase their spending by $4,500 a month, in addition to the $6,500 a month in planned spending.

“With that kind of financial cushion in place, Sanjay and Maya may want to look at retiring earlier than 65,” Mr. Ardrey says. He did a projection with a retirement age of 60 for Sanjay and age 57 for Maya. Even if they retired sooner they can still meet their goal, though the additional spending room would fall to $1,000 a month more than the $6,500-a-month target.

Despite this rosy picture, there are things that Sanjay and Maya can do to improve their financial picture, Mr. Ardrey says. First is to open tax-free savings accounts and contribute the maximum allowable. “Being able to save an additional $6,000 each and every year tax-free will greatly benefit them in retirement,” he says. Unlike RRSPs, withdrawals from TFSAs are not taxable.

As well, a considerable amount of their investments remain in Indian rupees, which adds foreign-exchange risk to their investment portfolio, the planner says. They should look to move those investments to Canada where they can form part of an overall investment strategy, he says.

Because Sanjay plans to run his own business, they might want to consider a less volatile asset mix, the planner says. Given low interest rates and turbulent stock markets, they could add some private income-producing investments such as a private debt fund or a global real estate fund, Mr. Ardrey says. “These funds would be designed to supplement their returns while reducing the volatility risk of the equities.”

Client situation

The people: Sanjay, 35, Maya, 32, and their son, 2.

The problem: How best to chart a path to a solid financial future.

The plan: Open an RESP for the child to take advantage of the government grant. Open TFSAs for both of them so their earnings can grow tax-free. Consider lowering risk in their investment portfolio.

The payoff: A brighter financial future than they may be anticipating.

Monthly net income (budgeted): $19,000

Assets: Bank accounts: $32,700; stocks $72,000; mutual funds $145,000; Indian mutual fund $27,900; his RRSP $37,000; her RRSP $49,000; his DC work pension $6,300; residence $1.25-million. Total: $1.6-million

Monthly outlays (forecast): Mortgage and property tax $4,200; condo fees $750; home insurance $70; electricity, heating $150; maintenance $240; transportation $400; groceries $800; child care $1,880; clothing $540; gifts, charity $200; vacation, travel $600; other discretionary $1,000; dining, drinks, entertainment $700; personal care $100; club memberships $150; sports, hobbies $150; subscriptions $40; other personal $100; prescriptions, supplements $100; health, life insurance $105; phones, TV, internet $215; his group RRSP $830; her RRSP $2,160. Total: $15,480. Surplus of $3,520 goes to unallocated spending and saving.

Liabilities: Mortgage $850,000

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