Debt could reset retirement clock

The Globe and Mail     April 13, 2013
Financial Planner:       Michael Cherney

Client situation

The people

Ray, 51, and Rena, 53, and their two children.

The problem

Determining whether they can quit their jobs in four years and still have $130,000 a year after tax to live on.

The plan

Consider working a few years longer, in which case they can achieve their goals with ease.

The payoff

Financial independence and the peace of mind it brings.

Assets

Cash in bank $4,200; his company stock $134,000; estimated value of businesses net of mortgage $2-million; TFSA $400; his RRSP $262,000; her RRSP $66,000; his employer pension plan $92,800; her work pension plan $27,000; RESP $52,700; home $650,000; vacation property $350,000; commercial property interest $95,000. Total: $3.73-million

Monthly net income

$12,235

Monthly disbursements

Property taxes $720; property insurance $300; electricity, water $350; heating $280; security $30; maintenance $750; gardening $200; transportation $730; groceries $1,000; clothing $415; line of credit $700; car loans $880; gifts, charitable $140; vacation, travel $1,000; other discretionary $300; vacation property expenses $700; dining out, entertainment $775; grooming $300; clubs, sports $400; pets $150; subscriptions $15; doctors, dentists, drugstore $275; telecom, TV, Internet $145; RRSPs $475; RESP $400; TFSA $400; his stock purchase plan $325; DB pension plans $330. Total: $12,485

Liabilities

Business loans (mortgages) $1.25-million; line of credit $101,000; car loans $45,000. Total: $1.4-million

As employees and entrepreneurs, Rena and Ray are eagerly working toward what they hope will be early retirement. He is 51 and works in sales, she is 53 and works part-time in health care. They hope to throw off their shackles in four years. They have two children, 18 and 20, both of whom are pursuing studies. They have a home and vacation property in Alberta, a substantial investment in (mortgaged) income-producing industrial real estate and a separate but related small business. When they quit, Ray and Rena want to travel, perhaps spending a couple of months each year in a warmer climate. Ray may spend more time operating his business or even start up another one. They want to renovate their home and cottage. “I have been working full time since age 21,” Ray writes in an e-mail – “about two days after my last exam at university.” So it’s time for a change. If they retire from their jobs in four years or so, most of their income will come from their businesses. As well, they both have modest work pensions. Their goal is to generate enough retirement income to have $130,000 a year after tax to spend. Can they do it with nearly $1.4-million in debt? Ray asks. We asked Michael Cherney, an independent Toronto-based financial planner, to look at Ray and Rena’s situation.

What the expert says

Rena and Ray are “a breed apart,” Mr. Cherney says. On one hand, they hold down conventional jobs with all the attendant benefits; on the other, they have taken on a tremendous amount of debt as entrepreneurs. Now they’re eager to enjoy the fruits of their investments.

Can they achieve their dreams in four years?

“If they scrimp and save and push the envelope a bit – and their businesses stay as successful as they have been – they may be able to pull it off,” Mr. Cherney says. If they waited eight or nine years, though, “it would be a piece of cake.”

Here is what the planner calculates they would have if they retire in 2017: $70,000 a year from their two businesses, $15,550 from Ray’s defined-benefit pension plan (not indexed), $3,466 from Rena’s defined-benefit pension plan (mostly indexed) and $36,300 from their combined investments, including Ray’s defined-contribution pension plan (he has both kinds of pensions). The planner’s calculations assume an “aggressive” 5-per-cent temporary withdrawal rate from their savings, for a total after tax of $125,316.

This falls short of their $130,000 target. To help close the gap, they could ensure that the income from the small business owned by Rena and the two children is paid out by way of dividends. This would save “a significant amount of taxes” and help pay for the children’s tuition, Mr. Cherney says. Education costs will be offset by the $52,700 they already have in a registered education savings plan.

Ray could take over management of the other business, but this wouldn’t really make sense, the planner says. Ray would be quitting one full-time job for another, lower-paying one.

Nine years from now, when Ray is 60, “things look much different,” Mr. Cherney says. The loan against the small business would be paid off, so dividends would be much higher. Both of their pensions would be worth more. As well, they could begin collecting reduced Canada Pension Plan benefits, although they may not need the income and so might be better off deferring CPP.

A good portion of the family’s retirement income is based on the continuing success of the couple’s two businesses, the planner notes. “If either starts failing, they could be in trouble.” Strong management and realistic forecasting are critical, he adds. Fortunately, the underlying real estate is well located.

In drawing up his forecast, Mr. Cherney assumes that Ray lives to age 93 and Rena to 95, inflation averages 2.5 per cent a year, their investment returns average 4.5 per cent in their registered accounts and 3.5 per cent in their taxable accounts, and Old Age Security benefits are clawed back.

The information is used for illustrative purposes only and is based on the perspectives and opinions of the owners and writers only. It is provided with the understanding that it may not be relied upon as, nor considered to be, the rendering of tax, legal, accounting, financial or other professional advice. Investors should always consult an appropriate professional regarding their particular circumstances before acting on any of the information here. It may also contain projections or other “forward-looking statements.” There is significant risk that forward looking statements will not prove to be accurate and actual results, performance or achievements could differ materially from any future results, performance or achievements. All information provided is believed to be accurate and reliable, however, we cannot guarantee its accuracy or completeness.

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the Prospectus or Fund Facts documents before investing. Mutual funds are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated.

For this Toronto couple, plans for an early retirement hinge on compromise

The Globe and Mail     June 8, 2018
Financial Planner:       Michael Cherney

Client situation

The people

Jeffrey, 59, and Jane, 54

The problem

Have they saved enough to retire if they sell their Toronto-area house and move to a smaller town?

The plan

They sell and move to Niagara. Jeffrey quits working and Jane commutes to work for another couple of years. They lower their spending or consider working longer.

The payoff

Financial security

Monthly net income

$9,000

Assets

His bank accounts $20,000; her bank accounts $50,000; his stock portfolio $160,000; her RRSP $490,000; residence $1,350,000; cottage $160,000. Total: $2.23-million

Monthly outlays

Mortgage $1,600; property tax $525; water, sewage $150; home insurance $100; hydro $500; heating $75; maintenance $300; garden $150; vehicle lease $500; auto insurance $200; other auto $800; groceries $1,000; clothing $170; gifts, charity $240; vacation, travel $580; dining, drinks, entertainment $750; personal care $150; sports, hobbies $460; subscriptions $40; health care, life insurance $220; phones, TV, internet $440; group benefits $50. Total: $9,000

Liabilities

Residence mortgage $319,000

For the past couple of years, as the value of their suburban Toronto house soared, Jeffrey has been pleading with his wife Jane to sell it and the cottage and retire to some place where real estate is less expensive. That way, they could afford to spend six months a year in a warmer climate.Jane has steadfastly resisted, arguing that they haven’t saved enough money yet. Jeffrey is age 59 and is self-employed, and until recently earning about $45,000 a year, including dividends from his company. Jane is 54 and brings in $88,000 a year in a management job. Neither has a work pension.Last winter, Jeffrey was injured in an accident. He is unable to work at his previous pace, dropping his income to about $12,000 a year. “I’ve been begging my wife to get out of the rat race with me, yet she insists the funding is not sufficient,” Jeffrey writes in an e-mail. Originally, he’d been thinking of moving to small-town British Columbia, but Jane refused.So, Jeffrey proposed a compromise. If the numbers add up, he would quit now. They’d sell their house and cottage and move to the Niagara region, where Jane could commute to work for another couple of years before retiring.Will their savings, plus whatever they net from downsizing, provide their desired retirement goal of $70,000 a year after tax? Jeffrey asks.We asked Michael Cherney, an independent Toronto-based financial planner, to look at Jeffrey and Jane’s situation.

