Situation Woman in her mid-50s worries she cannot afford a comfortable retirement
Strategy Work to 71, adopt defensive portfolio strategy, maintain savings
Solution A retirement with no change of lifestyle and without excessive financial risk
A health care professional we?ll call Simone lives in Quebec, spending her days in hospitals, many nights too when she is on call. At 56, though devoted to her work in palliative care, she is still reeling from a divorce five years ago that left her raising her two teenage children.
Her home, a storey and a half, 800 square foot English cottage surrounded by gardens of lavender and rosemary, roses and peonies, is just five minutes from her village hospital. The cottage is much of what she salvaged from her marriage, her second, when she drew down $300,000 savings from her RRSPs to finance her husband?s failing businesses. The withdrawals were subject to tax, adding to losses.
I am beginning the last portion of my working life. I don?t want to be under any illusions or to have to rely on my kids
Simone?s problem is to put her retirement on a sustainable course. The dilemma is financial, but she can make good gains with appropriate tax strategies and investments. She has no company pension plan, so she carries the risk and the rewards of her plans.
She remembers past financial errors ? putting too much money into high tech ventures her husband could not make profitable. ?Those are mistakes that will never recur,? she says. The problem now, as she readily admits, is to build a financial plan that will get her through her remaining working years and then her retirement.
Simone has rebuilt her financial life as an independent contractor for a local health authority. She generates $70,000 to $92,000 a year in billings. With no company pension plan and with only $78,800 left in her retirement savings, Simone knows she must tread carefully ? not retiring too soon or investing foolishly.
?I want to be sure that I am on track for retirement and that, when I quit work, that I will have enough money to live on,? Simone says. ?I am beginning the last portion of my working life. I don?t want to be under any illusions or to have to rely on my kids. This is the time for a financial reality check.?
Simone has two children in their early 20s, both in university. Past financial problems had a legacy: there was no money for registered education savings plans for the children. But Quebec?s university tuition costs are low, a few thousand dollars a year for most undergraduate faculties. The children have jobs and pay these expenses themselves. She provides a roof over their heads, feeds them, and subsidizes them to the tune of $350 a month.
In retirement, Simone plans to keep her tidy village cottage and settle down to a life of gardening with a little travel as her budget allows.
But she isn?t in such a big hurry to do that ? she enjoys her work and recognizes that, financially, she may not be ready.
She worries that her well diversified portfolio with a current value of $78,800 plus $37,000 cash won?t be enough to boost her retirement income to a level adequate to sustain her present monthly expenses. Her mortgage with $108,000 outstanding, will be paid off in 8 1/2 years, just before she turns 65.
Family Finance asked Caroline Nalbantoglu, a financial planner who heads CNal Financial Planning in Montreal, to work with Simone. The object ? evaluate ability to save for that retirement, estimate total income at 65 and in later years and devise investment strategies for building investment value.
Cash management
Tax management has to be part of Simone?s savings plan, Mr. Nalbantoglu explains. Simone has already contributed $10,237 to her RRSP for 2012. If she uses her cash to boost contributions to a total of $35,200 for 2012 to fill available RRSP space and adds $13,000 each year thereafter through her age 65, and grows contributions at 6% before inflation adjustment of 2.5%, then in at 65, she should have about $187,500 in her RRSP in 2013 dollars. Tax refunds from RRSP contributions directed to the mortgage would allow it to be paid off in about 4 years.
At 65, Simone would have a CPP benefit of $12,150 a year and a potential annual payout of $7,500 from her RRSP at 4% for total income of almost $19,647 a year. At 67, Old Age Security would add $6,553 a year for total annual income of $26,200. After 10% average income tax based on personal, age and pension credits, her monthly income would be about $1,965. That would not support present spending even after elimination of costs of servicing her mortgage, helping her children, driving to work, and socking away money for retirement.
Enhancing retirement income
To maintain her way of life, Simone should work additional years to 71, and keep contributing to her RRSP at $13,000 a year, Ms. Nalbantoglu suggests. She would be adding to capital and reducing the number of years that she will have to draw down her savings. When she is 71, her RRSP would have a balance of about $319,000. At that time, RRIF payments at statutory rates of about 7.4 % or about $23,600 a year will push her income up to $42,300 before tax. After 15% average income tax, she would have about $3,000 a month in 2013 dollars to spend. That is what she spends now minus her mortgage payments, which will have ended, child care and retirement savings.
This is a story about a person with no financial background who has made a lot of very good decisions
To make sure that her investments do not let her down, Simone needs to adopt a defensive strategy for her current portfolio allocation of 63% equities, 32% bond index exchange traded funds and 5% cash. She must cut her exposure to long bonds due in 10 or more years that have made her a good deal of money in the last four years but that are on the verge of large declines when interest rates rise and make existing bonds less attractive.
Simone could shorten the terms to maturity by moving out of her general Canadian bond index fund to an ETF that holds investment grade corporate bonds with five year terms to maturity or by selecting an ETF that ladders investment grade corporate bonds with terms from one to five years. She might also lock in interest returns and exclude any risk of loss by splitting the fixed income part of her portfolio into half GICs and half 5-year high quality corporate bond ETFs.
?This is a story about a person with no financial background who has made a lot of very good decisions,? Ms. Nalbantoglu says. ?It is about a person who has learned to be careful with money, avoids excessive debt, and plans a viable retirement. Diligent in investing and in making up for some past losses, she is a model for good planning.?
Need help getting out of a financial fix? Email andrewallentuck@mts.net for a free Family Finance analysis.
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