With Over $1.5-Million in Assets, Couple’s ‘Financial Neglect’ Could Still Limit Money for Travel, Children

Andrew Allentuck
Nearing 60, frugal couple in Saskatchewan needs to find funds for world travel
Take charge of investments and raise rate of return by cutting management costs
In Saskatchewan, a couple we’ll call Jason and Brenda, 59 and 56, respectively, have built orderly, secure lives. John, who sells heating and cooling equipment and Brenda, a management consultant, have two children living at home, ages 19 and 23, both in university. Each month, the couple takes home $7,775, which buys a good living in their town.
They travel a good deal, taking extended holidays to exotic spots in South America and Asia. They want to do more of the same in retirement, but they are anxious that, with no company pensions, they will not be able to afford much more than weekends in Moose Jaw.
“We are worried about retirement because neither of us has a defined benefit pension,” John says. “We would like to be able to continue our travels in our retirement.”
That travel would take $7,000 to $9,000 a year. In order to determine the affordability of their plan, Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. of Kelowna, B.C., to review the couple’s future finances.
Budgeting for Retirement
They have $687,000 in financial assets plus $58,000 in RESPs for their children. They also rent an apartment in their basement for $8,100 a year. Considered as an asset which returns 3% a year over inflation, it has a present value of $270,000. That pushes their total income generating assets other than RESPs to $957,000. Thus their present assets can produce $28,710 a year at the same 3% return without any reduction of capital. However, if just the financial assets combined with annual savings growing at 3% a year to $820,000 by the time John is 65 are paid out so that all capital is expended in the next 30 years to Brenda’s age 95, then they would have $40,617 in 2014 dollars in annual pre-tax income plus their government pensions.
At 65, those pensions would be two Old Age Security payments of $6,618 a year and two Canada Pension Plan benefits of $12,460 a year. The total, $38,156, would add to the returns from savings on the total payout by Brenda’s age 95 model and the assumed continuing rent from their basement apartment, $8,100 a year to make total income $86,873 a year. Assuming that their qualifying pension income is split and that they pay 20% average tax, they would have about $5,790 to spend each month, Mr. Moran estimates.
That income would support their present budget. If RRSP, TFSA and other savings are taken out, they would need just $3,227 a month to get by. The difference of income less present budget, $2,563 a month, could be spent on travel. That would be $30,756 a year and would cover their travel plans with a large surplus.
Earlier retirement is possible if the couple will accept a lower income. For example, for retirement at age 60, their financial assets would grow to $707,600. That would support income plus return of capital for 25 years of $39,452. Add rental income of $8,100 a year, and reduced CPP for the couple, $15,948 and they would have total income of $63,050 a year. After 15% average tax, they would have $4,470 to spend each month. They would still have a $1,243 monthly surplus for travel. At 65, they could add OAS at $6,618 each to bring total income to $76,286. After 20% average tax, they would have $5,400 to spend a month in comparison to present expenses, leaving $2,173 a month for travel in addition to present travel spending.
The numbers need to be matched with common sense on what model to use — preservation of capital or total payout of capital — and when to start retirement. The annuity payout model would leave them with no financial capital. But they would still have their house and the rental stream from the basement apartment as well as their government pensions. If the house, with a present value of $675,000, were to appreciate at just 2% a year in the 38 years from Jason’s age 60 to Brenda’s age 95, it would have a value of $1.43 million. If sold for 95% of that price to allow for selling costs and the remaining capital invested in diversified financial assets yielding 3% after inflation, it would generate pre-tax income of $40,755 a year. Adding in government pensions of $38,156 if they have taken retirement at 65 or $29,184 at if retirement began at 60, they would have total annual income of about $79,000 or $70,000, respectively.
On the other hand, if they want to leave significant sums to their children in excess of the value of their house, they may prefer the capital preservation model. This is a question of personal values, not just calculation, the planner notes.
There is also a matter of timing. Travel to the places they like in the developing world requires a certain level of physical well-being. Thus they might prefer early retirement with what amounts to more travel in their sixties and early 70s and less later on.
Managing Money
They could have more money for their travel and for their children if they would take a more active role in managing their money. They already have the means to hire an independent money manager who might charge 1.0% to 1.5% of assets under management – perhaps $6,900 to $10,000 a year. They could then avoid mutual fund charges that, if all their money were invested, be about $17,000 a year. Fees paid for handling non-registered assets would be tax deductible.
That begs the question of which manager. Jason and Brenda have left investment chores to their bank’s fund salesperson and to an independent mutual fund salesperson. They do not know the names of their funds. They do not know why they keep one large position in the one stock they own. They have a mountain of cash earning very little. This is financial neglect.
Jason and Brenda need to learn at least enough about capital markets to judge the work of any manager they may consider hiring or, perhaps, enough to ask their present investment advisors why they should buy whatever is recommended. That means studying capital markets, learning why prices of stocks and bonds go up and down, and studying enough accounting to sense if they are being bamboozled. This homework is potentially interesting and, even if it is a burden, it could pay handsomely, Mr. Moran suggests.
(C) 2014 The Financial Post, Used by Permission