WHAT THE EXPERT SAYS

Jeffrey and Jane expect to net $950,000 from their house sale after paying off their mortgage and paying real estate commission, Mr. Cherney says. They figure they’d have to pay $550,000 for their Niagara-area home. As well, they plan to sell their cottage for about $160,000, netting $150,000. This leaves them with $550,000 to invest.

“They would take the rest to help finance their early retirement,” the planner says. Jeffrey would quit now, Jane in two years.

In preparing his estimate, Mr. Cherney assumed they live to the age of 95, inflation will average 2.5 per cent a year and their investments will yield 4.5 per cent a year on average.

Including their existing savings of $160,000 for Jeffrey and $490,000 for Jane, “they can come close, but not quite meet their goal,” Mr. Cherney says. They’d have $65,000 a year, about $5,000 short of their retirement goal.

The simplest thing would be to cut their spending target. That shouldn’t be very hard, Mr. Cherney says. They will no longer be making mortgage payments and their transportation costs will fall once Jane has quit working. Or they could pick up some part-time work. Jane could postpone her retirement by a few years, which might suit her, the planner says. Another solution, which would suit Jeffrey, would be to earn a higher rate of return on their investments. Mr. Cherney notes that the couple’s actual rate of return is much higher than the 4.5 per cent he has projected.

“Jeffrey has been a very successful do-it-yourself investor, with 100-per-cent stocks,” the planner notes, “but this comes with risk that Jane may not be comfortable with.”

In reviewing the couple’s finances, Mr. Cherney offers a few suggestions.

So far, Jane and Jeffrey have not taken advantage of tax-free savings accounts. The planner suggests they immediately open TFSAs and put some of their holdings there to benefit from the tax-free growth.

Jane has substantial unused RRSP contribution room, so Mr. Cherney recommends she put some of the proceeds from the house sale into her RRSP to get a big tax deduction while she is still working. Her marginal tax rate is 31.48 per cent. When she eventually converts the RRSP to a registered retirement income fund and begins withdrawing, her tax rate will be much lower.

As well, she might want to put some of the money into a spousal RRSP for Jeffrey to allow him to eventually take advantage of the federal pension income credit. They can’t claim the credit against RRIF income until they are 65.

A note on their wills. Jeffrey has updated his will since he and Jane married – it’s his second marriage – but Jane has not. “They should both have their wills reviewed by the same lawyer so that the wills can be mirrored, subject to any obligations that Jeffrey still has from his first marriage,” Mr. Cherney says.

The information is used for illustrative purposes only and is based on the perspectives and opinions of the owners and writers only. It is provided with the understanding that it may not be relied upon as, nor considered to be, the rendering of tax, legal, accounting, financial or other professional advice. Investors should always consult an appropriate professional regarding their particular circumstances before acting on any of the information here. It may also contain projections or other “forward-looking statements.” There is significant risk that forward looking statements will not prove to be accurate and actual results, performance or achievements could differ materially from any future results, performance or achievements. All information provided is believed to be accurate and reliable, however, we cannot guarantee its accuracy or completeness.

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the Prospectus or Fund Facts documents before investing. Mutual funds are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated.

Homeward-bound, but hold off on buying

The Globe and Mail     October 19, 2012
Financial Planner:       Michael Cherney

Client situation

The people

Gene and Vicky, both 31.

The problem

Deciding whether to use their savings to buy a rental property.

The plan

Use the money for savings and paying down the mortgage because the forecast net rental income leaves little room for error. Longer term, a rental property may make more sense.

The payoff

Taking full advantage of Gene’s RRSP and Vicky’s TFSA. Having enough money on hand for Vicky to comfortably take a few years off while their child is young.

Client situation

Monthly net income including bonus: $7,011.

Assets

Cash equivalents $103,000; TFSAs $17,000; his RRSP $10,000; her RRSP $7,300; residence $590,000. Total: $727,300.

Monthly disbursements

Mortgage: $2,033; other housing expenses $810, transportation $360; groceries $480; clothing, dry cleaning $220; gifts $140; charitable $250; vacation, travel $150; personal discretionary (entertaining, dining out, club membership, sports, subscriptions, grooming) $750; drugs, dental: $85, telecom $100. Total: $5,378. Savings capacity: $1,633.

Liabilities

Mortgage $454,000 at 2.15 per cent variable.

Vicky and Gene have been working in London but are moving back to Canada and are about to have their first child. Both are age 31. He works in financial services, she in health care. While they were abroad, they rented out their Toronto house and enjoyed the experience. “We are comfortable with financial risks and love being landlords,” Gene writes in an e-mail. They have saved up a sum of money – $120,000 – that they plan to use for a down payment on a second property. Their primary residence is valued at $590,000 with a $454,000 mortgage. The investment property would cost about $600,000 and generate net rental income of $500 a month after mortgage, taxes and insurance, Gene calculates. “Is it wise to use some of our savings, together with a big fixed-rate mortgage, to buy an investment property at this point in our lives?” Gene asks. They want to remain flexible enough to manage through a few years during which Vicky will be staying at home with their child. “And if not, what do you recommend we do instead with our savings?” We asked Michael Cherney, an independent financial planner in Toronto, to look at Gene and Vicky’s situation.

What the expert says

Vicky and Gene are in a good position for a young couple, Mr. Cherney says. However, whether it makes sense to buy an additional property is unclear.

“I don’t love the idea,” the planner says. The $500 a month is “too small a margin for error.” Risks include a real estate market downturn, unexpected maintenance expenses and a rise in mortgage rates.

As an alternative, they might consider buying a house with a rental unit, say in the basement, or building a basement apartment in their existing home. If they decide to sell their home and buy another one, Mr. Cherney recommends they sell their existing home before they buy a new one given the weakening market. What should they do with their $120,000 in cash?

