Big decisions ahead for couple

Meanwhile, Tim has been offered a job as the manager of a small, growing firm for a salary of $75,000 a year. He’s thinking of accepting this opportunity while taking early retirement at his current firm, which would – at least, for now – give him a pension of 50% of his past five years’ salary. However, Tim’s medical and insurance benefits would cease; the new firm doesn’t offer any benefits.

Tim has $150,000 in an RRSP and $200,000 in a non-registered account, mainly as a result of inheritance. He and his 54-year-old wife, Glenda, have $20,000 each in tax-free saving accounts (TFSAs). Glenda works part-time as a receptionist, earning $30,000 a year, and plans to continue working in that position until Tim retires. She also has $150,000 in her RRSP. Her job has no medical or insurance benefits.

Tim and Glenda have an $800,000 home, whose $150,000 mortgage is scheduled to be paid off in 10 years. The couple also have a line of credit on the house, which has a balance of zero. The couple’s two children are financially independent. Because Tim and Glenda paid for the children’s university education, there is no concern about leaving money for the children.

Tim and Glenda spend about $60,000 after taxes, RRSP and TFSA contributions, mortgage payments and the lease for Tim’s car, which is $400 a month. Glenda has an older car, which she replaces every five years or so for about $5,000, paid for from cash flow. In retirement, the couple plan to purchase another second-hand car for Tim for a similar price.

They would like to spend $60,000 in today’s dollars to age 95, and want to know if that will be feasible if Tim takes the new job and his pension is reduced by 50%.

the recommendations: the best option, from a purely financial perspective, Faulkner says, is for Tim to take the new job and the commuted pension from his current job. However, Faulkner notes, Tim and Glenda can meet their retirement income goal of $60,000 in today’s dollars even if Tim retains his pension rights and the benefits are cut by 50%.

That said, Fernandes has reservations about Tim taking the new job, given his age. Fernandes believes it would be too risky to leave a $90,000-a-year position with full benefits for a lower salary and no benefits at age 55. Furthermore, the lack of benefits would mean Tim and Glenda would need to buy additional insurance, the cost of which would reduce their potential income.

Fernandes also thinks Tim may be over-reacting about the risk of a cut to his pension benefits – many companies’ pension plans, Fernandes adds, are only 70% funded because low interest rates are pushing up pension liabilities. When interest rates rise, the pension is likely to become closer to being fully funded.

Faulkner leaves it to his clients to determine the risks of the various options they are considering, so he focuses on the financial implications of those options. His analysis is based on projections made using The Razor financial planning software, which was developed by Financial Plan Advantage. This software’s modelling indicates that if Tim takes the new job and the commuted pension from his existing job, the couple’s maximum potential income during retirement would be $89,000 in today’s dollars – almost $30,000 greater than their goal of $60,000.

Faulkner, in running his projections, assumes no additions to assets through savings if Tim stays in his current job or if he takes the commuted value of the pension, as well as maximum RRSP and TFSA contributions if he takes the new job and the reduced pension from the old job. All scenarios assume a 5% annual average return after fees and inflation of 3%.

If Tim stays at his current job and his pension benefits aren’t reduced, the couple could spend up to $87,700 in today’s dollars. That’s considerably higher than the $82,800 they could spend if Tim takes the new job and the pension remains unchanged.

If Tim’s pension is cut by 25%, the couple’s maximum potential income drops to $77,000 if he stays in the current job, but would be a slightly higher, at $78,400, if he takes a reduced pension and the new job. If the pension is cut by 50%, the couple’s potential income falls to $69,700 if Tim stays where he is and to a considerably higher $73,900 if he takes the new job.

Faulkner recommends quite a bit of insurance if Tim takes the new job, although some of the insurance will be needed only to age 65. In particular, Faulkner recommends term-10 life insurance of $344,000 for Tim and $138,000 for Glenda, at a total cost of $1,450 a year; disability insurance for $4,000 a month for Tim, at a cost of $2,700 a year; 10-year term critical illness of $210,000 for Tim and $84,000 for Glenda, at a total cost of $5,100 a year.

@page_break@ Fernandes agrees that this insurance coverage would be prudent, but also would suggest enhanced medical insurance, which would cost about $4,000 a year.

Both financial advisors agree that Tim and Glenda don’t need long-term care insurance, as they have enough assets to be “fully self-insured.”

Faulkner believes the couple can choose to refine their goals because all the potential income levels are higher than their original goal. The first option is to increase the couple’s retirement-spending expectations. Alternatively, they could do one of the following:

– choose to retire earlier – as early as when Tim is 58

– take less risk by choosing very conservative investments that aim to produce an average annual return of only 3.2%

– spend up to $496,000 of their financial assets on things such as travel, buying a vacation home, helping their children buy houses or funding insurance needs.

Neither Faulkner nor Fernandes thinks it matters if the mortgage is paid off now or if it goes for another 10 years, but both advisors say that there’s no need to pay it off before the couple can do so without incurring penalties. However, Fernandes also points out that Tim and Glenda could pay off the mortgage, then take out an investment loan for the same amount. That would give the couple a return on those assets and the interest on the loan would be tax-deductible.

Both advisors suggest Tim and Glenda put any spare money into their TFSAs. Indeed, Fernandes recommends that the couple redirect money from their non-registered accounts into their TFSAs if they don’t have sufficient funds from their income. Fernandes notes that Tim and Glenda have a 40-year investment horizon, given current life expectancy, so the potential benefit of sheltering the returns in TFSAs is large.

Although additional savings aren’t needed to secure Tim’s and Glenda’s retirement income, Fernandes notes that Tim would benefit from additional RRSP contributions, given the deduction he would be entitled to because of his tax bracket. But Fernandes doesn’t see any reason for Glenda to make more RRSP contributions.

Fernandes would recommend a 70% equities/30% fixed-income asset mix for Tim and Glenda, assuming they have the risk tolerance for it. Fernandes feels the couple need that much in equities to get a 5% average annual return in this environment of low interest rates and moderate economic growth.

The 30% fixed-income component would include 5% in real estate investment trusts, which Fernandes views as income-generating investments. The other 25% would be split equally between investment-grade and government bonds. Fernandes believes this is not the time for bond ladders; to get a decent yield, you have to go further and further out on the yield curve, which adds risk – and that’s not a risk most clients can manage.

The equities component would be divided equally among Canadian, U.S. and international equities, including emerging-markets stocks. Fernandes believes emerging-market exposure is important, given their growth prospects, and adds that the risk of investing in some emerging markets has declined.

Fernandes also recommends F-class mutual funds for about two-thirds of the portfolio and exchange-traded funds (ETFs) for the remaining one-third, noting that both have low fees. He uses ETFs in situations in which he doesn’t see a lot of additional value from active management, such as for U.S. large-caps and government bonds.

Fernandes would put the fixed-income into the RRSPs and most of the equities into the TFSAs and non-registered accounts. All mutual funds in non-registered accounts would be corporate-class versions to make them tax-efficient.

Faulkner doesn’t manage money. He prefers to refer his clients to an advisor with whom he has a relationship, who specializes in investment management.

Fernandes charges a fee of 1% of assets on more than $250,000. Faulkner’s fees are based on his ongoing relationship with his clients. Both advisors receive commissions from insurance they sell.IE

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