Beth is starting a new chapter in her life and naturally has some concerns.
“I am a recently divorced mother of two children,” Beth writes in an email. “I think I am financially stable, but frankly, I’m scared to death about having enough money for retirement now that I’m on my own,” she adds. “I need as much help as I can get.”
Beth is age 52, her children 12 and 13. She has a well-paying executive job, earning about $140,000 a year plus a substantial bonus. She has no company pension. The small-town Ontario house where she now lives is valued at $1.5-million with a mortgage of about $545,000. Beth has some cash in the bank – her share of the proceeds from selling the former family home – and wonders whether she should invest it or pay down her mortgage. Both she and her former husband contribute to a family registered education savings plan for the children’s postsecondary education.
“I have lived and worked in many places in the world and want to have enough money in retirement to continue traveling and to provide for and visit my children, wherever they might end up,” Beth writes. Her retirement spending goal is $70,000 a year.
“When can I withdraw?” Beth asks.
We asked Nushzaad Malcolm, a financial planner at Henderson Partners LLP in Oakville, Ont., to look at Beth’s situation.
What the expert says
If Beth invests her cash – about $550,000 – and gets a 5-per-cent return after fees and before tax, she could retire at age 63 at the earliest, Mr. Malcolm says. “Her lifestyle expense goal of $70,000 a year after tax, indexed to inflation, is manageable throughout her retirement and she has the room to exceed it by $2,000 to $3,000 per year.”
Beth is taking all the right steps with her registered account saving strategy, the planner says. She contributes 2 per cent of her salary to her deferred profit sharing plan, or DPSP, allowing her to get the maximum company match. She then transfers the DPSP balance to her registered retirement savings plan. She contributes the maximum each year to her RRSP.
“Thus, she obtains the maximum possible RRSP deduction and reduces her taxes owing,” Mr. Malcolm says. She also contributes $5,000 a year ($2,000 personally, $3,000 from her ex-spouse) to the family RESP for her two children. This provides the maximum Canada Education Savings Grant of $500 for each child per year. The grant is available until age 17 with a lifetime limit of $7,200 per child. “She can fully fund both her children’s education using the funds from the RESP,” the planner says. His forecast assumes a cost of $20,000 a year for each child for four years of undergraduate studies, indexed by 4 per cent a year.
Next, he looks at Beth’s drawdown strategy. While RRSPs are typically converted to registered retirement income funds, or RRIFs, at age 71 with drawdowns commencing in the following year, “we would suggest that drawdowns take place at any point that taxable income is reduced,” Mr. Malcolm says. This could start as early as Beth’s age 63, when she retires. “Deregistering the RRSP/RRIF account is ideal when taxable income is low because one avoids losing a significant portion of the withdrawals to taxes.”
Beth has stated that one of her goals is to pay off her mortgage. Given the mortgage balance and existing payment schedule, she will finish paying off her mortgage by 2039, when she is 69. If paying down the mortgage sooner is a priority, she has the ability to make prepayments as long as she is employed, the planner says.
Most conventional fixed mortgages provide for an annual prepayment up to 10 per cent to 20 per cent of the mortgage value without any penalties. “By targeting an annual prepayment of $18,000 a year, for example, she can ensure that her mortgage is fully paid off at the time of her retirement.” To make the extra payments, she could use investment income generated by the non-registered assets or even liquidate some of them.
To achieve an annual rate of return of 5 per cent, Beth needs to ensure her cash is appropriately invested, Mr. Malcolm says. “Holding her funds in cash will restrict her ability to earn a return and erode her purchasing power, potentially hindering her ability to retire by age 63 or even age 65.” If she does have a short-term need for some of the cash, he recommends she put it in a high-interest savings account or a guaranteed investment certificate in the meantime.
“If the time horizon is longer, conventional strategies include the use of longer-term investments such as stocks and bonds,” the planner says. She could use low-fee mutual funds and exchange-traded funds, both of which hold multiple stocks, bonds or funds within a single fund. They provide greater diversification than investing in individual stocks or bonds, he notes. “Such funds can provide market participation in an industry, geographic region, index, commodity, or currency, and can be bought and sold within a self-directed account or a managed account.”
Using a self-directed account with a discount brokerage is the most cost-effective solution, Mr. Malcolm says. “However, it requires a higher level of understanding of the market and a more acute knowledge of the types of funds Beth may want to invest in.” Given that Beth is seeking investment guidance, he suggests she seek a professional – preferably one that holds to the fiduciary standard of care, such as an investment counselor or portfolio manager – for her longer-term investment goals. Their job is to understand their client’s comfort level, cash flow needs and expectations and to construct an appropriate investment portfolio based on their risk tolerance, he adds.
“Keep in mind that investment professionals charge annual fees based on assets under management and these can be very significant over time,” Mr. Malcolm says. “It is thus imperative that they deliver a satisfactory return on investments after tax and fees, and that the value added is reviewed each year.”
Online portfolio managers, or robo-advisers, are another alternative, the planner says. “They assess your risk ability/risk tolerance based on a profile assessment completed online and provide a preconstructed portfolio to invest in,” Mr. Malcolm says. Their fees tend to be lower than in-person portfolio managers. “Popular Canadian robo-advisers include Wealthsimple, BMO SmartFolio and Justwealth,” the planner says. A list of portfolio management firms can be found at the Portfolio Management Association of Canada website, pmac.org.
The people: Beth, age 52, and her children
The problem: When can she withdraw and can she sustain annual expenses of $70,000 a year? Should she use her cash to invest or pay down her mortgage?
The plan: Work at least to age 63 and try to pay off the mortgage by then, making annual prepayments to principal. Target a 5-per-cent return on investments. Start to draw down her registered savings when she first retires and her income is low.
The payoff: A better understanding of her optimum retirement age and confidence that she has taken the right steps to achieve her retirement objectives.
Monthly net income: $10,945
Assets: Principal residence: $1.5-million; RRSP: $541,100; RESP: $162,000; foreign bank account: $24,000; cash: $551,100. Total: $2.79-million
Monthly outlays: Mortgage $2,990; property tax $775; home insurance $310; electricity $380; heating $135; maintenance $50; garden $45; transportation $100; groceries $500; clothing $100; child expenses $665; gifting $50; charity $80; holidays $835; dining, drinks, entertainment $200; personal care $100; club membership $60; pet expense: $20; sports and hobbies $50; subscriptions $30; health care $100; internet and cellphone $140; employee contribution to DPSP $215; RRSP $2,040; RESP $415; additional saving $560. Total: $10,945
Liabilities: Mortgage: $545,570
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