The first $10,000 will go to setting up their household when they return to Toronto. The remaining $110,000 could be divided as follows: $30,000 to use up the contribution room in Gene’s registered retirement savings plan, invested in a portfolio of no more than five Canadian and foreign stock and bond exchange-traded funds; $13,500 to Vicky’s tax-free savings account to lift it to the maximum of $20,000; and the remaining $66,500 to pay down their mortgage, giving them increased flexibility.

If they decide to switch houses, the $66,500 would help pay for transaction costs (such as real estate commissions, land transfer tax, legal fees and moving costs) with any remainder going to the down payment.

Vicky and Gene are saving about $1,650 a month, about 15 per cent of Gene’s pre-tax income, “which is very good,” Mr. Cherney says.

They could save even more if they wish. They can increase their already admirable savings to between $2,000 and $2,500 a month and use that to fund a combination of Gene’s RRSP, Vicky’s TFSA, a registered education savings plan for their child or children, and paying down their mortgage, he adds.

Looking ahead to when Vicky and Gene retire, Gene is fortunate to have a defined benefit pension plan that will pay him $65,000 per year (current dollars) if he continues with the same company to age 65, the planner notes. With his pension, his RRSP and Vicky’s TFSA, “they are in a good position for a comfortable, and possibly early, retirement,” Mr. Cherney says.

Between now and then, the couple will have some big decisions to make. Will they want to move to a larger house? Will they continue with their frugal ways? Will they opt to send their children to private school? When will Vicky return to the work force and at what income level? As well, Gene’s pension plan could be watered down over time, or he could change employers.

Mr. Cherney is not ruling out the possibility of their buying an investment property at some point in future.

“I just don’t think this is the right time.” If they come across a well-located property at the right price a few years from now, “They may well be able to greatly improve their position,” he says. “They do have the right mindset.”

The information is used for illustrative purposes only and is based on the perspectives and opinions of the owners and writers only. It is provided with the understanding that it may not be relied upon as, nor considered to be, the rendering of tax, legal, accounting, financial or other professional advice. Investors should always consult an appropriate professional regarding their particular circumstances before acting on any of the information here. It may also contain projections or other “forward-looking statements.” There is significant risk that forward looking statements will not prove to be accurate and actual results, performance or achievements could differ materially from any future results, performance or achievements. All information provided is believed to be accurate and reliable, however, we cannot guarantee its accuracy or completeness.

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the Prospectus or Fund Facts documents before investing. Mutual funds are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated.

House rich but career challenged

The Globe and Mail     May 4, 2012
Financial Planner:       Michael Cherney

Client situation

The person

Eve, 46

The problem

How to compensate for her dwindling freelance income given that she has not been trained to do anything else.

The plan

Pick up a part-time job to allow her to continue with the work she loves and consider branching out into some other line of work.

 

By curbing her spending and increasing her income now, she will be able to hold on to her home and her investment property, which will serve as her pension once the mortgage is paid off.

Monthly net income

Net real estate income before income tax $2,500; average freelance income, $2,170 and falling. Net income after tax (average, variable): $3,750

Assets

Cash and short-term $6,050; TFSA $2,015; RRSP $44,000; home $700,000; rental property $685,000. Total: $1.4-million

Monthly disbursements

Housing costs $865; transit $25; groceries $420; clothing $100; gifts $100; charitable $25; vacations, travel $300; other $180; dining out, entertainment $470; sports $330; other personal $20; dentists $40; telecommunications, cable $315; RRSP $80; her university tuition (she’s a part-time student) $175; TFSA $100. Total: $3,545 Surplus: $205

Liabilities

Mortgages on rental property $375,000; line of credit $20,400. Total: $395,400

It would be easy to envy Eve her lifestyle. She has a mortgage-free home in a sought-after part of downtown Toronto, work she loves and a rental property that throws off substantial cash flow. Eve’s world has changed over the years. At 46, she is divorced with shared custody of her two children, ages 10 and 12. The erratic income she has earned as a freelance photographer is dwindling and could disappear altogether before long. She’s worried about finding employment at her age and uncertain about what she wants to do. Eve sees her rental property as her pension. She has two mortgages on the property, one that will be paid off in more than 20 years, the other in about 16. Short term, she wants to pay down her $20,000 line of credit and wonders whether she should cash in her registered savings to do so. Longer term, her goal is not to have to work for a living any more. “I don’t drive a car, don’t eat out at fancy restaurants, don’t take drugs, but play lots of squash, which costs,” she writes in an e-mail. She is apprehensive about the future. “Given that I am not keen to get a real job and don’t think anyone will want me now, how doomed am I?” Eve wonders if she can afford to retrain for a new career and whether it would be worthwhile. “I’m working for peanuts. I love it but it’s going to run out,” she writes. “Or should I perhaps think about buying another rental property?” Then, as if having second thoughts: “Am I in a position to have choices?” she asks. “When can I feel safe and retire?” We asked Michael Cherney, an independent financial planner in Toronto, to look at Eve’s situation.

What the expert says

“The bad news is that Eve is going to have to make some changes now,” Mr. Cherney says. The good news is that her rental property is an “ace in the hole” for her later years. With no pension and little in the way of savings, “she would normally be looking at a difficult retirement.”

The challenge will be getting there. Loss of her precarious freelance income is only one of the risks Eve faces, the planner notes. The other is interest rate risk. Eve is paying variable rates on her two mortgages of 2.15 per cent and 2.4 per cent, rates that could rise substantially in time.

“Her current interest expense of about $8,500 a year could more than double,” Mr. Cherney says. Because she is only barely making ends meet, something will have to give.

Eve has a flexible Scotia Total Equity Plan that allows her to take out a fixed-rate mortgage to partly pay down her variable rate loans as well as her line of credit. He calculates she could switch about $70,000 of her debt from floating to fixed now at a rate of 3.5 per cent for five years. While the interest rate would be higher than she is paying now, locking in would help reduce the risk that she will pay even more in future.

Unless she can find more lucrative employment, perhaps a part-time job to supplement the creative work she loves, Eve will have to shave her expenses, Mr. Cherney says. The $330 a month she spends on sports and hobbies is a prime candidate. As well, she may be underestimating some of her costs and neglecting to build an emergency fund for unexpected property repairs and maintenance.

“This is important. If she is unable to adjust her revenues/expenses, she could end up in a crisis.”

Looking ahead, Eve has set a retirement income target of $4,500 a month in 2012 dollars before taxes. This looks achievable thanks to her rental property, the planner says – but not as soon as she had hoped. With net rental income (before tax) of about $30,000 now, Eve will have to pay off her mortgage loans first.

She will be able to retire in 20 years at age 67, at which time her net rental income will be about $38,500 in 2012 dollars. Adding $4,564 of Canada Plan Benefits and $6,481 of Old Age Security benefits, together with withdrawals from her modest registered savings, will lift her income to $54,000 a year before tax.

Should she buy another rental property?

