Situation Retiree with low-return savings has ample income now but could run out of money in future
Solution Shift cash balances to dividend-paying stocks and bond ladders, monitor exposure to clawback
In Toronto, a man we'll call Sid, 64, has retired from a job in publishing. He brings home $3,060 per month from part-time product testing and modest investment income. Frugal and thoughtful, he spends just $1,495 a month for his basement apartment, a bus pass, food and other necessities and caring for two old motorcycles. He runs his computer on a neighbour's Wi-Fi in exchange for chores. He never goes to restaurants. He saves half his take-home income.
Sid fears running out of money, yet he has $1,071,000 in financial assets. Of that, $292,000 is in cash in money-market accounts earning little or nothing. There are other cash balances in his TFSA and a chequing account, all eroding after inflation and tax. It's a problem, but he rationalizes losing purchasing power to maintain liquidity and to avoid potential investment losses.
“I live a Spartan bachelor's life,” he explains. “I have almost no entertainment expenses, I have all the clothing I need, I shave my head so no hairstyling costs, I have no wife, no kids, no ex-kids, no dog, no cat. My entertainment is singing in a church choir and some volunteer work.”
Investing and spending
Sid is aware that he needs to boost investment income if only to make his money last into very old age. He plans to do more volunteer work but he'll have to stretch his investment income to travel, spending time and money in Europe. The problem is thus one of philosophy — balancing his frugal life with a wish to live it up a little, knowing that with over $1 million in financial assets he is technically wealthy, and having the intellectual challenge of managing his cash-heavy portfolio.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowa, B.C., to work with Sid. His view — Sid has more money than he needs to live as he does but not enough to live as might wish in a tropical country where he can ride his motorcycles year round. If he needed care, there could be a problem, Moran says.
Sid is set in his ways. He could afford to buy a condo but he rejects the idea, preferring to rent his basement suite for $800 a month. Renting, even if financially advantageous, means that Sid is entirely out of the property market. If the home in which he rents were to be sold, he might have to move and perhaps pay more for shelter. His rent will rise over time.
Philosophically, Sid is a survivor. He does yard work as partial payment for his apartment. He plans to start CPP and OAS at 65. He could defer each for five years for a 36 per cent boost to OAS and 42 per cent boost to CPP. His parents lived to their mid-70s but did not lead healthy lifestyles. Time should be on Sid's side, but he wants to start both at 65. It's a gamble.
Sid could need more money one day if he requires care, Moran notes. But if he raises his income too much, he will have to pay the OAS clawback, which starts at about $75,000. Care costs would be deductible from income, especially higher income if his investments produced it. The higher one's taxable income, the more tax efficient it is to incur deductible expenses.
What to do Move cash to dividend-paying stocks and laddered bond ETFs gradually, keeping some cash for emergencies and monitoring exposure to the OAS clawback. Running investments just for tax management is putting the cart before the horse, Moran says. Even though the clawback discourages investments that produce income which trigger it, the clawback tax on its own is only 15 per cent on sums over the trigger point.
Estimating retirement income
If Sid were to grow his $549,000 RRSP at three per cent per year after inflation and were to spend all capital and income starting at 65 in the 25 years to age 90, he could withdraw $31,528 per year in 2018 dollars before tax. If he converts the RRSP to a RRIF, which is eligible for the pension income credit, he would have a $2,000 per year tax credit.
Sid's Tax-Free Savings Account has a $10,000 of contributions and $1,000 of growth. He should top it up to $57,500, the present maximum. He has the cash to do that. If the balance grows at three per cent per year after inflation and Sid spends it over the next 25 years from age 65 to 90, it would support payouts of $3,300 per year before all capital and income is exhausted.
For his taxable investment account with $448,000 in various stocks, Sid can switch into shares with sustainable, strong dividends. Chartered banks, telcos and many utilities fit the bill. Were he to invest and achieve a four per cent real annual return with just a little more risk from dividends and capital growth, he could have $17,920 per year starting at age 65. Annuitized, the money would generate $25,727 per year before his capital is exhausted. We'll assume that he chooses straight interest and modest capital gains in order to retain capital as a reserve for safety in later life. That way, if he lived beyond 90, he would still have substantial funds.
Thus, at age 65, his investment income from investment and registered accounts would be $49,448 plus nontaxable cash flow of $3,300 from the TFSA. His CPP would add $11,870 per year and Old Age Security $7,040 per year, all in 2018 dollars. Sid's gross income at 65 would therefore be $71,658 including the non-taxable TFSA component. Depending on the structure of the taxable investment income, he could be pushed over the threshold of about $75,000 for the start of the OAS clawback.
Assuming that Sid does start CPP and OAS at 65, his income after 20 per cent average income tax and no tax on TFSA payouts would be about $4,800 per month. “He plans to leave a large bequest to a charity,” Moran says. “The problem is what he will do with his growing surplus. He could raise charitable contributions now rather than leaving the task to his executor.”
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Retirement stars: four retirement stars **** out of five