In Toronto, a couple we'll call Henry, 69, and Melissa, 62, remain working in an effort to bolster their retirement incomes. Formerly an executive in the financial services industry, Henry continues to work on contract. His salary, $60,700, is just 40% of the $148,000 he earned in 2004 before he retired. Pension income adds $18,420 for total income of $79,120. But even with Melissa's $27,670 annual income, their total current income, $106,790, is well below the income he and his wife enjoyed before retirement. Henry, though expert in his field, cannot work forever. They worry their standard of living will decline.
"We have wide differences in my previous employment income and my current income, yet we survived the change," Henry explains.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Henry and Melissa. "These folks want to retire completely.
"He also wants to leave legacies for his three adult children, but his priority is for his wife and himself. It should be noted that she is seven years younger than Henry and has family with a history of longevity."
We have to acknowledge that Henry will not be able to stay in the labour force a great deal longer. It may be a year or two, or more, but he will eventually have to rely on pension income and savings, Mr. Moran says. Currently, he receives $1,050 per month or $12,600 from the Canada Pension Plan. That represents a 15% premium over the maximum base income of $10,905 per year, the result of delaying application for benefits. Delays have, until recent changes, generated a bonus of 6%. Melissa will receive a smaller CPP benefit of about $2,000 per year as a result of interruptions to her career.
Henry receives Old Age Security in the amount of $5,820 per year, which is 94% of the current maximum of $6,204 per year. The shortfall, the result of having been resident in Canada for 38 out of the 40 years required for full benefits, is more than made up by a foreign pension that pays him $4,200 per year. The foreign pension is not indexed but it is taxable, as are benefits from Canadian pensions.
When Melissa reaches age 65, she will qualify for an OAS payment of $5,820 per year, again the result of not quite reaching the full 40 years residence in Canada needed for full benefits of $6,204 per year. Total benefits so far when Melissa turns 65 -- $30,440 per year. Melissa should wait to apply for CPP benefits, because the penalty for early application is severe for a person whose family history suggests longevity, Mr. Moran notes.
Henry and Melissa will be able to boost their pension incomes with their private savings, which total about $1-million. The mix is heavily tilted toward income-producing assets capable of generating $50,000 a year in cash. Merely drawing money out is less wise than planning a withdrawal program, Mr. Moran says.
If their $1-million capital were to generate a conservative 3% per year for the next 30 years until Melissa is 92, they would be able to withdraw $49,533 per year before taxes. If after taxes and management fees, they were left with a 2% net return, they could have $43,774 in sustainable income, the planner estimates.
There are two problems in administering funds for a 30-year period: fees and market volatility. Their savings are invested in mutual funds with fees that average 2.4%, which is money their managers get and they do not. With their portfolio size, they could use a professional manager at a 1% annual fee and obtain an enhanced return of $49,533 for annual total income, including public pensions, of $79,973.
Over this extended planning period, Henry and Melissa will be hostage to inflation. They currently save a significant portion of their income in cash and RRSPs.
Their public pensions are indexed, which protects 38% of their income. Yet they also face market risk -- the chance that their investments could tumble in value as a result of crises such as the one that collapsed equity values in 2008 through March 2009.
Annuities and Insurance
They could provide more guaranteed income with annuities, which are really life insurance policies running backward. For a fixed sum, an insurance company will promise to pay a contractually agreed stream of income for the life of the annuitant and spouse, and for a minimum number of years. Should the annuitant or spouse enjoy very long life, the annuitant wins. Should he or she die relatively early, the guaranteed payments can go to designated beneficiaries, such as their sons.
Annuities look like good deals, for they pay bond interest and a return of capital plus whatever extra income the insurer can wheedle out of the market. The downside is that most annuities do not keep up with inflation. Inflation protection is available, but it tends to be too expensive to be practical.
Annuities have other benefits. Not only is income knowable for as long as the contract runs, but one need never bother with investment management. Asset selection is the problem of the insurance company and, should it run into trouble, an industry compensation fund run by Assuris covers annuities and many other life-insurance products, subject to -- you have to expect this from lifecos -- a lot of fine print. See assuris.ca.Bottom line: Annuities offer professionally managed assets, the certainty of contractual income and the comfort of knowing that invested capital can never run dry. A balance of public pensions and self-or professionally managed assets and annuity income will give Henry and Melissa the income they need for the rest of their lives. They will have their $540,000 house that they can sell, either adding to capital or apportioning to their children or to good causes.
Looking at permanent income, with self-management or some boost from annuity income, Henry and Melissa should be able to count on permanent income of about $80,000 in 2009 dollars. That would be more than adequate for their current level of spending and would, in fact, leave a margin for hobbies or travel.
If one spouse were to die ahead of the other, the result, unfortunately, would be a tax boost for the survivor, for more income would be taxed in his or her hands.
The survivor could no longer split pension income and would therefore probably find him or herself in a higher tax bracket. The survivor might need household help as well. Life insurance that provides a first-to-die benefit would help cover the tax gap, but Henry and Melissa should have a sufficient surplus over spending to pay additional taxes, Mr. Moran estimates.
"In spite of this couple's apprehensions about declining income, they will clearly have enough money to continue their way of life," Mr. Moran says.
"Frugality is their friend. If they continue to spend carefully, they will have no financial crises. They can add to income by cutting management fees or guarantee income via annuities. They have several options and all of them are ways to maintain their standard of living."
Partly retired executive finds income plummeting
Enhance income from extensive million-dollar investment portfolio
Standard of living maintained in retirement
MONTLY AFTER-TAX INCOME
House $540,000, RRSPs $675,000, Non-registered $395,000
TOTAL $1, 610,000
Property taxes $400, Utilities $330, Phone, cable $180, Food, household $1,600, Home and car insurance $550, Car: gas, repair $300, Public transit $220, Charity, gifts $150, Furnace maintenance $25, Travel $300, RRSPs $1,000, Newspaper, magazines $30, Miscellaneous $400, Savings $1,515
Used By Permission (c) 2009 The Globe and Mail