Clara and her husband, Clive.Nicole Osborne/The Globe and Mail
“We had a Financial Facelift done just over 10 years ago and would like to do another as life doesn’t always go as planned,” Clara writes in an e-mail. “My husband was laid off late last year, and even though we are both 65 years old, he was hoping to work for another three to five years to finish paying off our mortgage and to build up our investment portfolio.”
Clara and her husband, Clive, have four grown children and a house in an Ontario city valued at $950,000. The mortgage outstanding is about $88,000. Clive had been working in tech sales.
Clara has retired from her job in health care and is getting a defined benefit pension of $27,600 a year indexed to inflation. Clive, who worked in tech sales, had a group registered retirement savings plan. He received a severance package, and they had some savings in their emergency fund, “but that has run out and we have had to pull from our RRSPs,” Clara writes.
Clive is finding it difficult to find work at his age. “If he is not able to get a job in the next few months, how should we proceed with our living expenses?” Clara asks.
They have held off taking Canada Pension Plan benefits, but to ease cash flow problems they have started to draw Old Age Security benefits. They wonder when would be the best time to start CPP. Should they pay off the balance of their mortgage when it comes due in two and a half years?
They’ll need a newer vehicle soon (about $50,000) and are planning some renovations to their house ($150,000) over the next few years, Clara writes. Their retirement spending goal is $100,000 a year, falling to $80,000 a year after the mortgage is paid off.
We asked Warren MacKenzie, who prepared the previous Financial Facelift for Clara and Clive, to look at their situation. Mr. MacKenzie is an independent certified financial planner. He also holds the chartered professional accountant designation.
What the Expert Says
From a financial point of view, there is no need for Clive to be concerned about getting another job, Mr. MacKenzie says. “They already have sufficient net worth to achieve all their financial goals.”
The challenge they face is that they do not have sufficient cash flow to achieve their near-term spending goals ($200,000), the planner says. “They need to understand that in retirement there is nothing wrong with using up the money they saved to use in their retirement.”
One simple solution would be for them to start drawing CPP, withdraw the $76,000 in their tax-free savings accounts and take the balance from their registered retirement savings plans. But this would create a big tax liability. “Fortunately, there is a more income-tax-efficient way to achieve their goals,” Mr. MacKenzie says.
Because they are in good health and have a normal life expectancy, they could delay taking their CPP benefits to age 70. By doing so, their monthly benefits would be 42 per cent higher than if they start at age 65, giving them more to spend later.
To pay for the new car, they should withdraw the funds from their TFSAs, he says.
“In terms of the home renovation, instead of paying for it by withdrawing from their RRSPs all in one year, they should use the balance of the funds in their TSFAs and set up a home equity line of credit (HELOC) for the balance,” the planner says. They would then pay down the HELOC and the existing mortgage by each drawing $40,000 per year from their RRSPs for the next five years.
That is before they are required to convert their RRSPs to registered retirement income funds (at age 71) and begin taking mandatory minimum withdrawals the year they turn 72. The interest on the HELOC will not be tax deductible, but it is more tax-efficient to draw down part of their RRSPs before they begin collecting CPP, he says.
Their taxable income will be higher after they begin to collect CPP so the RRSP withdrawals taken over the next five years will be taxed at a lower tax rate than would be the case if they waited until later. Taking early withdrawals will likely reduce any future clawback of their OAS benefits, the planner says.
“Over the rest of their lives, income tax will be one of their bigger expenses,” the planner says. To minimize it, they should split Clara’s pension. They should also split their RRIF withdrawals. They will empty their TFSAs to pay for the car and home renovations, but when they are getting CPP and taking RRIF withdrawals, they will have surplus funds. “Then they should start to maximize their contributions to their TFSAs.”
The planner’s forecast assumes an average rate of return on their investments of 5 per cent per annum with inflation running at 2 per cent. He assumes they sell their home at age 90 and move into a top-notch assisted-living home costing $8,000 per month each. “If they make it to age 100, my projection shows that they will be leaving an estate of more than $1-million in dollars with today’s purchasing power.”
In 2030, after they begin collecting CPP, their combined cash flow will be about $153,000 a year, comprising CPP of $43,000, OAS of $19,000, Clara’s DB pension of $31,000 (with indexing) and about $60,000 in RRIF withdrawals, Mr. MacKenzie says. The cash outflow will be $90,000 a year in basic expenses, $29,000 in loan repayments and $26,000 in income tax, for a total of $145,000.
They have term life insurance policies that cost $119 per month and which will mature in 2030. Considering their financially stable position, and given that the cost to renew the policies will be much higher in 2030, it may not be worthwhile to renew, the planner says.
Their combined portfolio, which Clara manages, is invested in six exchange-traded funds and some guaranteed investment certificates. The asset mix is about 20 per cent Canadian equities, 35 per cent U.S. equities, 20 per cent international equities and 25 per cent bonds and GICs. “Clara rebalances every two years and over the past five years she has averaged [a return of] about 10 per cent per annum,” Mr. MacKenzie says.
While their investments are well diversified internationally, the asset mix has more risk from stock market exposure than is necessary to earn the average return of 5 per cent a year that the planner used in his forecast. Given that they can achieve their goals with a lower-risk portfolio, Clara might want to consider moving to a 60 per cent stock, 40 per cent bond asset mix, the planner says.
Client Situation
The People: Clive and Clara, both 65.
The Problem: Can they spend $200,000 soon on a car and some renovations and still meet their retirement spending goal?
The Plan: Arrange to pay for the outlays in the most tax-efficient manner. Split income. Postpone CPP benefits to age 70.
The Payoff: Fears allayed.
Monthly net income: As needed.
Assets: Cash $2,000; her TFSA $39,815; his TFSA $36,020; her RRSP $595,625; his RRSP $693,110; estimated present value of her pension $500,000; residence $950,000. Total: $2.8-million.
Monthly outlays: Mortgage $1,405; property tax $570; water, sewer, garbage $40; home insurance $85; electricity $280; heating $125; security $35; maintenance, garden $450; transportation $1,055; groceries $1,000; clothing $160; gifts, charity $420; vacation, travel $1,000; dining, drinks, entertainment $160; personal care $150; golf $15; two dogs $180; sports, hobbies $100; subscriptions $65; miscellaneous $115; doctors, dentists $100; drugstore eye glasses $150; life insurance $120; phones, TV, internet $370. Total $8,150.
Mortgage: $88,000 at 1.89 per cent.
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Some details may be changed to protect the privacy of the persons profiled.