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By ANDREW ALLENTUCK
Special to The Globe and Mail
Report on Business
Saturday, September 20, 2008
A Toronto couple we'll call Humphrey and Lucille, both 61, have put in their time in management jobs.
Adrian Mastracci, “fee-only” portfolio manager at
KCM Wealth Management in Vancouver, says, “They are frozen in fear of the volatile markets. But they have advantages.”
Humphrey works for a professional association, Lucille for the provincial government. Together, they bring home just more than $140,000 a year after tax. With a half-million-dollar house and $1,078,000 in financial assets, no liabilities, their children grown, and no expensive hobbies or other cash drains, they should be able to move into a moderately prosperous retirement. Lucille plans to quit work in 2009, Humphrey in 2012. They want $90,000 a year in annual pretax income when their working lives end.
Humphrey and Lucille fret that the slump in the stock market will ruin their plans. "For some time now, we have worried about a market bubble and have moved most of our investments to GICs or money market funds," Humphrey explains.
WHAT OUR EXPERT SAYS
Facelift asked Adrian Mastracci, a financial planner and portfolio manager who heads KCM Wealth Management in Vancouver, to work with the couple in order to devise an investment plan that will enhance the security of their capital and provide a dependable income stream.
"They are frozen in fear of the volatile markets," Mr. Mastracci says. "But they have advantages. Humphrey already receives $15,000 each year in pension income from a former job and they have no debt."
Assuming that their investments produce 6 per cent a year and inflation runs at 3 per cent annually, that Humphrey gets the maximum Canada Pension Plan benefit of $10,615 a year in 2008 dollars, that Lucille gets $4,777 a year for her CPP benefit and that both receive full Old Age Security, currently $6,070 a year, they will need $725,000 of investment assets to reach their retirement income goal, the planner says.
Their balance sheet shows they have more than enough money to achieve that goal. Indeed, their financial assets could produce as much as $115,000 a year if they are expended by the time Humphrey reaches 86 and Lucille 91 - five years longer than their estimated ages at death. However, that assumption could leave them broke, except for their home, if they were to live beyond those ages. As well, inflation, unexpected costs of illness, low investment returns or capital losses could impair their plans.
If inflation were to rise by just one percentage point from 3 per cent to 4 per cent, the $90,000 target income would rise to $157,800 in 2008 dollars in 20 years. At 4-per-cent inflation, the target income would have to be $190,000 in 20 years, Mr. Mastracci says. Even if they do not plan to expend all their money by their deaths, they need to plan for the unexpected, he adds.
Without the assumption that all assets are eventually consumed, the couple's total annual retirement income at age 65 would be $92,387 a year, assuming that Humphrey continues to receive $15,000 pension income from prior employment, $21,000 from Lucille's present employer in pension income, and that the couple gets $15,392 of CPP benefits and $12,140 of OAS benefits and $28,855 of income from registered and non-registered investments.
The couple can avoid the Old Age Security clawback that begins at $63,511 by splitting their CPP benefits. They should also defer taking benefits from their registered retirement savings plans in order to extend tax-free accumulation. Even after conversion to registered retirement income funds, most of their capital will still grow tax-free. Only annual distributions will be taxed.
The core of the couple's concern is the volatile stock market. They are fixated on equity mayhem and have failed to notice, for example, that Canadian government bonds have done quite well as interest rates have declined. Their guaranteed investment certificates do not give them returns as high as they might be able to get in bonds with longer maturities, in carefully chosen bond funds or in exchange-traded bond funds, Mr. Mastracci says.
They should continue to hold stocks, the planner notes. If they use stop-loss orders, they will reduce their risks. They can also diversify their equity holdings away from Canadian markets that are dominated by energy, materials and financial services. If they hold 60 per cent of their financial assets in bonds and other fixed income assets and put 40 per cent of their financial assets into one-half Canadian stocks and the other half American and global stocks, they will have achieved substantial risk control, Mr. Mastracci adds.
Humphrey and Lucille can also make use of the tax-free savings accounts introduced in the 2008 federal budget. TFSAs will allow up to $5,000 a year of savings on which income tax has already been paid to be sheltered from further taxation while in the fund or when paid out.
If Humphrey and Lucille put a total of $10,000 a year into TFSAs each year for the next 20 years, assuming that they obtain net returns of 3 per cent after inflation, they will be able to build additional savings of $268,700 in 2008 dollars for their retirement, the planner notes.
"This couple has an attractive situation, but Humphrey has been frozen like a deer in the headlights for years by his fear of stock market losses," Mr. Mastracci says. "He needs to gain financial management skills and to raise his bond content. With less overall risk, he will be able to sleep better."
Client situation
THE PEOPLE
Couple in Toronto nearing retirement.
THE PROBLEM
Fear that falling stocks will ruin plans for comfortable life after work.
THE PLAN
Diversify holdings, add bonds to reduce portfolio risk.
THE PAYOFF
More stable income and additional funds for retirement.
NET MONTHLY INCOME
$11,667.
ASSETS
House $500,000, cash & GICs $205,600, registered assets $873,200. Total: $1,578,800.
MONTHLY DISBURSEMENTS
Property taxes $300, utilities $400, maintenance $1,000, food & restaurants $1,100, entertainment $500, clothing $600, RRSP $2,000, RESP for grandkids $832, car, fuel & repairs $550, insurance for home & car $210, travel $800, life insurance $150, charity & gifts $1,150, savings $2,075. Total $11,667.
LIABILITIES
None
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