Situation: Woman in mid-60s fears she is not ready to retire and maintain her modest way of life
Solution: Consider annuitized income, cut mutual fund management fees, cut back on gifts to kids
A woman we’ll call Hilda is self-employed in southern Ontario as a documents manager. Now 65, she expects she must continue working to age 70 in order to pay her bills in retirement. She generates $2,500 a month from her work, adds $720 per month from the Canada Pension Plan, $590 from Old Age Security and $100 from a foreign pension or total pre-tax income of $3,910 per month. After tax, she has $3,340 monthly to spend.
Hilda’s means are modest. She has $510,600 in total assets of which $275,000 is her condo’s estimated market value and $5,000 in her car. The issue is whether her financial assets, which have a recent value of $230,600, will be sufficient to supplement her OAS and CPP benefits and small job pension to allow her to live much as she does now.
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“Assuming I’ll be working for the next five years, should I continue contributing to CPP until age 70?” she asks. Is the return worth it? And what will I have to live on at age 70?”
Family Finance asked financial planner Daniel Stronach, head of Stronach Financial Group in Toronto, to work with Hilda. “She needs more money to retire, but Hilda has never taken an active interest in her investments,” he explains.
“She is asking what she can do to ensure that her income does not dwindle,” Stronach says. “This is critical, for she does not make RRSP contributions in spite of having $30,000 of RRSP room. The need to boost income by some means is urgent. She has five years to do it.”
Moderate income situations require a fresh look at savings vehicles, the planner says. RRSPs are not tax efficient for Hilda because the tax savings in her low bracket are very small. Hilda already puts $200 a month into her Tax-Free Savings Account. Moreover, taking money out of a TFSA is very easy, unlike the red tape that goes with cashing money out of RRSPs. Therefore skip all further RRSP contributions. Save in the more flexible TFSA instead, he advises.
Hilda should not contribute to CPP after 65. As a self-employed person, she has to pay the employer and employee shares, total 9.9 per cent. It would pay her for life, but the bet is not worthwhile, Stronach says.
Estimating retirement income
As long as Hilda works, she will generate savings. At present, she saves $200 in her TFSA and $660 in non-registered savings. The total, $860 per month, is $10,320 per year. If she saves that sum for five years, then with 6 per cent growth less 3 per cent inflation, it would become $54,790 in 2018 dollars, and her total savings would grow to $323,760. If that sum generates 3 per cent a year after inflation and only the income is paid out, it would generate $9,700 a year or $810 per month indefinitely. However, if funds were paid out over 25 years to deplete all capital and income, it would generate $18,600 per year or $1,550 per month in 2018 dollars. That is almost double the perpetual income payout at 3 per cent of capital with full retention of capital.
An annuity calculation which pays out all income and capital by a certain date is not the same thing as buying an annuity for life or for a certain term from an insurance company. The annuity calculation for just a specific term without purchase of an annuity keeps full control of capital and market risk in Hilda’s hands.
Registered Retirement Income Fund payout rates use rising payouts over time as compared to constant annuity payouts. If Hilda’s self-administered RRIF investments generate more income than low starting payout rates set by government tables and if she banks that surplus for higher payouts later on, the plan would work. She would do well to take advice from a financial planner and consult an insurance professional, Stronach cautions.
A life insurance company which might sell her an annuity would guarantee payouts, provide protection against civil claims and could, if she chooses that option, guarantee a minimum number of payments to her three grown children, or anyone else for that matter, even if Hilda were to die very soon. But insurance-based annuities have many fees. Anyone buying an annuity gives up a lot of money up front to get a trickle of income.
At Hilda’s stage of life, her $18,600 annual annuity proceeds generated either by a contract with an insurance company — subject to sales costs — or by her own calculations would amount to $1,486 per month. Adding in $720 per month CPP, $590 from OAS and $100 from a monthly foreign pension would give her a pre-tax monthly income of $2,896. That is $444 less than her present monthly allocations. However, if she trims monthly gifts to her children, cuts savings after retirement and boosts investment returns, she would close the gap. She would still have $7,900 cash in a savings account, for emergencies.
It would be a tight budget. Hilda admits she has not given attention to her investments. She pays an average 2.5 per cent in management expenses for her RRSP and TFSA mutual fund investments. On the $222,700 total of these accounts, that is $5,567 a year. Hilda could migrate this money to income-focused exchange traded funds with fees as low as a tenth of one per cent for a total annual charge of $222. The annual savings would be $5,345 or $445 per month. She would need to study and shop ETFs, but savings would be her income to keep.
Allowing for pension income credits when her RRSP converts to a Registered Retirement Income Fund and qualifies as a pension plus age tax credits, Hilda’s tax rate would average about 10 per cent and leave her with $2,606 a month to spend. That’s $734 a month less than she allocates now, but just by reducing $320 monthly gifts to her adult children, trimming $860 monthly TFSA and non-registered savings after retirement, cash flow would cover expenses and leave a little extra for travel, entertainment and other treats she has denied herself.
“This plan will give Hilda a secure retirement with a measure of discretionary income,’ Stronach says.
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Retirement stars: two retirement stars ** out of five