A savings plan to heal market loss
In Northern Ontario, a couple we'll call Richard and Lily, 54 and 49 respectively, have provincial government jobs paying a combined after-tax income of $8,200 a month, a sum that buys a good life in their town. For now, they are doing well.
But when they retire - as they hope to do within eight years - they will be relying on employer and public pensions for support.
Their savings, which at one time totalled $300,000, have been wrecked by the stock market collapse. More than half of their holdings in equity mutual funds for retirement and their children's post-secondary education has been destroyed.
Their problem now is to wrap up their working lives, ensuring that they live within their means. It is a significant concern because they spend 98 per cent of their take-home incomes. Last year, they borrowed $100,000 to buy a fresh crop of mutual funds to rebuild their losses.
They feel trapped.
"We'd like to live in our home for nine months of the year in retirement and spend the other three months somewhere warm, like Florida, Arizona, Spain or Portugal," Richard says. "We'd like to have more money for our retirement and for the kids' education, but the market has devastated the value of our investments. We'll have to help them as best we can."
WHAT OUR EXPERT SAYS
Facelift asked Vancouver-based financial planner Adrian Mastracci, president of KCM Wealth Management in Vancouver, to work with Richard and Lily.
"These folks are fortunate to have indexed government pensions, but they have not developed a strategy for their investments," Mr. Mastracci says. "They have mutual funds with high fees and - considering that they are almost all equity funds - more risk than they may realize. It shows in their losses."
In spite of their pensions, Richard and Lily are pushing at the limits of their retirement incomes. They have assumed that the U.S. dollar or the euro will not rise in value against the loonie and increase the cost of living outside Canada.
The defined benefit government pensions will support their retirement, but only to a point. The provincial payouts are annuities that will vanish as each partner dies, leaving the other with a reduced income.
Richard and Lily figure they will need $80,000 a year before tax when they retire. In eight years, when they plan to begin retirement, Richard will be 62 and Lily 57.
They can begin retirement with $58,500 from Richard's pension (which includes a $9,500 annual bridge payment until he is 65), and $20,900 from Lily's pension (which includes a $4,500 bridge to age 65). That's a total of $79,400 - close enough to their $80,000 goal. All figures are in 2009 dollars.
By the time Lily reaches 65, Richard will be 70. They will have $65,400 from two pensions without the supplementary bridges, Canada Pension Plan payments of $10,905 each and Old Age Security payments of $6,204 each - a total of $99,618 before tax, well over their $80,000 goal.
All that could change if Richard and Lily came up against an unexpected expense, so Mr. Mastracci wants them to increase their net financial assets by $150,000. That would require that they save $123,800 in eight years, assuming they can obtain a 3-per-cent real return.
That means they have to save $13,800 a year or $1,150 a month. They could achieve those savings after their teenage children start earning their own money. For now, they need to plan future savings.
They can clear their $100,000 margin loan by selling the mutual funds they bought - which have a current value of $98,000, incurring a $2,000 loss. They can sell gradually as backload fees decline to 1 or 2 per cent, if they wish. When their $100,000 investment loan is eliminated, they will save interest of $3,144 a year.
That would still leave $230,600 owing on a line of credit and a car loan. Their car loan should be paid off within five years, liberating $3,816 a year.
To increase their liquid assets, they could also sell their vacation property, which would put $118,250 in their pockets (before selling expenses). They will save annual interest payments of $2,928 on the property's loan and $1,200 in property tax.
These tax and interest-saving measures would bring their current annual savings of $1,968 to a total of $13,056.
They won't be spending as much money on kids' sports, food and clothing when they have retired, which could lead to a savings of $1,150 a month. Combined with the other savings, they will have far surpassed their annual savings goal of $13,800.
Counting the cash generated by the property sale, they will have actually saved $132,456 in the first year. After that, in the second and later years, they will be able to save an annual total of $14,206, easily surpassing their goal.
They can direct this money to Tax-Free Savings Accounts with $5,000 annual limits and use up some of their RRSP room that totals $55,600. They should consider buying fixed-income GICs or other devices that offer security and dependable income, Mr. Mastracci says.
"This case is about a couple with a substantial income and not a lot of savings to show for it," the planner says. "It is late in life to begin an aggressive savings campaign, but they have to do it. They should also consider delaying retirement by two to as much as five years, depending on how quickly they go to work on adding to their savings."
Special to The Globe and Mail
Interested in a free Financial Facelift? andrewallentuck@mts.net ***
CLIENT SITUATION
The People: Husband, 54, and wife. 49, planning retirement.
The Problem: Savings wrecked by stock market meltdown.
The Plan: Sell assets, pay off loans, use liberated cash for fixed-income investments.
The Payoff: A secure
retirement.
After-tax monthly income: $8,200
Assets: Cash $5,200
RRSPs $32,430
RESPs $32,400
Taxable funds $98,000
House $275,000
Vacation land $150,000
Car $15,000
TOTAL $608,030
Monthly disbursements:
Lines of credit $1,535
Investment loan $262
Vacation property loan $244
Property tax house $340
Vacation property tax $100
Car loan $318
Second car lease $235
Utilities, $677
Life, house, car insurance $510
Food $1,000
Gas for cars $350
House and car maintenance $150
Clothing $150
Investments for kids $200
Entertainment & sports $800
House cleaning $120
Charity & gifts $220
Allowances $400
Misc. $425
Savings $164
TOTAL $8,200
Liabilities:
Investment loan $100,000
Lines of credit 216,000
Vacation property loan $31,750
Auto loan $14,600
TOTAL $362,350
