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By Andrew Allentuck
The Globe and Mail
Report on Business
Saturday, May 5, 2007
Being able to live in good health well into your nineties is a wonderful thing, yet in financial terms, it's a stretch for one's savings. A couple in British Columbia, who we'll call Jack and Ella, and who are 60 and 57 respectively, wonder how much they can spend in the decades they expect to live to match their parents' longevity. Jack's mother is in her late eighties. Ella's mom lived to her late nineties. Jack, an executive who is partly retired, and Ella, who works for a large corporation, want to be sure in the years of leisure and travel ahead that they don't outlive their savings.
Adrian Mastracci, fee-only portfolio manager at
KCM Wealth Management in Vancouver, says, "Long life need not be a financial burden. If they plan now, then they will have a better chance of achieving all their goals in the many years of life they expect."
"How much can we afford to withdraw from our RRSPs between now and when we begin to collect public pensions, and still have enough for the rest of our lives?" Ella asks. Her question raises issues that will become more common as ever more Canadians reach what is sometimes called the advanced senior years.
What our expert says
Facelift asked Adrian Mastracci, a portfolio manager and financial planner who heads KCM Wealth Management in Vancouver, to work with Jack and Ella in order to devise ways to protect their capital, sustain a reasonable return for up to four decades and generate adequate cash flow.
"These people have an expectation of longer than average life," he explains. "That's a special planning problem."
Currently, Mr. Mastracci notes, Ella has a gross annual income of $75,000 a year. Jack generates gross income of about $14,000 a year. They have a combined net annual income of about $66,000. They estimate that their retirement expenses will be $70,000 a year in 2007 dollars on top of capital costs of $40,000 to $50,000 to buy a used motor home that will help to keep their hotel costs down.
Their financial base, the planner says, will be a combined net worth of $1.39-million, including $766,000 of registered investments, a $450,000 house and non-registered stocks, $152,000 in cash, and a small amount of personal property. They owe $7,700 on a line of credit and $79,000 to a family member.
Their financial resources should be up to the task of covering living expenses, the planner says. Assuming that Jack lives to age 90 and Ella to age 100, as their parental histories suggest is possible, that their investments generate an average annual return of 6 per cent and that inflation runs at an average annual rate of 3 per cent, they can meet their $70,000 living expense target by doing several things.
Jack should apply for Canada Pension Plan benefits immediately. He will lose 0.5 per cent a month for each month prior to age 65 that benefits begin at an estimated rate of $7,000 a year. The reduction of full benefits of about $10,365 that he might receive at age 65 is offset by the fact that he is in a low tax bracket right now.
Ella should continue to work at least part time from age 60, at which age she has considered retirement, to age 65. The combination of her employment income and Jack's consulting income should be at least $30,000 a year before taxes. They can add $26,400 a year from savings to maintain their annual $70,000 income target, Mr. Mastracci says. By the time Ella reduces her work at age 60, her employment pension will add $6,600 a year in 2007 dollars to the $7,000 a year Jack can expect from CPP and the $26,400 a year they can withdraw from investments.
By 2014, when she is 65, Ella can expect $9,600 a year from full CPP benefits. Jack will already be receiving $5,903 a year in Old Age Security benefits and Ella will receive the same amount. Both CPP and OAS are assumed to increase at an average annual rate of 2 per cent. After Ella's employment income ends, they should withdraw about $36,700 a year from their investments in order to achieve the $70,000 target gross income, Mr. Mastracci suggests. This withdrawal rate can be sustained until Jack's age 90, his assumed time of death, and then a reduction of 25 per cent of withdrawals until Ella is assumed to die at 100.
By that time, all funds will have been expended and Ella will have no income other than CPP and OAS, which will have been indexed to maintain 2007 purchasing power. She will also have her house and what one assumes will be decades of price appreciation. It could be sold to provide funds, should she have the good fortune to live beyond age 100, Mr. Mastracci notes.
The Old Age Security clawback, which begins at $63,511 net income in 2007, should not affect the couple. If they split their pension incomes for tax purposes, as the Minister of Finance has proposed, they have even less risk of loss to the clawback, the planner adds.
Administering their own money gives them the ability to increase or decrease payouts to cope with inflation or changing personal situations. They can make a few changes to increase their future after-tax income. Ella, who has a much higher income than Jack, should direct future RRSP contributions into a spousal plan for Jack. He must leave contributions in place for at least three years. Withdrawal of sums contributed to the plan before three years have elapsed would cause them to be taxed back into Ella's hands.
Jack and Ella can increase their investment returns by making several changes to their portfolios. Jack, who has been burned by previous investments, does not have enough equity exposure. Mr. Mastracci recommends that Jack aim for equity exposure of as much as 40 per cent of his portfolio. That's because stocks have long-run returns that tend to rise with inflation. Bonds and most fixed-income investments provide a guaranteed return, but, with the exception of inflation-linked bonds, they have little ability to pace inflation.
Ella has accumulated 20 stocks, 27 mutual funds, and 28 fixed-income assets including a ladder of stripped bond coupons in her RRSP. She has done well, but success has come at a price. Her equity mutual funds were purchased with deferred sales charges that have pushed up her management fees to as high as 3 per cent. That's a lot of money to pay for being the recipient of advice to buy funds that in several cases overlap their assets, Mr. Mastracci says.
Ella can reduce costs and increase the time she spends managing each asset by culling the portfolio, ensuring that she does not sell funds before the penalties for early encashment drop to zero or close to it. She can then reinvest to achieve the planner's recommended structure of 25 per cent Canadian stocks, 15 per cent American stocks, 10 per cent global stocks and 50 per cent fixed income. She should emphasize value picks that appear to be inexpensive in comparison with the companies' intrinsic value measured by earnings or balance sheet measures. In rebalancing their portfolios, Jack and Ella should consider replacing high-fee funds with others whose sales fees are either zero or are paid up front, or index funds with no sales fees and low management fees, Mr. Mastracci adds.
"Long life need not be a financial burden," he says. "If they plan now, then they will have a better chance of achieving all their goals in the many years of life they expect."
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Client situation
Jack, 60, and Ella, 57, live in British Columbia.
Net monthly income: $5,500.
Assets: RRSPs $766,000, cash $79,000, non-registered $73,000, house $450,000, cars $31,000.
Monthly expenses: Property taxes & fees $380, food & dining out $1,025, entertainment $115, clothing $125, grooming $175, utilities $385, house cleaning $80, auto fuel, repairs & parking $320, car, life & home insurance $245, charity & gifts $520, fitness $90, loan payments $565, savings $1,475.
Total: $5,500.
Liabilities: Loan from family $79,000, line of credit $7,500.
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