My advice is no, she already has almost $400,000 in debt,” the planner says. Besides, prices are so high now – “and she really has no money for a down payment” – that borrowing against her home to buy a third property, even if she could, would end up being a “net negative drain” on her cash flow, making the situation worse.

The information is used for illustrative purposes only and is based on the perspectives and opinions of the owners and writers only. It is provided with the understanding that it may not be relied upon as, nor considered to be, the rendering of tax, legal, accounting, financial or other professional advice. Investors should always consult an appropriate professional regarding their particular circumstances before acting on any of the information here. It may also contain projections or other “forward-looking statements.” There is significant risk that forward looking statements will not prove to be accurate and actual results, performance or achievements could differ materially from any future results, performance or achievements. All information provided is believed to be accurate and reliable, however, we cannot guarantee its accuracy or completeness.

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the Prospectus or Fund Facts documents before investing. Mutual funds are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated.

To keep the old family home, or not

The Globe and Mail     October 8, 2010
Financial Planner:       Michael Cherney

Client situation

The People:

Bev, 40, Erik, 39, and their two children, 6 and 8.

The Problem:

To continue to rent out the family home they inherited or sell it to improve their lifestyle and enable them to retire early.

The Plan:

Because it’s not strictly a financial decision, the couple need to sit down and decide where they want to live, how long they want to work and whether it’s worthwhile to continue being absentee landlords absorbing a rental loss.

The Payoff:

Once that decision has been made, they can get on with their lives and the financial planning necessary for Bev to resume her studies, the children to go to private school and the saving necessary to retire early if they choose to.

Monthly net income:

$5,520

Assets:

Bank accounts $76,587 (bequest); savings accounts $23,892; RRSPs $90,489; stocks $28,750; Bev’s locked-in retirement account $6,404; children’s trust $40,000; RESP $32,584; children’s stock portfolio $5,000; residence $275,000; rental property $750,000. Total: $1.3-million.

Monthly disbursements:

Employer pension plan $207; food and eating out $1,000; clothing $100; drugs, dental $20; child care $175; gym $66; miscellaneous $530; property taxes $266; house insurance $228; utilities $150; TV, telecom $220; maintenance $100; vacations $400; entertainment $20; auto expense $250; loan payment $84; life insurance $40; donations $45; RESP $500; gifts $50; kids piano, sports $360. Total: $4,811. Savings capacity: $709.

Liabilities:

Line of credit $20,000; mortgage on Gananoque house $113,000. Total $133,000.

When Bev’s father died four years ago, he left her some money and the house he built for his family on the shores of the St. Lawrence River near Gananoque, Ont. Last year her brother, who was only 42, died of cancer and left her a bequest. Saddened and perplexed, Bev, who just turned 40, is torn between hanging on to her childhood home or selling it to benefit herself and her children. She and her husband Erik, 39, “find ourselves in the position of having more money than we could ever have imagined,” she writes in an e-mail. The inheritance from her father enabled them to pay off the mortgage and set up a trust fund for the two children, aged 6 and 8. The family is comfortably settled in a small town north of Toronto where Bev works in communications and Erik in sports. Occasionally, Bev imagines moving into the Gananoque home, but the children are already settled in school and her husband is happy in his work. She would like to quit her full-time job and perhaps take a graduate degree. If they sold her father’s house, they could afford an in-ground swimming pool and private school for their children. “In truth, I am not sure we are managing our finances in the best way since taking on all this extra money,” she writes. “Is it crazy to hang on to my family home when it loses money each year?” We asked Michael Cherney, principal of Michael Cherney Financial in Toronto, to look at the couple’s situation.

What the Expert Says

A big change in financial circumstances is a perfect time to draw up a new financial plan, Mr. Cherney notes. Yet the question – whether to keep or sell the house Bev inherited from her father – is not strictly a financial one.

Selling the house would free up enough cash for the couple to achieve all their goals, including retiring early, the planner says. To help with the decision, he prepared two projections, one in which they sell the house before retirement and the second where they keep it indefinitely.

If they keep the Gananoque home indefinitely, they will be able to retire at age 65 with an annual income of $70,000, or about 82 per cent of their pre-retirement income, he calculates. If they sell the property and work part-time, earning $25,000 between them for 10 years, they could retire a full 10 years earlier, at age 55, with an income of $75,000 a year.

Mr. Cherney’s calculations assume an inflation rate of 2.5 per cent, that they raise their annual RRSP contributions from $5,000 to $9,000 a year and that they reduce their registered education savings plan contributions from $6,000 to $2,000.

They already have about $33,000 in an RESP, “which is substantial for kids of this age,” he says. As well, they can gradually transfer the $40,000 in trust for the children into the RESPs ($5,000 a year for two children) to take advantage of the federal government’s Canadian Education Savings Grant.

Mr. Cherney also assumes they will earn an average annual rate of 5 per cent on their registered savings and investments and 4 per cent after tax on their non-registered accounts. If they work to 65, Erik would qualify for the full Canada Pension Plan but Bev would not because her income is lower.

Mr. Cherney offers three reasons to sell the Gananoque house now: The upkeep and taxes are high and are not fully offset by rental income; the real estate market may have peaked and prices in future could be lower; and it may be easier to manage the money from the sale than being absentee landlords.

He also offers a couple of reasons to sell later. They could keep the house in the family, at least for now. And the potential appreciation in value would be taxed at the capital gains rate – and perhaps could even be non-taxable through the use of the principal residence exemption.

However, the fact the property has been rented may limit any exemption, Mr. Cherney cautions. As well, they would have to use the property themselves, if only as a cottage, rather than continuing to rent it. Other tax planning opportunities may be possible if the exemption applies, he adds.

Bev and Erik should gradually shift their non-registered investments into their tax-free savings accounts, and then gradually withdraw the money when they retire. Having good-sized TFSAs would be especially advantageous if they decide to retire early, he says.

The information is used for illustrative purposes only and is based on the perspectives and opinions of the owners and writers only. It is provided with the understanding that it may not be relied upon as, nor considered to be, the rendering of tax, legal, accounting, financial or other professional advice. Investors should always consult an appropriate professional regarding their particular circumstances before acting on any of the information here. It may also contain projections or other “forward-looking statements.” There is significant risk that forward looking statements will not prove to be accurate and actual results, performance or achievements could differ materially from any future results, performance or achievements. All information provided is believed to be accurate and reliable, however, we cannot guarantee its accuracy or completeness.

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the Prospectus or Fund Facts documents before investing. Mutual funds are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated.

Pair dig their oars into long-term plan

The Globe and Mail     March 13, 2010
Financial Planner:       Michael Cherney

Client situation

The People:

Melody, 40, Dave, 39, and their two children

The Problem:

An enviable one: What to do now that they have an extra $800 a month to save, spend or invest.

The Plan:

Catch up with unused RRSP room by contributing the maximum to spousal RRSP for Melody, and catch up with RESP contributions for children’s education.

