Early retirement is within reach

The Scenario: Ann, 55, is a management consultant in Toronto who is taking a promotion that involves travelling three out of every four weeks and pays a salary of $150,000 vs the $110,000 she had previously been earning. Ann sees this as an opportunity to save a lot of money for retirement.

Ann is going to sell her mortgage-free house, worth about $600,000, and will be renting a small, one-bedroom apartment in a secure building for $1,800 a month, which is about equal to her house maintenance and repair costs. She doesn’t want to buy a condominium now because she will want a bigger place with larger rooms and two bedrooms when she stops travelling.

She also plans to give her car to one of her three financially independent children and will decide whether to buy another car when she stops travelling.

With no car and the amount of business travel Ann will be doing, she thinks that her expenses, including rent, will be only $45,000 a year in today’s dollars. She would continue making maximum RRSP and tax-free savings account contributions and invest whatever is left over.

Ann plans to work at this job for five years, then retire if she has enough assets to spend $60,000 a year in today’s dollars, after taxes, to age 95. A key question will be whether she should: buy a condo costing $400,000 in today’s dollars at that point; or continue renting, but at $2,500 a month in today’s dollars.

If Ann can’t generate the $60,000, she would be prepared to continue working at a job that doesn’t require travelling, which her company assures her that she could do, although with a pay cut to $100,000.

Ann has no pension, but participates in a group RRSP at work; she also has disability, accidental death, medical and dental benefits. Ann has $400,000 in the group plan, another $200,000 in an individual RRSP, $100,000 in a non-registered account and $15,000 in a TFSA.

Ann isn’t concerned about leaving money to her children as their father is well off.

The Recommendations:
Bain and Parlee agree that Ann should be able to retire at age 60, buy a condo and spend $60,000 in today’s dollars to age 95. She may run out of financial assets a year or two before she’s 95, but that won’t be a problem because she can tap into the value of the condo through a reverse mortgage, for example, Parlee says. However, both he and Bain note, many people spend less after age 80, so that might not be necessary.

Bain’s only caveat on early retirement is that it’s important for people to be mentally and physically active after they stop working. As long as Ann has activities she will be doing, she should be fine retiring at 60.

Parlee suggests Ann take $340,000 from the proceeds of the sale of her house and set it aside for the condo purchase, investing it conservatively. He suggests a 40% equities/60% fixed-income asset mix, with the latter primarily invested in preferred shares as long as interest rates remain very low. This should provide a return of 5% after fees, so the assets would grow to around $400,000 in five years, or enough to buy a condo worth that much in today’s dollars, given Parlee’s 2% inflation assumption.

For the next five years, Parlee suggests the rest of the money from the sale of the house be invested 40% in equities, 45% in preferred shares and 15% in high-yield fixed-income. This should result in a real return of 4% a year. After Ann retires, Parlee would remove the high-yield component and replace it with traditional fixed-income, which could include bonds if interest rates are higher.

Bain also recommends a 40% equities/60% fixed-income asset mix but without the high-yield component; she assumes a real return of 3% a year.

Parlee assumes Ann would lease a car and pay the lease out of her $60,000 a year. There will be no repair or maintenance costs and it is less of a commitment, as most leases are for three years. Both he and Bain, who also didn’t assume car purchases in her projections, think that if Ann is living in downtown Toronto, she may find that she doesn’t need a car; she could rent if she needs one for major shopping or trips.

As Bain puts it: “Unless Ann has lots of friends and relatives in the country or loves driving, it would make sense for her not to have a car.”

Parlee doesn’t think Ann, as a single person who is not concerned about leaving an estate, needs critical illness or long-term care insurance. He notes that Ann has disability insurance at work and will have enough assets should she need home or institutional care later in life.

In contrast, Bain suggests a $500,000 CI policy at a cost of about $10,000 a year for the five years Ann is still working. Bain notes that Ann’s job, with all the travelling involved, is demanding and stressful and could result in an illness, especially one that she was predisposed to, such as diabetes if it runs in her family. If that happened, Ann might not be able to save the capital needed for the lifestyle she desires; the CI benefit would provide that capital.

“What I like about CI,” Bain says, “is that you get the money and can decide what to do with it.”

Like Parlee, Bain doesn’t see a need for LTC insurance but says it is an emotional issue that needs to be discussed. Bain notes that some people want the comfort of it even if they would be OK financially without it; others can’t bear even to talk about it.

Both advisors emphasize the need for Ann to update her will and medical and personal powers of attorney now — and to update them regularly in the future. Bain warns that if Ann develops a serious relationship that would involve living together or marrying, estate planning would become urgent, including a marriage contract or cohabitation agreement that should be made before they are under the same roof. Bain also notes that Ann’s ex-husband could have financial reverses or her children could face financial difficulties that could change her view on leaving an estate.

Bain and Parlee both think Ann should start taking Canada Pension Plan benefits at age 60, on the theory that a bird in the hand is worth two in the bush. Bain does, however, note that this will need to be discussed again when Ann is close to age 60 because of the forthcoming changes in CPP benefits aimed at discouraging early retirement.

Both advisors assume Ann will continue making maximum RRSP and TFSA contributions. Bain suggests Ann start taking withdrawals from her RRSP at age 60, while Parlee suggests using up the non-registered money first and waiting until age 72 to begin RRSP withdrawals.

Both Bain and Parlee also favour using the TFSA to shelter capital gains — in the early years at least, when Ann will have lots of cash flow. Some of the TFSA could be set aside as an emergency fund when Ann is dependent mainly on RRSP withdrawals for her income.

Parlee suggests using a mixture of managed portfolios, exchange-traded funds and individual securities. He recommends that the target for the equities component be 50% Canadian and 25% each for U.S. and international. The fixed-income component would initially be 75% traditional fixed-income — mainly in preferred shares for now — and 25% high-yield. He notes that there are excellent high-yield fund portfolio managers who get good returns by investing in BB-rated or “just below” investment-grade corporate bonds, for which there’s not much risk of default.

Bain has lowered the amount of equities she advises clients to hold because of this asset class’s poor returns since 2000. Her analysis of Morningstar Canada data to March 31, 2010, shows that 46% of equity mutual funds had losses over 10 years, while only 54% had gains. But in the 10 years ended March 31, 2011, after a year of recovery, 65% of equity funds had gains, while 35% showed losses.

Although Bain admits it can be argued that the long-term risk still may favour the use of a larger equities component in a portfolio, given that people are living so much longer; still, most people in retirement cannot handle the volatility that can accompany equities investing.

Furthermore, most people are seeing a much higher level of risk with so many nations buried under debt. Many feel it is now prudent to be more conservative.

As a result, Bain is finding that recently, more clients are choosing to move down the risk scale. And as that is an emotionally driven decision for clients, Bain feels that encouraging people to take on more risk is problematic.

Bain uses private money management for most of her clients’ investments but also includes ETFs, mutual funds, segregated funds (with or without guaranteed minimum withdrawal benefits), guaranteed investment certificates and annuities.

In Ann’s case, in which she has no company pension, Bain would discuss buying an annuity or a GMWB product to cover Ann’s basic expenses.

Bain would charge $1,500-$2,000 for a financial plan of this nature.

Parlee doesn’t charge for plans as long as the client invests the assets with him, as he charges a fee on the percentage of the assets. That fee, combined with fees for the managed products, would be less than 2% of asset value. IE