Couple in their 40s with $3 million in assets must diversify if they want early retirement

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An Ontario couple we’ll call Jerry and Kathy, each 43, are raising three children ranging in age from 11 to 14.  Jerry is a consulting engineer, Kathy a civil servant. Their income can total as much as $250,000 per year, but on average they bring home $11,333 per month and add $1,000 net after all costs from two rental units. They are tired of their jobs. Their goal — retirement at 55.

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They would like to retire with an after-tax income of $82,000 per year. The problem is that much of their savings are locked up in their two rentals — with net combined value of $1.26 million — and their $1,600,000 home. They have $94,000 in an RESP for their kids, $110,000 in their RRSPs and two new cars, valued at an estimated $80,000. The couple’s savings are in cash in a bank earning approximately nothing even before inflation.

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So far, Jerry and Kathy have concentrated on debt reduction rather than accretive investing in individual stocks or ETFs and mutual funds. Their portfolio is relatively illiquid, with much of their net worth tied up in the two rental properties and the civil service pension income that will not be available for a couple of decades.

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Structure of income savings

Family Finance asked Owen Winkelmolen, head of Planeasy.ca, an advice-only financial planning firm based in London, Ont., to work with Jerry and Kathy. His view — “they are missing opportunities,” he explains.

“They have net worth of $2,355,000, but because of bad experiences in stocks, they have put most of their savings into property. Only $110,000 of that net worth, six per cent, is in financial assets. Diversified they are not.”

First — the kids. Jerry and Kathy add $458 per month to RESPs with a present balance of $94,000. That attracts the Canada Education Savings Grant bonus of the lesser of $500 or 20 per cent of contributions with a cap of $7,200 per beneficiary. That makes total contributions $6,595 per year and the sum of all past and future contributions $126,975 in five years. At that time, observing the CESG cutoff at 17, the RESPs will provide each child with $42,325, enough for four years of study if they are living at home.

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Basis of retirement income

Kathy will have a defined-benefit pension available as early as age 55. However, due to time she took off from work to raise their children, the expected payouts will be rather modest — just $2,618 per month if taken at 55 and much less if taken sooner.

Their biggest liability is the opportunity cost of keeping their savings entirely in cash, the result of Jerry’s painful losses in the stock market over a decade ago. Jerry and Kathy have preferred to pay down their line of credit, which now has $25,000 outstanding and is due to be paid in full in two years, and buy back some of Kathy’s pension.

Building a secure retirement is going to take a change in savings and investment strategy, Winkelmolen reasons. The couple’s main investments at present are two rentals. The mortgages will not be paid off until Jerry and Kathy are 72, which is 17 years after their present retirement date target. With the mortgages still absorbing rental income, it would be a good idea to sell them. The sale should come in the first or second year of retirement, when the couple’s regular income has stopped and their tax bracket has declined, but before 65 when OAS and CPP start, Winkelmolen advises.

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The properties have a present combined value of $1,260,000. After five per cent costs for primping and transaction fees, $63,000, there should be $117,400 capital gains taxes to pay as well as the cost of discharging mortgages, $320,970 estimated outstanding in 12 years. That would leave $758,630 net proceeds.

They can use those funds to pay out their home mortgage which, Winkelmolen estimates, will have a balance outstanding of $61,295 in 12 years at age 55. Next — use retained savings to build TFSAs. They have no TFSAs now. The contribution room should be $153,000 for each partner at age 55, Winkelmolen estimates. The $391,335 remaining can be invested in non-registered accounts.

By the time they are 45 and the line of credit and pension buyback are done, Jerry and Kathy can start to add to their RRSPs from available cash from the sale of properties. Jerry, with the higher income and lots of RRSP room, should make the contributions. The couple’s present balance of $110,000 growing with $36,000 annual contributions at three per cent after inflation should be $560,530 in 10 years when they are 55. Annuitized to pay out all income and capital in the following 40 years, it would generate $23,544 per year.

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The couple should have total combined TFSA room at their age 55 of $153,000 each or $306,000. The combined sum, invested at three per cent after inflation would generate $12,852 per year for the following 40 years. Non-registered funds of $391,335 invested with a return of three per cent after inflation for 40 years would generate $16,437 per year.

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Income at start of retirement

Assuming a rate of return of three per cent after inflation on their investment accounts, they will have annual income from 55 to 95 of $23,544 from RRSPs, $12,852 from their TFSAs, and $16,395 from non-registered accounts. Combined with pension income of $2,618 per month or $31,416 per year, they will have a total of $84,207 per year at age 55. After splits of eligible income and 14 per cent average tax on all but TFSA withdrawals, they will have $74,217 to spend per year, less than their $82,000 annual retirement income goal. A little part-time work will close the gap, Winkelmolen suggests.

At age 65, Kathy’s pension loses a $3,274 annual bridge benefit, so she will receive net $28,142 per year. CPP will pay $22,621 combined benefits, and OAS will pay two $7,707 benefits. That’s a total of $118,968. After splits of eligible income and 18 per cent average tax on all but TFSA cash flow, they will have $99,870 to spend each year, comfortably above their goal.

Retirement stars: Three *** out of 5

Email andrew.allentuck@gmail.com for a free Family Finance analysis.