In Saskatchewan, a couple we'll call Norman, 65, and Susan, 53, have built their lives on solid jobs and a simple, down to earth way of living. They have built what looks to be a comfortable, secure retirement on the basis of Norman's administrative job and Susan's job as a manager for a large business.
Today, their take home income is $10,200 a month after tax including modest rent from farm land they own and Old Age Security benefits. They have some issues, but their accomplishment can be a model for others.
Their problem is how to ease into a retirement that will allow them to maintain their way of life. It's a little farming in the summer and watching baseball games and spending time in their trailer in Florida in winter. What has built their fortune and keeps them going is being frugal.
It's the story of how folks can use tax breaks like RRSPs and, more recently, TFSAs, and the sheer will not to spend beyond their means to create the financial framework of a durable retirement.
They dine at discount store lunch counters for ten bucks for two and carefully weigh the costs and benefits of buying a new trailer. Nevertheless, they worry that their good fortune will peter out as their savings dry up. Their defence against the poverty they fear is a high rate of savings, for they retain about half their take home income.
Family Finance asked Caroline Nalbantoglu, a financial planner who heads CNal Financial Planning Inc. in Montreal, to work with Norman and Susan. Their financial strength, she says, lies in their high rate of savings, Susan's defined benefit pension and in their substantial net worth, $1,043,000.
They plan on making their retirements official and complete before the end of 2014. Norman wants to quit in July 2013. He is already receiving OAS benefits of $546 a month. He will give up his $5,411 take home income and then apply for CPP benefits of $1,013 a month. Susan, who currently brings home $3,250 a month after tax, wants to quit a year later. At retirement, Susan's job pension will be $3,509 a month to her age 65, when it will drop to $2,550 a month. At that time, she can add Canada Pension Plan benefits, currently $1,012.50 a month.
Their pension income in 2014 will be $5,068 a month in 2013 dollars plus $200 monthly rent from their farm land for a total of $5,268 a month. When Susan reaches 65, she can add $546 a month in 2013 dollars from OAS.
Investment income at 3% after inflation from the couple's $438,000 financial assets can add $1,100 a month for $6,168 total monthly pre-tax retirement income until Susan begins to receive OAS, when it will rise by $546 a month.
At Norman's age 72, RRIF rules will approximately double payouts from his RRSPs – the largest part of the couple's registered holdings, pushing income up by as much as $1,900 a month to approximately $8,068 a month or about $96,800 a year. If they split pension income, they will avoid the OAS clawback which begins at $70,954 in 2013. After 25% average income tax, they will have $6,050 a month to spend, far more than the $4,849 they now spend each month with savings taken out. They will have a very large cushion for unexpected expenses should they arise.
For now, their finances are secure, but it is possible to foresee trouble ahead.
Their government pensions and Susan's job pension are indexed to inflation, but they will need to make their investment portfolio pace the rising cost of living. It is not certain that it will, for the assets, all high cost mutual funds, appear to have been chosen for international travellers rather than these Western Canadians who figure Florida is foreign enough.
Of their mutual funds, most are global equity holdings. That diversifies their investment base beyond Canada, which is good, but it adds cost, for, on average, global funds have fees half a per cent higher than straight Canadian equity funds.
They could increase their investment in a low fee real return bond fund, which they already hold, and it would guarantee income that paces inflation without risk of large capital loss.
Moving money from costly global funds to less costly Canadian equity funds will improve the efficiency of the portfolio, that is, returns in relation to cost. If they shift from mutual funds to exchange traded funds with lower fees, they could increase returns by perhaps 2% a year and still retain an interest in global ETFs for the diversification they provide. Their funds have been held for more than six years, so penalty charges for taking money out that nick withdrawals before that time will not apply.
Getting a higher return from the portfolio will help to pace inflation. Yet the 12-year difference in their ages means that Norman and Susan need to balance inflation with security. They can manage their own portfolio, selecting stocks or ETFs or mutual funds that appear to be able to pace rising prices. That leaves investment risk in their hands. Or they can reduce investment risk by buying annuities.
Annuities guarantee income and shift investment risk to the insurance company that operates them. But annuities have fixed payments in most cases and do not pace inflation.
There is a solution – a gradual shift every five years or so of, say, 10% of investment assets from their portfolio of registered or unregistered assets to an annuity.
Because life expectancy shrinks as one ages, each purchase will pay successively more income. As well, the amount of money exposed to market risk will decline. The annuities should have a sufficient number of payments guaranteed so that Norman's death will not cut her annuity income, Ms. Nalbantoglu cautions.
“Norman and Susan have done everything right,” Ms. Nalbantoglu says. “The twists and turns of the pension system will make their incomes wobble until Susan receives her Old Age Security. However, they will be able to generate a surplus and therefore a buffer if they continue to be frugal. Their retirement should be financially secure.”