The Payoff:

Lower taxes in retirement thanks to income splitting, tax-effective education savings through RESPs and a comfortable and secure retirement.

Monthly net income:

$5,600

Assets:

Home $320,000; RRSP $27,000; CSBs $4,000; RESP $2,000. Total: $353,000

Monthly disbursements:

Child care $570; property tax $230; car and house insurance $220; hydro $130; heat $160; phone and cellphone $120; entertainment and recreation $500; food and eating out $930; car loan payment $345; student loan payment $125; children’s extra-curricular $100; parking, gasoline, tires, car maintenance $550; clothing $150; vacations $400; donations $20; gifts $50; savings $200; Subtotal $4,800; Savings capacity $800; Total $5,600

Liabilities:

Car loan $9,000; student loan $4,500; Total $13,500

For Melody and Dave, it was a Christmas present to remember from his grandparents: the full discharge of their $250,000 mortgage. “We are still reeling from their generosity,” Melody writes in an e-mail from Kingston, Ont. The grandparents, who had been holding the mortgage, effectively put an extra $800 a month – or $9,600 a year – into Dave and Melody’s pocket. The gift could not have been more welcome because the couple were getting a bit behind. Dave, a teacher, is 39. Melody, who works part-time in financial services, is 40. They have two children, who are 3 and 6. They have unused contribution room in their registered retirement savings plans (RRSPs) and have lagged in saving money for their children’s education through “This is an incredible gift that has opened up doors to many opportunities that we just couldn’t even consider before,” Melody writes. The question is what to do first: Pay off debt or save and invest? And, how do they make their savings and investments tax effective? We asked Michael Cherney, a Toronto-based financial planner, to look at Melody and Dave’s situation.

What the Expert says


A sudden increase in cash flow is the perfect time to seek financial planning advice, Mr. Cherney says. Dave and Melody haven’t had a chance to get used to having more money so it will be easy for them to save.

First, they need to catch up. From now to 2013, Dave should contribute $10,000 a year to a spousal RRSP for Melody so they can split their income when they retire. He will get the tax deduction. By spreading the contribution over four years instead of making a lump-sum contribution, Dave will “optimize” his tax refund at about 40 per cent a year.

As well, the couple should contribute $10,000 a year to an RESP for their children for the next four years.They will get $500 per child in government grants for each of the four years. And, since they have not maximized their RESP contributions, they can carry forward an extra $500 per child in unused government grants each year.

From 2014 until 2031, when Dave plans to retire, he should continue making contributions to Melody’s spousal RRSP, although the allowable amount will drop to about $2,000 a year once he has exhausted his unused contribution room. They should also continue contributing to their children’s RESP, although this amount, too, will drop over time.

The lower outlays after the first four years will free up money for Melody to open a tax-free savings account (TFSA).

Unlike Dave’s situation, Melody’s retirement savings should go into a TFSA rather than an RRSP because she is in a much lower tax bracket, Mr. Cherney says. With income of $32,000, she is likely to be taxed at the same rate or even higher after she retires, and withdrawing money from a TFSA won’t affect her eligibility for other benefits or trigger a claw-back of Old Age Security.

TFSAs are also more flexible. If, in the meantime, the family’s cash needs to increase, they can withdraw the money from the TFSA without tax or penalty and their contribution room will be restored.

But wait: The $20,000 in new outlays exceeds the $9,600 in new cash flow. Mr. Cherney says about $4,000 of the shortfall will come from Dave’s income tax refund each year. The couple have already been socking away $2,400 a year in savings and can divert that money to the new savings plan. Mr. Cherney suggests they borrow the remaining $4,000 a year ($16,000 in total), adding it to their $13,500 in existing debt.

“I don’t usually counsel clients to borrow funds unless there is a good reason,” the planner says. “Here, there is.”

They could use a home equity line of credit to lower the interest rate they are paying on their $9,000 car loan. As for Melody’s $4,500 student loan, the interest is deductible, so she should not roll it over into a larger loan because she would lose the deductibility.

When Dave and Melody retire – which they hope will be when he turns 60 – they will start drawing payments from the Canada Pension Plan and Dave’s teacher’s pension. In addition, they will convert Melody’s spousal RRSP to a registered retirement income fund (RRIF) and start gradually drawing from it and Melody’s TFSA to supplement their income.

Dave’s pension payments will qualify for income splitting as soon as he retires, allowing them to reduce their average tax rate immediately, “which is a huge benefit, especially for a couple whose incomes were not previously even,” Mr. Cherney says.

The planner estimates their retirement income will be $70,000 a year and that their savings will last until Melody is 95 and Dave is 94. That assumes a 5-per-cent rate of return on their investments and a 2.5-per-cent annual inflation rate.

The information is used for illustrative purposes only and is based on the perspectives and opinions of the owners and writers only. It is provided with the understanding that it may not be relied upon as, nor considered to be, the rendering of tax, legal, accounting, financial or other professional advice. Investors should always consult an appropriate professional regarding their particular circumstances before acting on any of the information here. It may also contain projections or other “forward-looking statements.” There is significant risk that forward looking statements will not prove to be accurate and actual results, performance or achievements could differ materially from any future results, performance or achievements. All information provided is believed to be accurate and reliable, however, we cannot guarantee its accuracy or completeness.

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the Prospectus or Fund Facts documents before investing. Mutual funds are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated.

Income splitting vital to couple’s plans

The Globe and Mail     October 16, 2009
Financial Planner:       Michael Cherney

Client situation

By next spring, Ed and Cleo aim to have sold their Vancouver house and moved to their dream home in the sunny Okanagan Valley. Cleo, who is 60, has already taken early retirement and Ed, 58, plans to follow next June.“When you live in the rain for 55 years, you get tired of it,” Ed said in an interview.

The people

Couple Cleo, 60, and Ed, 58

The problem

Raising enough monthly income from investments in a tax-efficient and secure way to retire comfortably.

The plan

Take advantage of income splitting and ease into the stock market slowly.

The payoff

Worry-free retirement knowing they can travel and enjoy an active lifestyle.

Monthly net income:

$8,728

Assets

House $950,000; second residence $650,000; RRSPs $650,000; RESP $20,500; cash and investments $487,000; Total: $2,757,500

Monthly disbursements

Mortgage and taxes $1,937; maintenance fees $356; food/eating out $1,450; clothing $175; transportation $400; entertainment/holidays $835; gift/donations $195; utilities $396; insurance $125; personal allowances $200; son’s university tuition $1,200; RRSP contributions $1,459. Total: $8,728

Liabilities Mortgage

$186,000 Total: $186,000

While Ed and Cleo (not their real names) have a wealth of assets, they also have some questions. Their social life is still centred in Vancouver. They plan to buy a modest condo there so they will have a place to stay when they are in town. Should they put it in their son’s name? He’s 22 and in his fourth year of university so this would give him a leg up in the pricey Vancouver real estate market. Should Cleo start drawing on her RRSP right away? And how can they invest the $600,000 or so they have sitting in money market funds without undue risk? We asked Michael Cherney, a Toronto-based financial planner, to look at their situation.

