A couple we'll call Victor and Suzy have decided to drop out of the struggle to make money. Ontario residents ages 50 and 48, respectively, they have no children or other dependents, no debts and they are frugal to a fault. Their plan, already in process, is to quit their work and enjoy life. As a result, their incomes have slumped to what amounts to subsistence — together they bring in just $20,000 per year.
They are not without resources, however. When they worked – Victor was an engineer for two decades and Suzy an administrator in a small company – they generated a low six-figure total family income and saved zealously. With good fortune in their investments, they built up financial assets of $817,159. That nest egg will have to hold them for what could be four or more decades. Yet they worry that their substantial personal assets may not be enough for the next few decades of living.
“Our goal would be to use the next 20 to 25 years of healthy living to do what we want,” Victor says. “We just haven't been able to figure out what that means, except we know it means as little work as possible and a warm climate. We don't plan to leave an inheritance to anyone.”
Family Finance asked Caroline Nalbantoglu, head of CNal Financial Planning Inc. in Montreal, to work with Victor and Suzy.
The problem, as the planner sees it, is that Victor and Suzy are burning up their capital. Their present spending is $3,243 per month, including what they spend in the months away from Canada but not including savings. Their earned income from Victor's occasional consulting work, about $1,667 per month, requires they subsidize expenses out of their savings to the tune of $1,576 per month. If they do nothing about the deficit and if their non-registered savings generate 2% per year over the rate of inflation, they will have nothing left but their RRSPs by the time Victor is 62. Then they have to start withdrawing funds from their RRSPs, Ms. Nalbantoglu estimates.
If they each withdraw $11,500 from their RRSPs, take about $10,000 from non-registered investments and continue to earn $10,000 each per year in total, then they should be able to maintain an after-tax annual income of $43,000 until Victor is 65 and can begin receiving estimated CPP benefits of $6,420 per year.
Then he will stop working completely. Their income will dip for a few years. They can subsidize it by making withdrawals from their non-registered assets. In their mid-sixties, Victor's withdrawals from the RRSP will have to rise to $15,500 per year. Suzy's CPP benefits at age 65 will be $5,820. When each is 67, Victor and Suzy will be entitled to full Old Age Security benefits. At present, those benefits are $6,660 per year. Those government benefits plus their RRSP withdrawals will total $41,060 and if they continue to take both their RRSP withdrawals and their government benefits as described, they will be able to maintain an indexed income of about $40,000 indefinitely.
When Victor is 75, they expect to sell their condo and to move to an assisted-living facility. Their RRSPs at this point will be about $523,000. Money from the sale of their condo would cover any reasonable gap between income and the cost of the arrangements they envision.
A life of no work
Will this long-range plan work Ms. Nalbantoglu suggests that their stays in warm places, probably the U.S., will cost more than the $10,600 per year they anticipate spending. “This is the price of vegetating in the sun, not doing things,' she says. “Eventually, they will want to be more active and activities cost money. What do they intend to do with all that free time for the rest of their lives”
The question is not just rhetorical. The cost of out-of-country medical and hospital insurance will increase dramatically as they grow older. Moreover, if they overstay their tax-free welcome in the U.S., they could wind up having to prove they are mainly residents of Canada. The paperwork is demanding and cumbersome.
Even to generate a subsistence income, Victor and Suzy will have to adjust their portfolio. The 2% return after estimated 3% inflation is modest, yet the present allocation in their portfolio is 64% cash and fixed income. That will not support the 5% gross return they need at a minimum. Victor and Suzy would have to raise equities to 64% and drop fixed-income to 33% to achieve a 5% pre-tax investment income.
The risk of retiring early and depending on savings is enormous. Predictions of returns on savings are based on current economic conditions, but those assumptions can change. Interest rates could soar, equity returns could slump. The longer the period during which people do not earn income, the more they are at risk of having unforeseen events defeat the plans. Thus early retirement, as Victor and Suzy are doing it, puts them at substantial planning risk.
Dropping out at their relatively young ages and coasting for four decades on savings is a risky plan. They have a few choices. They can:
• Hold a high cash balance and avoid short-term risk to their portfolio, accepting instead the guaranteed outcome that they will be swamped by inflation in a few decades;
• Rotate their investments to two-thirds stocks and one-third bonds or other fixed income and take higher short-term market risk; or
• Go back to work at least on a part-time basis, raise their pre-tax salary income to perhaps $30,000 per year and wait until their 60s before making a complete break with the drudgery of work.
This last choice is the safest, Ms. Nalbantoglu adds.
In the end, Ms. Nalbantoglu says, they can live on $40,000 a year and spend four months of the year in a warm place. “Their retirement objectives are achievable. I just don't think they are realistic,” she says.