The Johnstons have traded in their big-city lives and jobs for an idyllic rural home. Now what?
In a picturesque corner of British Columbia, Fred and Julia Johnston (not their real names), both 56, are building new lives after giving up the rat race in the high-level corporate specialties that occupied their lives back east. They won't be earning the $200,000 before tax they used to generate, but they expect to have a higher quality of life and they had a good head start. Fred left his job with a package of benefits worth $20,000 and Julia sold $20,000 of stock following their move west in June 2010. But now their short-term transitional funds are running out and they need a new source of income, in large part because they spent more on their new home than expected.
Fred and Julia had budgeted $480,000 to build a beautiful house — elegantly modern, featuring a massive kitchen with marble counters, soaring glass walls, hardwood ceilings and tastefully placed antiques — on a $250,000 acre of land overlooking a lake. But construction overruns forced the couple $120,000 into debt and introduced a new anxiety: the need to find work to pay all the bills. "We are anxious about being remote from the kinds of jobs we are accustomed to. But as far as giving up those jobs, we were more than happy to do it," Fred explains. "We traded employment security for reduced stress."
But they need a plan and a bridge until they can draw retirement benefits. They want secure, but still interesting jobs that will take care of their household expenses until they reach age 62 — a potential retirement date — or 65, a final retirement date, Julia says. Their combined salaries should provide them with at least $3,000 a month, which would help pay off their $120,000 line of credit within six years.
The plan ought to be simple. The couple has no children and no desire to do anything more than use up their assets, including their house, which they plan to sell when they're about age 76. But there are problems. Their assets total about $1.6 million, but take off the $120,000 line of credit, and their current net worth is $1.4 million. They will have to carefully guard that fortune if it is to support them for the 30 to 35 years they can expect to live, according to actuarial tables. They will also need to make more money. One problem: How much leisure will they have to trade to make that extra income?
What The Experts Say
Solving the Johnstons' dilemma will be easier if they get jobs, say our advisors, but for now the couple has to cope with their limited spending power by managing their debt. "If they can qualify, they should reduce borrowing costs by locking in their mortgage rates at what will seem low rates in the not-too-distant future," says Derek Moran, a registered financial planner who heads Smarter Financial Planning Ltd. in Kelowna, B.C. "They could also shop for a less expensive line of credit. A major insurance company offers credit lines at prime less 1%, so that would save them money on the 4% they are now paying. Savings would be perhaps $900 per year."
The couple's living expenses are reasonable, but unsustainable in the long run, Moran says. They can apply to have their property taxes deferred until they sell their home. That would save them another $350 per month or $4,200 per year. But at this point, they still need more income to cut their debt to zero before age 62. Without jobs, they can quite easily eliminate their debt by drawing from their current savings. Unfortunately, most of their money is held in registered accounts so tapping them means paying income tax. Alternatively, their savings could support an income of $40,359 per year until they are 62, assuming annual growth of 3% over the rate of inflation after management fees. But even when added to Julia's $7,500 annual defined-benefit pension plan, that won't be enough to pay off their debt.
If the Johnstons can defer dipping into their RRSPs until they're 65 by earning enough to pay their living costs and pay off their debt, they will be in good financial shape, Moran says. From age 62 to 65, they would have an annual income of $66,840, which includes returns from investments of $59,340 (all figures in 2011 dollars). From age 65 onward, the couple would have their pre-65 income plus two Old Age Security benefits of $6,291 each, CPP for Fred of $9,151 per year, and CPP for Julia of $9,003 for a total income of $97,576.
If that income is not sufficient, the couple could consider a reverse mortgage or remortgaging their house, adding debt and perhaps amortization. Reverse mortgages are really a last resort, says Moran, because they tend to have high interest rates and they compound the sums due upon the sale of the house or death. A secured line of credit or extending mortgage terms are better alternatives. But the Johnstons are resourceful enough that they should be able to make $3,000 in income per month.
The Johnstons' investment portfolio, however, needs a makeover, says Benoit Poliquin, a Chartered Financial Analyst and a portfolio manager and vice-president at Pallas Athena Investment Counsel in Ottawa. Their portfolio lacks an overall investment plan and doesn't have stock and fixed-income allocation targets. Currently, 37% of their portfolio is in equity mutual funds and 63% is in bond mutual funds, mostly held in segregated funds. Segregated funds assure the investor that no capital loss will erode the nominal purchase price of the asset. But that peace of mind comes at a fairly stiff price — about 0.75% to 1.2% added on to average mutual fund fees of 2.5% for stock funds and 1.5% for bond funds. Considering that nearly two-thirds of the couple's money is in bond funds with a long-term return of 4% to 5% per year, the average 2.2% bond-fund fees they're paying cuts half or more of their bond income.
Fees on the couple's mutual funds average about $13,000 per year, plus brokerage commissions. The couple could have its stocks and funds handled by a professional manager for a 1% to 1.25% fee. But because their funds are backloaded with deferred sales charges, Poliquin says the migration to a professionally managed portfolio will have to be done over time.
"Fred and Julia are prosperous, thoughtful people with moderate wealth," Moran says. "They have achieved many of their dreams, but done so by taking on debt they did not expect and buying into some assets that need to be adjusted. With new jobs to supplement their income, perhaps a little belt tightening if they don't get those jobs, and adjustment of their portfolio to reduce costs and thereby increase returns, they can have the security they want."
Tip of the Month: Timing the market is fool's work
Acquiring the knack for knowing when to buy and when to sell is easier said than done. Studies show investors would have to be right 70% to 80% of the time to break-even on Canadian stocks after trading costs, based on liquidating entire portfolios and repurchasing them when the omens dictate. Best bet: Remember the old saying that it's time in the market, not timing the market, that counts.
(c) 2011 The Financial Post, Used by Permission