What Our Expert Says

Ed and Cleo have an embarrassment of riches, Mr. Cherney says. They own two residences totalling about $1,600,000 in value, with a modest mortgage of $187,000. They also have financial assets of about $1,150,000. “And this is before you look at Ed’s two defined benefit pensions.”

It is important to distinguish between a defined benefit (DB) pension and a defined contribution (DC) pension, Mr. Cherney notes. With a DB pension, the employer guarantees the retirement income. With a DC pension, the risk is entirely the employee’s. With an increasing number of companies opting for DC pensions to reduce their risk and benefit their bottom line, Ed finds himself in a shrinking group of fortunate workers.

To boot, one of Ed’s two pensions has full indexing together with a pre-age-65 supplement for Canada Pension Plan (CPP). Even in a low-inflation environment, it is easy to lose sight of the destructive power of inflation to erode the value of retirement income.

Over the course of a 30-year retirement (which is becoming an increasingly common event with today’s longer life spans), a $40,000 pension will shrink by more than one half, even assuming a low inflation rate of 2.5 per cent. So, the value of full indexing on a pension, as well as on CPP and Old Age Security (OAS), can scarcely be exaggerated, Mr. Cherney emphasizes.

Ed’s income from his registered pension plan will be eligible for income splitting rules, effective immediately upon retirement. These rules allow for the allocation of up to one half of pension income to the spouse for tax purposes, allowing Ed and Cleo to split their retirement income, which will total about $100,000 a year, equally from day one.

This is another advantage of Ed having a defined benefit pension. While income-splitting rules also apply to income from a Registered Retirement Income Fund (RRIF), these don’t kick in until age 65, or six years after their retirement starts.

The couple wonder whether they should start depleting Cleo’s Registered Retirement Savings Plan (RRSP) (currently valued at $450,000) during her low-income years at the beginning of their retirement. While this may well have been a wise decision before the inception of the income-splitting rules, there is no need for it now because Cleo’s unused low tax brackets will be filled by Ed’s split income.

Given that RRIF income is fully taxable, there is no reason to start drawing it until the latest possible time, or the year after they turn 71, and then only at the minimum. Until then, any required income after pension, CPP and OAS should come from the non-registered funds.

Tax-Free Savings Accounts (TFSA) also fit into the couple’s plan. Each has one, containing $5,000. They have so much in the way of non-registered savings that they can transfer the annual maximum from these savings into their TFSAs, allowing for tax-free growth.

Because most, if not all, of their income will come from company and government pensions and from RRIFs, they will likely not need any of the money in their TFSAs during their lifetime, and it will flow tax-free to their son upon the death of the second surviving spouse.

However, if it is needed during their lifetimes, it can be withdrawn without any tax, and recontributed later, as required, because contribution room is restored upon a withdrawal.

Another question from the couple is whether Cleo should take advantage of her outstanding $13,400 RRSP contribution limit. The answer is yes, but not until 2011. She will then have about $50,000 in income based on the split from Ed’s pension (as well as her own CPP income), which can be reduced by this deduction.

This contribution makes sense given that the couple are maximizing their TFSAs anyway, and given that there are still another 10 years before she needs to start withdrawing from her RRIF.

The couple were lucky enough to escape the stock market carnage last fall, and they now have about $600,000 in money market investments that they would like to invest. Mr. Cherney recommends an asset allocation of 60 per cent to 70 per cent equities and 30 per cent to 40 per cent fixed income given their age and circumstances.

“I have one particular caution in the case of equities,” he says. Because much of the couple’s money is now in cash or equivalents, he strongly recommends not jumping into equities on a wholesale basis.

One overlooked risk for retirement income is “early decline risk.” Early declines are much more damaging to the long-term value than are later declines when money is being withdrawn from a portfolio, because there is less capital with which to make up the losses.

“For this reason, the couple should look at transferring to equities on a gradual basis, perhaps over three to five years.”

As for buying a condo in their son’s name, the planner sees some benefits to doing so. “Since he is their ultimate beneficiary, it makes sense to allow him to start taking advantage of the principal residence exemption at the earliest possible age,” he said.

The information is used for illustrative purposes only and is based on the perspectives and opinions of the owners and writers only. It is provided with the understanding that it may not be relied upon as, nor considered to be, the rendering of tax, legal, accounting, financial or other professional advice. Investors should always consult an appropriate professional regarding their particular circumstances before acting on any of the information here. It may also contain projections or other “forward-looking statements.” There is significant risk that forward looking statements will not prove to be accurate and actual results, performance or achievements could differ materially from any future results, performance or achievements. All information provided is believed to be accurate and reliable, however, we cannot guarantee its accuracy or completeness.

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the Prospectus or Fund Facts documents before investing. Mutual funds are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated.

Luxurious retirement possible but will have to wait

The Globe and Mail     June 13, 2009
Financial Planner:       Michael Cherney

Client situation

In Toronto, two men we’ll call Kevin and Steve have been in a committed relationship for more than a decade. Kevin, 50, is a vice-president at a major company. Steve, 39, was laid off from his management job in transportation nearly a year ago. Together, they take home $9,700 a month; consisting of Kevin’s pay plus Steve’s employment insurance benefits. “We’d like to retire in five years, but Steve’s unemployment is a problem,” Kevin explains. “We also like to travel to exotic destinations. We already spend $15,000 a year on trips. Can we do it all?”

What our expert says

Facelift asked Toronto-based financial planner Michael Cherney to work with Kevin and Steve.

“They have to balance their wish to maintain their present way of life with the impact early retirement will have on savings. They have an expensive way of life, and there is a fundamental fact they must understand: The longer they work, the shorter the period during which they will draw down their savings.”

The foundation for the couple’s plans is Kevin’s job. It pays $165,000 a year or $8,400 a month after tax. Steve’s EI benefits, $1,300 per month, will run out in August. Their financial future therefore rests on Kevin’s income, their $475,000 house, and financial assets of $756,000. They have no debts other than credit card bills that they pay in full each month.

For planning purposes, it is useful to assume that 1) Steve finds another job in his field at $50,000 a year, 2) Kevin continues to add at least $21,000 a year to his RRSP, 3) Kevin and Steve each put $5,000 into Tax-Free Savings Accounts every year beginning in 2009, and 4) investments grow at a real annual rate of 3 per cent a year.

With these assumptions, the men would have $1,175,250 in assets in their RRSPs, Tax-Free Savings Accounts and non-registered assets by the time Kevin wants to retire at age 55. These assets could produce $46,054 a year for the 46 years from Kevin’s retirement in five years to Steve’s age 90, the planner estimates.

