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By ANDREW ALLENTUCK
Special to The Globe and Mail
Report on Business
Saturday, April 26, 2008
In Calgary, a couple we'll call Vincent, 54, and Ruth, 51, operate a small business that provides them with $142,000 in gross income. Both previously married, they are carrying debts of $332,000 and have two children nearing university entrance. They want to buy a property for about $300,000 for retirement in perhaps 10 years. They will have a tough time doing it, however, for each month they spend more than they earn. With little inclination to save, they have just a decade to put their retirement plans on a sound foundation.
Adrian Mastracci, “fee-only” portfolio manager at KCM Wealth Management in Vancouver, says, "The business is their largest asset. They have to make it more profitable and more appealing to a future buyer.
“We are concerned that we will not be able to do the things that we have planned because of our debts,” Ruth says. “The debt also causes stress on a day-to-day basis. We need a realistic plan for meeting our goals.”
WHAT OUR EXPERT SAYS
Facelift asked Adrian Mastracci, a portfolio manager and financial planner who heads KCM Wealth Management Inc. in Vancouver, to work with the couple.
Couple must cut expenses
Noting that Vincent and Ruth take two ski holidays each year for a total cost of $10,000 and a summer holiday for $5,000, the planner suggests that they have already stretched their finances.
“They have a lot on their plate,” he explains. “Their $9,167 monthly after-tax income comes from a business they run, but they pay out all of its earnings. It retains almost nothing. They have no employee pension plan.”
The core of the couple's finances is their consulting business, which has an estimated value of $800,000, based on annual contracts that are renewed every year by the clients the business serves. The business generates $170,000 a year and splits that by paying Ruth and Vincent $85,000 each a year.
Ruth and Vincent figure they can retire on $90,000 in 2008 dollars before tax. That works out to $7,500 a month or 53 per cent of their current gross income of $14,167 a month.
Inflation is assumed to run at 2.5 per cent a year and investments to produce a return of 6 per cent a year throughout retirement. Each partner will get 80 per cent of the maximum Canada Pension Plan payout of $10,615 at age 65 and full Old Age Security of $6,028 a person. In order to meet their retirement income goal, the couple will need a total of $1,975,000 of investment assets at Vincent's age 65, Mr. Mastracci estimates.
It won't be easy to save up that much, however, for they currently report zero monthly savings. They can split business income by hiring their children to work for the business and pay them appropriate wages for the work they do. Those wages can help pay for their educational costs.
The current registered education savings plans, which have a $19,000 balance, should be replaced by a family RESP of which both children are beneficiaries. There is little time left to contribute for the elder child, now 17 1/2, so most of the RESP savings can be directed to the pool.
Spending $300,000 on a recreational property is a stretch given that they have a combined balance of $170,000 in their registered retirement savings plans and just $11,000 of taxable savings.
Ruth and Vincent could afford the recreational property if they sell or downsize their house, which has an estimated value of $650,000, but they cannot afford both a city house and a country cottage, Mr. Mastracci says.
If they can generate savings from the business and from their budget, they can put money first into debt reduction, paying off their Visa loan at 19.5-per-cent interest, and on lines of credit that carry interest charges of 7.25 to 9.25 per cent.
To clear all debts would require savings of about $33,000 a year for the next 10 years. Saving that much money is possible if Ruth and Vincent cut back expenses like vacations – a saving of $15,000 a year – and dining out and entertainment from $1,200 a month to $200 a month. After 12 years, the debts would be cleared and they would have $340,200 in their RRSP accounts, assuming no further contributions and a 6-per-cent average annual return. That would produce annual pretax distributable income of $20,400 before inflation adjustments.
Together with two $6,028 annual Old Age Security payments and CPP payments that total $16,984 for both, the couple would have nominal cash flow of $49,440 when they begin retirement. The only way to boost retirement income would be to invest the proceeds of the sale of their business. If it did realize its $800,000 current value, then that capital, if it generated 6 per cent a year, would add $48,000 to cash flow, bringing the total retirement cash flow at the start of retirement age 65 to $97,030, a sum well above the couple's $90,000 target, the planner says.
“In order to meet their retirement income goal, the couple have to begin cutting current expenses and, very importantly, to get their business ready for an eventual sale,” Mr. Mastracci says. “The business is their largest asset. They have to make it more profitable and more appealing to a future buyer.”
Says Ruth: “We don't like the idea of having to give up some pleasures now in order to have a decent retirement. But we have to do it. This is a reality check.”
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Client situation
THE COUPLE
Calgarians Ruth, 51, and Vincent 54, are planning retirement.
THE PROBLEM
Heavy debts make retirement difficult to finance.
THE PLAN
Pay down debts and set up family business for future sale.
THE PAYOFF
Comfortable retirement and money for kids for university.
NET MONTHLY INCOME
$9,167.
ASSETS
Value of business $800,000, RESPs $19,000, RRSPs $170,000, house $650,000, cash $11,000. Total: $1,650,000.
MONTHLY EXPENSES
Mortgage $2,000, debt service $1,580, property taxes $272, utilities & phones $650, food $1,000, dining out $800, entertainment $600, clothing $600, RESP $120, cars - fuel, repairs $500, travel $750, car & home insurance $180, life insurance $220, disability insurance $240, charity & gifts $100. Total: $9,612.
LIABILITIES
Mortgage $208,000, credit lines $112,000, Visa $12,000. Total: $332,000.
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