National Post article: Can Tom afford to retire by 63 with a $1.16 million portfolio?

Having enough money to retire is one thing. Knowing how to use it wisely is another.

Tom and Judy are in a strong financial position. With a $1.16 million investment portfolio and a valuable defined benefit pension, the bigger question isn’t whether Tom can afford to retire at 63 — it’s how they should make the most of what they’ve built.

Their situation raises several interesting retirement planning questions:

• How to think about whether it is worthwhile to delay an employer pension.
• When it makes sense to start CPP and OAS.
• How income tax rates in British Columbia compare with Nova Scotia.
• How large a mortgage their investments should be able to support.
• Whether they should consider a future cottage sale when deciding how much to spend on a home now.
• Why carrying a mortgage into retirement can sometimes make sense when you invest mainly or entirely in equities.

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

Can Tom afford to retire by 63 with a $1.16 million portfolio?

Married couple Tom* (61) and Judy (63) are at an inflection point. Judy retired just over a year ago and loves it. Tom plans to retire in two years. He’s happy to retire sooner, if possible, so long as they can achieve their target after-tax annual retirement income of $120,000 indexed to inflation. 

Tom and Judy have built an investment portfolio valued at approximately $1.16 million, largely in Registered Retirement Savings Plans ($620,000) and Judy’s Locked-In Retirement Account ($460,000). The asset mix in these accounts is 75 per cent equities, 23 per cent fixed income, and 2 per cent cash. They also have approximately $80,000 in Tax-Free Savings Accounts, with an asset mix of 65 per cent equities, 25 per cent fixed income, and 10 per cent cash.

If Tom does retire in 2028, he will be eligible to receive an annual defined benefit indexed employer pension income of approximately $100,000 with lifetime survivor benefits for Judy valued at 66 per cent of the pension. 

They are confident they have enough money to see them through retirement. Their financial focus now is tax efficiency and how to strategically draw down the wealth they have accumulated. 

Should Tom delay his employer pension until age 65 or later to minimize the couple’s tax costs? At what age should they start receiving Canada Pension Plan and Old Age Security benefits and begin withdrawing from their RRSPs? 

When Tom does retire, the couple are considering a shift to a bicoastal lifestyle. This could potentially see them divide their time between British Columbia, where their son lives, and their longtime home of Nova Scotia, where they own their principal residence and a cottage. 

At this point they are exploring their options and looking for advice to determine the most financially responsible approach. For example, should they purchase or rent a home in British Columbia, where house prices are much higher than Nova Scotia, but where tax rates are much lower.  Should they sell their principal home, currently valued at approximately $750,000 to help fund a new home on the West Coast and keep their East Coast cottage to use in the summer – at least for the next few years? 

“If we cleared $750,000 from the sale of our home in Nova Scotia, what is the outer envelope that we could spend on a new home in British Columbia that would effectively mean breaking even in terms of the additional mortgage debt versus the tax benefits of changing our province of residence,” asked Tom. 

The cottage is conservatively valued at $500,000 and has a mortgage of approximately $190,000 at 3.99 per cent for the next three years. The only other debt Tom and Judy have is a $70,000 home equity line of credit against the cottage. If they do purchase a home in British Columbia and take on a mortgage, when they’re ready to sell their cottage, those proceeds could be used to pay down that additional debt – if that is the best option. 

The couple don’t want the emotional comfort of being debt-free to create a blind spot in how they move forward. “We know that the choices we make now are really important,” said Judy. 

Financial Plan

For him to retire in 2 years with their desired lifestyle of $120,000/year after tax, they will need a before-tax income of $160,000. To achieve this, they would need $510,000. They are expected to have $1.35 million. They are 128% ahead of their goal, which is a comfortable margin of safety.

They are confident they have enough money to see them through retirement. Their financial focus now is tax efficiency and how to strategically draw down the wealth they have accumulated. 

Should Tom delay his employer pension until age 65 or later to minimize the couple’s tax costs? At what age should they start receiving Canada Pension Plan and Old Age Security benefits and begin withdrawing from their RRSPs? 

Don’t delay pension. Income split when it starts. Pensions typically are based on an actuarial formula that uses a rate of return of about 5%. Their investments are about 75% equities, which should give them a higher rate of return. That means they would likely lose a bit of lifetime income by delaying their pension.

It is common to only look at how much the pension would pay without considering how much more they should be able to get with more investments. Those with a high equity allocation are normally better off having more investments and a bit smaller pension.

Deferring CPP from age 60 to 65 gives him an implied return of 10.4%/year on investments they would have to withdraw to provide the same income. Deferring to age 70 gives him an implied return of 6.8%/year. Since his investments are about 75% equity investments, they should provide roughly the same as 6.8% while giving him more flexibility with his income, but would be quite unlikely to beat 10.4%. It is probably best for him to start CPP and OAS at age 65.

At this point they are exploring their options and looking for advice to determine the most financially responsible approach. For example, should they purchase or rent a home in British Columbia, where house prices are much higher than Nova Scotia, but where tax rates are much lower.  Should they sell their principal home, currently valued at approximately $750,000 to help fund a new home on the West Coast and keep their East Coast cottage to use in the summer – at least for the next few years? 

“If we cleared $750,000 from the sale of our home in Nova Scotia, what is the outer envelope that we could spend on a new home in British Columbia that would effectively mean breaking even in terms of the additional mortgage debt versus the tax benefits of changing our province of residence,” asked Tom. 

The same income gives them $5,000/year more after tax in BC vs Nova Scotia. That would pay for a mortgage about $125,000 higher. If they sell their home for $750K and clear just over $700K and pay for a mortgage of $125,000, that gets them a home in BC of about $850,000 with the same cash flow.

They have about $800,000 more than they need for their desired lifestyle. They should keep $100-200,000 at least as a margin of safety. That means they could use up to $600,000 to make mortgage payments. They could withdraw 4%/year or $24,000/year which would be about $17,000/year after tax. That could make payments on a mortgage about $400,000.

That means the maximum home they could afford with a safety margin is about $1.25 million.

If they do purchase a home in British Columbia and take on a mortgage, when they’re ready to sell their cottage, those proceeds could be used to pay down that additional debt – if that is the best option. 

Likely it is not best to consider their cottage in a possible home price now, since they may keep the cottage for many years.

The couple don’t want the emotional comfort of being debt-free to create a blind spot in how they move forward. “We know that the choices we make now are really important,” said Judy.  This is an insightful comment because most seniors with mostly or all equities in their investments could generally afford a significantly higher lifestyle if they keep a large mortgage with the same amount of additional investments. Their equity investments should have a higher rate of return after tax over time than normal mortgage rates.

-Ed