After Kevin’s retirement at age 55, the men would have total pretax income of $96,054. If their average tax rates are 25 per cent a year, they would have combined after-tax income of $72,040 a year. That’s less than their present spending of $116,400 a year, which includes such things as $30,000 a year on home renovations, Mr. Cherney notes. Large spending cuts, including slashing travel costs, would be in order.

To avoid having to reduce their standard of living, both men should work to their respective age 60. By doing that, their portfolio would grow to $1,586,642. The men would have investment income of $65,795, plus Steve’s expected annual salary, for a total of $115,795 before tax in 2009 dollars, the planner estimates. Kevin would be able to draw Canada Pension Plan benefits at 60 of $7,633 a year, which would be the maximum $10,905, less a penalty of 6 per cent per year for each year prior to age 65 at which benefits begin, the planner estimates.

Their total pretax income would have risen to $123,428 in 2009 dollars. At a 25-per-cent tax rate, they would have $92,571 left to spend. This after-tax income would cover expenses including travel at current rates, provided that the men have ended their house renovations at a cost of $2,500 a month. When Kevin reaches 65, he will receive Old Age Security benefits of $6,204 a year at current rates, making pretax income $129,632. After 25-per-cent average tax, they would have $97,224 a year to spend.

If Steve quits work at age 60, his earned income would cease. He would be eligible for early Canada Pension Plan benefits, but would be hit by the early retirement penalty. The men’s household income would decline from $129,632 to $79,632. Steve’s age 60 estimated CPP benefits could be $7,633, boosting total income to $87,265 a year. At 65, Steve will receive Old Age Security benefits of $6,204 a year, pushing total household income to $93,469, Mr. Cherney says.

Given Steve’s present unemployment, his Canada Pension Plan benefits are not dependable. But their investment income should be stable until Kevin passes away, assumed to be at age 90, at which time the couple will lose Kevin’s Old Age Security and his Canada Pension Plan benefits. Investment assets would roll over to Steve without tax. Steve, who for planning purposes will also live to age 90, would in turn exhaust his financial capital. If Steve were to live beyond age 90, he would still have a house that he could sell, Mr. Cherney notes.

The validity of this plan depends on Steve being able to find work at $50,000 a year. If he never finds work, the plan will fall short of its goals. However, a job that pays at least $30,000 or more a year would allow the men to have a comfortable retirement, provided they make appropriate spending cuts before quitting work, Mr. Cherney explains.

“If the men delay retirement and terminate house repairs, they can have the travel they want,” Mr. Cherney says. “This analysis is about choices and they are in the men’s hands.”

The information is used for illustrative purposes only and is based on the perspectives and opinions of the owners and writers only. It is provided with the understanding that it may not be relied upon as, nor considered to be, the rendering of tax, legal, accounting, financial or other professional advice. Investors should always consult an appropriate professional regarding their particular circumstances before acting on any of the information here. It may also contain projections or other “forward-looking statements.” There is significant risk that forward looking statements will not prove to be accurate and actual results, performance or achievements could differ materially from any future results, performance or achievements. All information provided is believed to be accurate and reliable, however, we cannot guarantee its accuracy or completeness.

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the Prospectus or Fund Facts documents before investing. Mutual funds are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated.

TWO HOMES ARE NOT SO SWEET

The Globe and Mail     January 17, 2009
Financial Planner:       Michael Cherney

Client situation

Woman, 58, with residences in Toronto and B.C.

THE PROBLEM

Cost of two homes limits other choices and retirement.

THE PLAN

Sell one home.

THE PAYOFF

Enhanced financial choices now and in retirement.

NET MONTHLY INCOME

$2,484

ASSETS

B.C. condo $550,000, RRSP $325,000, taxable invest. $715,000, car $15,000. Total: $1,605,000.

MONTHLY expenses

Property taxes $350, condo fees $250, utilities & phones $230, rent on Toronto apt. $2,100, food $450, restaurant $250, entertainment $200, clothing $250, car fuel $50, travel $200, car and home ins. $188, misc. $350, charity & gifts $300. Total: $5,168.

Liabilities

None

In Toronto, a woman we’ll call Cynthia runs a business out of her rented apartment. She also has a condo in British Columbia where she spends about half the year. Now 58, she has an active social life in Toronto, but plans to retire to B.C. However, the cost of maintaining two homes is much more than her annual $29,808 after-tax income can support. She has done it so far by spending her capital. “I’d like to be in both communities for the next 10 to 15 years, but what should I do? Buy a small condo in Toronto at a price of about $300,000? Can I afford to give up that much of my $715,000 in taxable investments?”

WHAT OUR EXPERT SAYS

Facelift asked Mike Cherney, a certified financial planner in Toronto, to work with Cynthia to examine the costs of her choices and to create a financial road map for her work and retirement.

Cynthia’s life will be easier if she gives up one of her residences, the planner says. Her current total monthly expenses are $5,168, more than twice her $2,484 monthly after-tax income. That cost overrun is being paid out of capital at the cost of her future living standard.

If she were to give up her Toronto apartment and settle permanently in B.C., her monthly expenses would decrease to $3,068 a month. Her expenses would still exceed her after-tax monthly income. Therefore she needs to consider selling her B.C. condo. Were she to realize $500,000 after expenses for selling the condo, her investments generating current taxable income would rise to $1,215,000.

Assuming that she can obtain a 4-per-cent annual return on those taxable assets, and that inflation runs at 2.5 per cent a year, she could have a total investment return, including income and reduction of capital, of $54,675 a year or $4,556 a month from her enhanced sum of capital, Mr. Cherney estimates. That cash flow would exhaust her taxable assets by her assumed death at age 94.

She can also add income from her registered retirement savings plan, which he estimates would be $12,840 a year on the same assumptions. That total, $67,515, will more than sustain her expenses until she reaches age 60 when she can take Canada Pension Plan benefits reduced by 0.5 per cent a month for each month prior to age 65 that she begins benefits. Her age 65 entitlement would be $8,492. Adjusted for early application benefits, she would receive $5,944 a year or $495 a month, the planner estimates.

Her income to age 65 would therefore be $73,459 a year or $6,122 a month. At age 65, she would receive Old Age Security, which currently pays $6,204 a year. On a monthly basis, her total age 65 income would be $79,663, or $6,639 a month, which would more than cover her present expenses and allow her to generate an emergency fund for unexpected expenses.

Cynthia, in conversation with Mr. Cherney, rejects the idea of giving up one residence. She thinks that she could put more hours into her business and raise her income by nearly $30,000 a year. That would be nearly four times her present income from self-employment. The planner thinks she can do this, but she would have to work much longer hours, he adds.

Betting that she can make her small business generate four times its current income is a risky proposition, the planner notes. Illness or injury could impair her income. She does not have disability insurance.

