Malcolm is concerned about how his wife Paula would fare if something were to happen to him after retirement.Amber Bracken/The Globe and Mail
Editor’s note:
At age 48, Malcolm’s near-term goal is to retire early from a high-stress career as a first responder. His wife, Paula, also 48, is no longer working, having stayed home for many years to raise their two children, 13 and 10. “She was sidelined from going back to work when the COVID-19 pandemic first hit,” Malcolm writes in an e-mail.
Malcolm is “leaning heavily” toward retiring in mid-2024.
“We have lived within our means and taken a common-sense approach to investing, saving, emergency funds, paying down our mortgage and not taking on debt,” Malcolm writes. Malcolm has a defined benefit pension that will pay $72,500 a year.
The catch is that his pension indexing will not start if he retires next summer, but will accumulate from the time he retires to age 60 and begin paying out then. “Our retirement goal is to maintain our current lifestyle and expenses, about $48,000 a year plus an additional $20,000 annually for trips and/or activities, until my indexing and our Canada Pension Plan and Old Age Security benefits start.”
Malcolm also gets a government disability pension of $20,000 a year. He is concerned about how Paula would fare “in the event something were to happen to me after retirement.”
We asked Gordon Stockman, a certified financial planner at Efficient Wealth Management Inc. in Mississauga, and Ahmed Mahiyan, a certified financial planner at Nextgen Financial Planning Inc., also in Mississauga, to look at Malcolm and Paula’s situation. Mr. Mahiyan holds the chartered financial analyst (CFA) designation as well, and Mr. Stockman the chartered professional accountant (CPA) designation.
What the experts say
If Malcolm and Paula want to retire in July, 2024, they can afford to spend their target amount of $68,000 a year, the planners say. Malcolm’s work pension of $72,500 a year and tax-free disability benefits of $20,000 will cover most of the required expenses until Malcolm’s death. “There is very little need to tap into their savings,” the planners say. “As long as Malcolm is alive, the financial plan is easily sustainable.”
To optimize taxes, they recommend splitting Malcolm’s income from his work pension with Paula. He can split it up to 50 per cent, which will make their income similar. They cannot split their CPP and OAS benefits. So, careful withdrawal strategies are needed when they liquidate their registered retirement savings plans (RRSPs) and their registered retirement income funds (RRIFs). “The goal is to make their income very similar, so the overall household tax bill is minimized.”
Malcolm is concerned with the inflation rate from age 49 to age 59 while he waits for his pension indexing to kick in. The savings in their RRSPs, tax-free savings accounts and non-registered accounts that they built over the years are enough to cover any cash flow shortfall during this period, the planners say. From age 60 on, all Malcolm’s retirement sources of income are indexed to inflation.
The planners assume a long-term inflation rate of 3 per cent.
Malcolm and Paula invest mainly in dividend-paying, blue-chip stocks of large Canadian companies. They might be better off focusing on the total return of their portfolio, the planners say.
Because most of their assets are in registered accounts, they are not taking advantage of the dividend tax credit. “Therefore, asset location needs to be done properly to optimize tax in the decumulation stage.” If possible, all dividend-paying Canadian stocks should be invested in non-registered accounts, growth stocks such as international and U.S. issues should be held in their TFSAs, and bonds and guaranteed investment certificates, along with U.S. dividend stocks, should be invested in the RRSPs.
Malcolm and Paula need a proper assessment of their risk tolerance to find the appropriate asset allocation, the planners say. “In the model plan, our investment return assumption is 4.66 per cent – or 5.66 per cent before investment fees – for a 60 per cent stock and 40 per cent bond portfolio.”
Both Malcolm and Paula will get reduced CPP benefits. If they delay taking the benefits to age 70, they can expect a 42 per cent increase in CPP and a 36 per cent increase in OAS. Any cash flow shortage from age 65 until age 70 can be covered by withdrawals from their RRSPs, non-registered accounts and TFSAs. The liquidation order can be a combination of RRSP and non-registered savings to minimize taxable income.
Malcolm and Paula had their wills and powers of attorney done in 2002, before their children were born. The planners recommend they update these documents to reflect their current financial situation and future wishes.
