Good Pensions, Low Cost of Living — Two Things that Make this a Five-star Retirement
In Saskatchewan, a couple we’ll Herb, 58, and Mary, 56, are trying to time their retirements. Each has put in more than three decades working for a large company. Together, they have built up more than $1.6-million of assets with no liabilities on their balance sheet. Their lives in their town of tidy houses and church spires, wheat fields in the distance and kids playing on lawns is an image out of an earlier era.
On the one hand, it would seem that with their two children looked after – the elder, age 23, grown and gone and the younger, 19, in university with an RESP for tuition and some expenses, they would have few problems. They plan to downsize their $500,000 house and move into a condo within five years, liberating $100,000 in the process. They would use the money for travel, wintering in the Caribbean. Much of their future security resides in their job pensions, yet there is more to the strength of the financial fortress that they have built.
Herb and Mary made two vital decisions: First, they held on to good jobs with solid pensions – his a defined benefit plan with indexation, hers a defined contribution plan with 100% matching of contributions by the employer. Those pensions will pay the largest part of their retirement income, because their other financial assets, which total $433,070, would not provide sufficient income to maintain their approximately $8,000 of monthly expenses net of contributions to their RRSPs, TFSAs and other savings.
Their other decision was to live in a mid-sized city in Saskatchewan where house prices and other costs of living are relatively low. Put their pension incomes, one of which is indexed, together with their low cost of living and they have a substantial financial surplus which appears in their savings rate. Indeed, if they can live within their retirement budget, they should also be able to leave a tidy fortune – they have aimed for $200,000 — to each of their children.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Herb and Mary. “They have their retirement assets in place to fund their goals,” he explains. “The main unknown is how much they can leave to their children, but if they maintain their savings habits, they should be able to leave considerably more than their target to the kids.”
Managing Cash Flow
The largest part of the couple’s cash flow will be their company pensions.
Herb’s pension is indexed to 80% of increases in the Consumer Price Index to a maximum of 3% a year. Mary continues to work with a gross salary of $7,500 a month. For now, Herb receives $3,940 per month before tax and works part time for $2,250 a month before tax. Their monthly gross income, $13,690, leaves them with $9,762 after tax.
Mary can take her pension in amounts that will vary with the age at which she elects to retire. At 58, she would get an estimated $2,905, a month, at 60, $4,203 a month, and at 65, $7,503 a month. These are estimated payouts of her defined contribution pension, but unlike those of a DB pension, they are not guaranteed. Nevertheless, the financial incentive to remain on the job is clearly very strong. At present, she considers cutting the cord at 61.
The couple’s job pensions will be supplemented by income from investments in their TFSA, RRSP and cash accounts. They are invested in seven mutual funds from one bank. The allocation is conservative: 40% to dividend funds for the TFSAs, 40% to bonds in the TFSA accounts, and a more aggressive mix of global funds in their RRSPs.
The allocations are reasonable and largely what financial planners are taught to do, but there is a problem – fees.
The funds are invested in pooled versions of the bank’s funds, reducing the total cost of each fund substantially. Yet at an estimated 1% average fee for equity and bond funds, the couple is paying $3,900 a year on $390,600 of fund assets. Were they to shift to exchange traded funds with mandates identical to those of their mutual funds and average management fees of 0.30% a year, then maintain their positions for ten years, their savings would be $27,300 plus whatever compounding they could achieve through their investments, Mr. Moran estimates.
If Mary retires at age 60 and before 65, she will have a pension of $4,203 per month before tax. Herb’s pension will continue at $3,939 a month, then drop by $850 a month at 65 when he can take Canada Pension Plan benefits.
Their $390,000 of present financial assets excluding their children’s RESPs will grow with total contributions of $2,076 a month ($916 to TFSAs plus $580 for Mary’s RRSP and a matching $580 from the employer) for three years to her retirement for a final balance of $506,300. Those funds with no further contributions after Mary retires in three years, if continuing to grow at 3% and if withdrawn over 30 years to her age 90 would support a pre-tax income of $2,090 a month.
Each will receive full Canada Pension Plan benefits of $1,013 a month at current rates at age 65 and each will be eligible for full Old Age Security of $546 a month.
Adding it up and excluding any part time work either partner may do to both attaining age 65, they would have total, pre-tax income of $10,233 a month.
If their pensions are split, each would have approximate net taxable income of $75,000 per year, which is over the $70,954 point at which the OAS clawback begins. TFSA payouts, about $3,000 a year, would not be taxable, lowering the clawback exposure, leaving total annual income of $8,100 a month after 35% average tax.
If they downsize their house and obtain $100,000 after selling costs, then, if invested at 3% before inflation, they would have $3,000 a year or $2,100 income after 30% estimated tax. There is no financial need for them to sell their house, however.
“The couple can meet their goals, maintain income for their children’s first degrees, and have the retirement they expect,” Mr. Moran says. “The remaining issues are management of investment fees and tax rates. I have no doubt that they can do both well.”