She could sustain two homes by a combination of working longer hours and reducing the cost of living in Toronto, perhaps by moving to a less expensive apartment.

Cynthia could also increase her income by renting out her Toronto apartment or renting her B.C. condo out when she is not using one or the other.

Most of Cynthia’s investments have been in guaranteed income certificates.

They have not suffered any losses of value in the current market slump. She has averaged a return of 4.75 per cent a year, though she will have to turn to preferred stocks or perhaps depressed common shares to equal this rate of return as the GICs mature, Mr. Cherney suggests. She could also consider a prescribed annuity as a tax-effective way of getting yield in non-registered assets and of providing income in the event that she lives a good deal longer than her life expectancy. She should wait for bond yields, on which annuities are based, to rise. That could be several years, the planner suggests.

Cynthia can boost her income through use of the Tax Free Savings Account that went into operation on Jan. 1. It can shelter $5,000 a year of contributions of income on which tax has already been paid. Payouts will not be subject to tax. There are no limits on withdrawals.

“She can make a choice or bet on raising her income,” Mr. Cherney says. “But if she fails to quadruple her present business income, which is $725 a month after expenses, she will be forced to make a decision about which home to keep. Moreover, she does not have a great deal of time to make up for slow business. A tough decision has to be made.”

“At some point, I will accept the necessity of giving up one residence,” Cynthia says. “I will probably keep the B.C. condo because I think my future is there.”

The information is used for illustrative purposes only and is based on the perspectives and opinions of the owners and writers only. It is provided with the understanding that it may not be relied upon as, nor considered to be, the rendering of tax, legal, accounting, financial or other professional advice. Investors should always consult an appropriate professional regarding their particular circumstances before acting on any of the information here. It may also contain projections or other “forward-looking statements.” There is significant risk that forward looking statements will not prove to be accurate and actual results, performance or achievements could differ materially from any future results, performance or achievements. All information provided is believed to be accurate and reliable, however, we cannot guarantee its accuracy or completeness.

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the Prospectus or Fund Facts documents before investing. Mutual funds are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated.

No benefit in home ownership for Toronto woman

The Globe and Mail     June 7, 2008
Financial Planner:       Michael Cherney

Client situation

Angela, 52, single, living in Toronto.

THE PROBLEM

Are her savings and pension going to be adequate for retirement?

THE PLAN

Verify cash flows at age 65 and enhance after-tax returns.

THE PAYOFF

Comfortable retirement with an option to continue work.

NET MONTHLY INCOME

$3,855.

ASSETS

RRSPs $169,200, cash $5,700, car $3,000. Total: $177,900.

MONTHLY EXPENSES

Food and restaurants, $467; rent, $925; phone and utilities, $191; auto expenses, $296; clothing, $142; commuting, $208; entertainment, $272; household expenses, $290; home insurance, $23; uninsured drugs, $58; grooming, $42; RRSP, $300; taxable investments, $188; gifts and charity, $75; line of credit, $300; savings, $78. Total: $3,855.

LIABILITIES

Line of credit, $2,600.

In Toronto, a woman we’ll call Angela is doing well in her insurance industry career. At age 52 and single, her gross income of $69,800 is enough for now, but she worries about the future. She rents a lovely cottage by Lake Ontario, but feels it is too late to buy a home. “I would like to maintain this lifestyle, but I don’t want to face poverty at 65, which is when I expect to retire,” Angela explains. “I may need money to hire some services and to pay for a decent retirement living situation. I might even want to work beyond age 65.”

WHAT OUR EXPERT SAYS

Facelift asked Toronto-based certified financial planner Michael Cherney to work with Angela in order to plan a comfortable retirement. His conclusion: With some adjustments to her savings and investments, Angela should be able to count on $48,000 a year in retirement income, which is 69 per cent of her current gross income.

With no further employment expenses, such as commuting, and no employment insurance, Canada Pension Plan and retirement savings deductions, her way of life should not suffer a significant reduction.

“Angela’s problem is straightforward,” Mr. Cherney says. “How can she afford to retire and travel on what amounts to one average income? She is anxious to plan for the time in 13 years when she would be expected to quit work.”

Angela’s job has a defined benefit pension that will pay her $15,146 a year at age 65 indexed to 75 per cent of the rise in the consumer price index.

Together, Angela and her employer deposit about 14 per cent of her gross income into her pension. As well, she has $169,200 in registered retirement savings plans, and hopes to add $2,300 this year. She also has $5,700 in a non-registered account and plans to add $3,600 this year. She saves steadily, but an enhancement of after-tax returns are possible.

Beginning next year, Angela can make use of tax-free savings accounts, created in this year’s budget. TFSA contributions are made with after-tax dollars, but funds in TFSAs will grow and be paid out tax-free.

Angela’s RRSPs will rise in value to $366,000 by age 65, assuming an average annual return of 5 per cent, Mr. Cherney estimates. She can withdraw 5 per cent a year to age 71. At that time, she would convert her plans to registered retirement income funds and withdraw the statutory minimums. The required withdrawals start at 7.4 per cent a year and grow to 20 per cent a year for RRIFs established in 1993 and later. She should convert her non-registered account to a TFSA next year and add $5,000 yearly to age 65. It would then be able to pay her $2,800 a year at age 65.

Canada Pension Plan benefits will provide $10,615 a year, the maximum payable, and Angela can also expect to receive $6,028 a year from Old Age Security in 2008 dollars. In future dollars, at the time of her possible retirement in 2021, Angela should have $22,243 from her job pension, $14,633 from CPP, $8,309 from Old Age Security, $18,298 from her RRSP/RRIF and $2,800 from her TFSA for a total pretax income of $66,283. That will equal her present cost of living in 2008 dollars inflated at 2.5 per cent a year to 2021.

By 2021, Angela’s assets will have risen to $366,000 in her RRSP/RRIF and $56,000 in her TFSA. She could buy a house, but what she could get for a mortgage payment on a 25-year amortization equal to the $925 monthly rent she now pays for her cottage residence would not be nearly as nice. She could build equity and own the house by age 79. But to what end, Mr. Cherney asks. She would wind up paying more for less. She has no plans to leave substantial sums to anyone. It would be an investment without a clear rationale, he says.

“If Angela works to age 65, she will be able to have a comfortable retirement,” Mr. Cherney says. “She will have the security of having most of her money come from government pensions and a defined benefit pension plan. Most of her cash flow will be largely indexed to the cost of living. The saving she is doing today will pay her well in her retirement.

“If Angela chooses to work beyond age 65, she will be able to increase her income,” the planner adds. “Canada Pension Plan benefits will increase by 0.5 per cent a month for each month past age 65 at which she elects to begin those benefits. She will hit a plan maximum at 130 per cent of age 65 benefits at her age 70. Continued work would generate more employment pension benefits and RRSP space.

” Most of all, by continuing to work, she would be able to defer the time when she has to begin to consume her savings.”

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