Financial Post Article: Couple expecting $1-million inheritance want to know if they can retire early

The Financial Post asked me to review the finances of a couple who are expecting a $1 million inheritance and want to know if that will help them retire early.

Given that an estimated US$84.4 trillion in savings, stocks and property will pass from baby boomers to their heirs and favoured charities by 2023, this is the greatest transfer of generational wealth in history.

In the article you’ll discover:

• Is their plan to retire in 5 years viable?
• Should they include their inheritance in their retirement plan?
• How can they use their home equity in their retirement plan?
• What investments and assets they currently have.
• Are their strategies effective?
• Are they going to run out of money at age 75?
• To what age should their retirement plan extend?

CLICK THE LINK BELOW TO READ THE ARTICLE BY MARY TERESA BITTI:

Couple expecting $1-million inheritance want to know if they can retire early

READ ON FOR ED’S NOTES & INSIGHTS INTO HOW HE CAME TO HIS CONCLUSIONS FOR THIS COUPLE:

Financial snapshot for the planners:

Income

Note: The couple do not have any U.S. assets.

Employment income: Jonas: $110,000 Kathleen $20,000

Investment income (dividends): $7,200 annually (estimated and automatically reinvested)

Pension (current/anticipated): $0

Assets

Primary residence approximate value: $1,400,000 (no mortgage)

Rental property approximate value: N/A

Other: N/A

Investment holdings

Cash: $105k in High-Interest Savings

TFSAs: Kathleen only: $80k ($55k in ETF and $35k in Mutual fund)

RRSPs: Jonas $400k ($275k in ETF, $125k in mutual funds). Kathleen $150k ($135k in ETF, $15k in mutual funds)

GICs: $0

LIRA: $0

RESPs: $0

NON-RRSP ETF: Kathleen $260k

NON-RRSP: Mutual Funds: Kathleen $42k

Stocks: $0

Rental property: $0

Other: $0

Life insurance: type (i.e., term, whole) value: $500k term. Term ends in 5 years. Can be converted to whole at cost TBD. Jonas also has $100k in coverage from work, but that goes away when he retires.

Monthly expenses

Mortgage or rent payments: $0

Utilities: $500

Groceries: $800

Transportation costs: $400 (including insurance on 2 cars, both relatively new and paid for)

Child care: $0

Insurance premiums: $160 (term life and house)

Home repairs: $1000 (estimated, but based on the “1% Rule”)

Credit card payments: $0

Property tax: $400 (likely to defer)

Loans: $0

Dining out: $200

Travel: $1250 (1 big trip each year at ~$15k – $10k for airfare and $5k for expenses)

Entertainment: included in utilities

Misc: $300

Total monthly expenses $4,650

Total current savings: $1,037,000 

Financial Plan & Analysis

Interesting case. Most clients are behind their goal, but Jonas & Kathleen are in good shape.

The big picture is that they actually have enough to retire in 5 years with their ideal $7,000/month income. They did not specify, but I assume they mean $7,000/month after tax.)

There are 2 large extra amounts they are considering:

1/ Inheritances

2/ Using their home equity (“Nuclear option”)

If they include either in their plan, they could either retire today or retire with quite a bit higher income.

The question is: What do they actually want to do with their lives? Would they prefer to retire sooner or with more money every year? If they retire with higher income, what would they do with it? More travel? More dinners & entertainment?

Regarding the 2 large items:

Inheritances: Clients mention that quite often. I tell them it is their financial plan, so they can include it or not, whichever they want. However, that money is not guaranteed to come to them. Their family member may move to a nice retirement home for years or have much higher health care costs. They may also decide to give it to charity or someone else. They could also live surprisingly long. It’s a bit risky to include an inheritance and live at a higher lifestyle today as though you will get it. My advice is to only include amounts they are pretty sure they will get and use conservative estimates for the amount and how many years from now they think they will get it.

Home equity (“nuclear option”): They have no dependents or anyone to leave it to, so leaving a paid-off home a few decades from now will be a large estate on its own. They can afford a significantly higher lifestyle if they use their home equity in some way. They can either:

Borrow to spend – They have a secured credit line and could apply for a larger one, then slowly use it during retirement. This is generally more effective than a reverse mortgage if done right. A reverse mortgage usually only gives them 20-40% of their home value since they are young.

Borrow to invest – They can use their credit line or a larger one to invest and take cash flow from the investments. This option would give them the highest retirement lifestyle, assuming they invest effectively. Borrowing to invest in retirement means they have to be growth focused, higher risk investors and is not for everyone.

• Sell & rent – Most people don’t want to leave their long-term home when they retire, so selling & renting can be emotional. It does make travelling easier.
• I would suggest asking them:
• Confirm the $7,000/month is after tax (not before tax).
• Would they prefer to retire sooner or retire with a higher income?
• What would they do if they have more money than the $7,000/month?
• For inheritances, are they confident enough in receiving them to start spending some of that money now? If so, how much and how many years from now conservatively are they quite sure they will receive?
• They called using their home equity the “nuclear option”. Does that mean they really don’t want to do it? Would they prefer to sell & rent, borrow to spend (like a reverse mortgage), or borrow to invest?

Questions for the experts:

How do we factor our inheritances into our retirement planning?

It is their financial plan, so they can include it or not, whichever they want. However, the inheritance is not guaranteed to come to them. Their parents or aunt may move to a nice retirement home for years or have much higher health care costs. They may also decide to give it to charity or someone else. They could also live surprisingly long. It’s a bit risky to include an inheritance and live at a higher lifestyle today as though you will get it. My advice is to only include amounts they are pretty sure they will get and use conservative estimates for the amount and how many years from now they think they will get it.

Is our plan to fully retire in five years viable? Are we better or worse off than we think we are?

As long as they use their $400,000 credit line to spend or invest, and inherit at least $500,000 within 15 years, they are on track for their desired retirement of $7,000/month after tax without having to cut back their lifestyle during their retirement. Luxury cruises and resorts are full of people in their 80s.

Should Jonas keep his dual citizenship?

Dual citizenship is a minor factor for them at this point. Getting rid of it would allow them to use his TFSA room, but tax on that should not be a lot. Usually the reason to keep it is potential to work in the US in the future, which is highly unlikely, so there is no reason to keep it. It takes some effort to renounce US citizenship and there is a modest benefit for doing it.

If for some reason we don’t receive the inheritances we have the option of selling the house. Will this be enough? It’s a big house and at some point we’ll want something smaller, or even just a rental.

If they don’t get an inheritances, they will need about $700,000 from their home to live the retirement lifestyle they want. They could either downsize to a home half the value of their current home, or sell to rent up to $2,500/month.

One big thing for this couple is not to leave a lot of money behind, but they should plan to have enough to maintain their lifestyle even if one of them lives unexpectedly long.

Are the strategies we’re considering appropriate? Are we going to run out of money when we’re 75 even with our contingencies? We want to enjoy our lives as fully as we can, and if that means cutting back in our later years, that’s acceptable.

Their strategies make sense and they are okay to retire, as long as they maintain their portfolio with a high allocation to equities. They need a long-term return of 7%/year to retire with the lifestyle they want.

Their planning is to age 100, even though they expect they may not live past age 85. It is important to retire confident that you will never have to work again. For half of couples in Canada, at least one reaches age 92. If they plan to run out by age 85 and one of them is still alive, then what? Planning to age 100 gives the confidence they have enough to retire without worry.

Ed