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By ANDREW ALLENTUCK
Special to The Globe and Mail
Report on Business
Saturday, August 16, 2008
Near Toronto, a couple we'll call Albert and Tess are easing into retirement. Albert, 62, has retired from a large manufacturing company. Tess, 65, still runs her own small consulting business but is in the process of winding it down. Its market value is modest, but she will sell it if she can.
Adrian Mastracci, “fee-only” portfolio manager at
KCM Wealth Management in Vancouver, says, “They are in a very enviable financial position.”
The transition from work - where Albert earned $125,000 a year before tax in a management position, and Tess has earned about $85,000 before tax - to retirement, and living on a fixed income, troubles the couple. They are going from income more than sufficient for their needs to an income they fear may not be enough. The couple have set a target retirement income of $120,000 before tax.
For now, they are well fixed. They have $2,190,700 in assets and no liabilities other than a $73,000 tab with Albert's stockbroker for a margin account. They worry that they may wind up in the same shape as Tess's parents, a couple in deteriorating health and with limited financial means.
"Preservation of capital has now become a high priority for us," Albert says.
"How can I transition our assets to provide a reliable and adequate income stream?"
WHAT OUR EXPERT SAYS
Facelift asked Adrian Mastracci, a financial planner and portfolio manager who heads KCM Wealth Management in Vancouver, to work with Albert and Tess. His assessment is that they can maintain their way of life, provided they can manage their tax liabilities and generate value from Tess's business. "They are in a very enviable financial position," he says.
Albert and Tess want to be able to sustain their income for their lifetimes. For now, they have Albert's pretax company pension of $67,800. He has not yet drawn Canada Pension Plan benefits that could be as high as $10,615 a year. He should do so when he turns 65, Mr. Mastracci advises. Tess gets $7,600 a year from CPP. Currently, the couple get $2,500 a year from taxable investments in the form of dividends and interest.
When Albert reaches 65, the sum of income from the company pension and CPP benefits will be $86,015. Adding on two OAS benefits of $6,070 each, which are vulnerable to the clawback that begins at net income of $64,718 a person, the couple would have $98,155 a year before tax.
If Tess ceases to work by the time Albert is 65 and no longer has her business income, then careful pension income splitting will preserve much of their Old Age Security pensions from being reduced by the clawback, Mr. Mastracci notes. To achieve their $120,000 pretax income target, they will need an additional $21,845 from their financial assets.
Assuming that Albert lives another 24 years and Tess another 26 years, which is their actuarial life expectancies plus five years for each, and assuming that inflation runs at 3.5 per cent a year and that investments generate an annual 6-per-cent return, the couple will require $980,000 in financial assets to generate sufficient income to reach their retirement income goal.
This nest egg could support annual draws on capital of as much $160,000 for the couple's lifetime, exhausting their capital by the assumed date of the death of Tess. But that rate of asset depletion would leave them exposed to hard times if capital markets collapse or if they have the good fortune to live into their 90s or beyond.
The prudent approach would be to retain some income for reinvestment. At the 6-per-cent nominal rate of return, the portfolio will generate $101,388 a year before tax. If they take $21,845 from that investment income to add to their pension flows of $86,015, they will be able to retain $79,543 a year for reinvestment to cover inflation, market risk and the potential for unusually long life, Mr. Mastracci estimates.
Tax management will be an issue for Albert and Tess. They should draw on taxable investments until each reaches age 71, at which time they can begin to convert assets in their registered retirement savings plans to registered retirement income funds. Postponement of converting to RRIFs will provide the longest possible period of tax-free income growth, Mr. Mastracci notes.
There is work to be done on the couple's portfolio, the planner adds. Albert has 60 stocks, exchange-traded funds and mutual funds. He has a margin account that uses borrowed money to magnify gains and losses. He has been aggressive with a preference for growth stocks that pay no dividends. He has no strategy for managing capital losses and he has some mutual funds with management fees as high as 3 per cent a year, Mr. Mastracci says.
Albert should either put in the time required to manage his portfolio or consider use of a professional manager for an all-in fee that could be about 1.5 cent a year. For now, Albert's goal should be to reduce risk by diversifying his equities and adding to fixed-income assets to achieve a 50/50 balance of stocks and bonds, Mr. Mastracci says.
"The couple have issues - inflation risk, portfolio risk and the problem of managing five dozen assets," Mr. Mastracci says. "If they resolve those problems, they will have a level of financial security that others can envy."
"I appreciate that we can continue to live in our current style, which is not lavish." Albert says. "We have worked hard for that security."
Client situation
THE PEOPLE
Ontario couple who need to stabilize retirement income.
THE PROBLEM
Worry that pensions and investments will not cover expenses.
THE PLAN
Adjust investments for income, lower risk, inflation and longevity.
THE PAYOFF
Secure retirement income with reserves for very long life.
NET MONTHLY INCOME
$9,545
ASSETS
Taxable investments $1,168,600, RRSPs $408,100, cash $14,000, business (Tess) $100,000, house $500,000. Total: $2,190,700
MONTHLY DISBURSEMENTS
Property taxes $462, food & dining out $1,336, entertainment $60, clothing $300, RRSP $1,666, Cars (2) gas & repairs $830, travel $1,330, car & home insurance $200, charity & gifts $680, miscellaneous $500, savings $2,181. Total: $9,545.C
LIABILITIES
Margin debt $73,000
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