In this base case scenario, Malcolm and Paula’s net worth is forecast to grow steadily from $1.2-million to $2.5-million at age 70. It then grows rapidly when their government benefits start, which gives a significant boost to their retirement cash flow. Their estimated net worth could be $8.9-million at age 95. “Our default assumption for life expectancy is 95 unless there are reasons to think otherwise.”
What if Malcolm dies prematurely?
“Now, the base case scenario looks very rosy given Malcolm’s generous pension plan and tax-free disability benefits,” Messrs. Stockman and Mahiyan say. However, the situation would get significantly worse if something were to happen to Malcolm. Because Paula would get only half of Malcolm’s pension, and his disability pension would stop, the registered assets – RRSP and TFSA – would need to be liquidated sooner to meet the cash flow shortfall.
If Malcolm were to die prematurely at age 60, for example, this would mean a significant drop in Paula’s income. She’d also lose his OAS benefits, although she would be entitled to the CPP survivor benefit. “However, the sum of the CPP survival benefit and Paula’s own CPP benefit cannot exceed a single person’s maximum CPP,” the planners note. They assume a 10 per cent reduction in retirement spending in this scenario, although this may be offset by potential increased medical costs for Paula later in her life.
Malcolm has a $358,000 life insurance policy, which would be paid at age 60 if he were to pass. This sum would be invested in the non-registered account and the TFSA. In this scenario, RRSP withdrawals of $30,000 a year would rise slightly each year from age 60 to 70 to keep up with inflation. “This would ensure we keep the tax bill even over the years.” Any shortfall of cash flow can be covered by the non-registered account and TFSA.
Paula’s net worth would be about $2-million at age 70, and $2.5-million at age 95. A significant portion of the net worth would be tied to the couple’s house.
“Given these circumstances, a proper insurance-needs analysis is very crucial,” the planners say. One concern might be Malcolm’s disability, which could make him uninsurable. Assuming he qualifies for additional insurance, having enough coverage until age 70 would provide the peace of mind that Malcolm is looking for, the planners say.
Client Situation
The people: Malcolm, 48, Paula, 48, and their two children, 13 and 10.
The problem: Can Malcolm retire before age 49 with an increase in travel spending? Will Paula be okay financially if something happens to Malcolm?
The plan: Retire as planned next year, deferring CPP and OAS benefits to age 70. If possible, take out enough term life insurance to make sure Paula could live comfortably if something were to happen to Malcolm.
The payoff: Peace of mind that they can enjoy the best part of their life in coming years.
Monthly net income: $8,600.
Assets: Cash and equivalents $47,000; joint non-registered investments $52,000; his TFSA $112,000; her TFSA $126,000; his RRSPs $133,000; her RRSP $173,000; registered education savings plan $89,000; residence $470,000. Total: $1,113,000.
Malcolm’s pension: Immediate lifetime pension and bridge benefit of $72,550 until age 60. It increases with inflation after age 60 and the bridge benefits stop at age 65. Also, Malcolm receives a lifetime tax-free Veterans Affairs disability pension of $20,000, which is indexed.
Estimated present value of his pension plans: Planners declined to provide.
Life insurance: Malcolm $358,000; Paula $40,000.
Monthly outlays: Property tax $387; water, sewer, garbage $380; home insurance $108; heating $110; security $10; maintenance $40; garden $15; transportation $585; groceries $750; clothing $150; gifting $280; vacation, travel $300; dining out $200; drinks $80; entertainment $160; beauty $80; sports and hobbies $80; subscriptions $10; doctors, dentists $20; health, dental insurance $209; life insurance $55; disability insurance $80; phones $55; cable $65; TV, internet $140; registered education savings plan $412; TFSA, non-registered account contributions $3,033; pension plan contributions $1,200. Total: $8,995.
Liabilities: None.
Editor’s note: In a previous version of this article the planners stated incorrectly that Malcolm would be entitled to full Canada Pension Plan benefits. In fact he will get only 69 per cent of the maximum and the planners used that lower number in their calculations. This version has been updated
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