Stella, 53, and Mark, 49 (above) and their three teenage children live in Toronto.
Stella nets $84,000 a year; $7,000 a month. Mark nets $64,000 a year; $5,334 a month. Total: $148,000 a year; $12,334 a month.
House, $450,000; rental house, $200,000; company pension, $92,000; RRSPs, $212,000; RESPs, $63,000; cash and money market funds, $250,000; taxable investments, $88,000; vehicles, $12,000; personal effects, $100,000.
Food, $1,180; cars, insurance, gas and maintenance, $700; disability insurance (Stella), $328; house insurance and maintenance, $500; travel and entertainment, $1,050; clothing, $500; RRSP, $1,375; RESP, $500; dental, medical, $330; charity, $125; savings, $5,746. Total: $12,334.
In Toronto, a couple we’ll call Stella and Mark have built a good life on hard work. Stella, 53, runs a small business and nets $84,000 a year. Mark, 49, is an engineer for a large company and nets $64,000 a year. With three teenagers at home, they have lived well but not planned for their future. “We are drifting financially with poor use of our assets,” Mark says. “We need a plan to guide us in managing business opportunities, our investments, saving for our children’s future and our own personal needs.”
What our adviser says
Facelift asked Toronto-based certified financial planner Michael Cherney to speak with Stella and Mark in order to develop a plan. His conclusion: “On a family income of about $150,000 a year, the family has done fine. But for Mark to retire in six years, as he would like, they have to begin making definite plans for the time when their earned income begins to decline. For now, they have more liquidity than they are using profitably.”
Stella and Mark are frugal, but they have substantial outstanding obligations to themselves for retirement and for their kids for their remaining years of dependency and for their postsecondary education, Mr. Cherney says.
Planning for retirement is the largest task Stella and Mark face, the planner says. Assuming that each lives to age 90, that inflation runs at an average 3 per cent a year and that both Stella and Mark begin drawing Canada Pension Plan benefits in 2016, then the couple will have a secure future, Mr. Cherney concludes.
The foundation of the couple’s retirement is Mark’s pension from his employer. That pension will begin its payout in 12 years when he is 61. At that time, the pension will be $3,099 a month in 2005 dollars. At age 61, he will also begin receiving CPP at a reduced rate of $606 a month. Early application for CPP will cost him 6 per cent a year of his maximum benefit. When he reaches age 65, he will receive monthly Old Age Security of $462.47 in 2005 dollars. At Stella’s retirement, which should begin when she reaches age 65 in 2016, she will have monthly CPP payments of $502 a month and monthly OAS payments of $462.47.
There are two sets of problems to be solved in the couple’s pension planning, Mr. Cherney notes. First is the structural problem of avoiding the OAS clawback that begins at an annual income of about $60,000 in 2005 dollars. Second is adjusting investment returns to a reasonable level of risk, he says.
Avoidance of the OAS clawback requires that Mark make maximum contributions to Stella’s registered retirement savings plan. He will thereby shift the risk of the clawback to Stella, who will have lower retirement income. He has $1,600 of unused contribution room, Mr. Cherney says. Stella should maximize her own contributions to her RRSP. She has $15,500 of contribution room, he adds.
RRSP contributions can be invested to produce returns of 5 per cent a year in registered accounts and 4 per cent a year in non-registered accounts subject to taxation, Mr. Cherney says. By maintaining RRSP contributions, Stella will accumulate $620,000 in her RRSP by age 69 and Mark $232,000 in his before he begins to withdraw funds through a registered retirement income fund at age 69. The RRSP must be converted to a RRIF, taken as a lump sum or turned into a life annuity by the end of the year in which one turns 69, the planner notes. At the time of inception, Stella’s RRIF will pay $19,000 a year. Mark’s RRIF will pay $11,600 at inception at age 69, Mr. Cherney says.
Educating the couple’s three children will be a costly undertaking. Recent Statistics Canada data indicate that the cost of tuition and books at a Canadian university is $28,000 for a four-year course if a student lives at home or $48,000 if the student has to pay room and board away from home, Mr. Cherney notes.
Assuming a 5-per-cent annual rate of inflation in the costs of postsecondary education, Stella and Mark will have to finance expenses in the range of $99,000 to $177,000, he estimates. Stella and Mark already have sufficient savings in RESP and taxable investment accounts. If one or more children choose to live out of the home, while at university, then the parents may want to provide additional financing through RESP contributions, the planner explains.
Although Stella and Mark have not focused their goals well enough to make firm decisions on how they can be financed, they can get better returns on their savings. To do that, they must move most of the approximately $250,000 they have in money market funds and cash into equities and bonds. The fees on specialty mutual funds in their portfolios average 3 per cent a year, even though specialty funds tend to have higher volatility than broad market equity funds and plain “vanilla” bond funds that have no foreign currency exposure, Mr. Cherney notes. Stella and Mark have the ability to pick their own assets and save on high management fees. They also have sufficient cash to build a diversified portfolio.
“This couple has, in a sense, an embarrassment of riches,” Mr. Cherney notes. “Their liquidity offers opportunities, yet it also creates problems. Stella and Mark have to decide how they and their children will be able to use their money. The paths lead to early retirement, sending the children to university with all expenses paid, and to bequests to their children or to charities.”
“We agree with the analysis,” Stella explains. “We have a huge portfolio of cash that is not earning much, real estate with the potential to generate large capital gains, and three great kids. We need to set our goals. Then the plan will make more sense.”
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