Can Elijah, 51, afford to retire early, even if his plans for self employment don’t pan out?
Elijah has a worsening health condition that makes keeping up with his $139,000 government job difficult, he writes in an e-mail. “My hope is to retire early (at the age of 55) and to eventually switch to part-time self-employment.” Elijah is 51, and his wife, Ava, is 50. “We are a single-income couple with no children,” Elijah writes.
Elijah and Ava are debt-free with a house valued at $800,000. They have registered and non-registered investments, with the stock portion of their portfolio mostly in blue-chip, dividend-paying stocks. Elijah’s non-registered account is mostly in guaranteed investment certificates.
Elijah has a defined benefit pension plan indexed to inflation that will pay him $45,045 a year at 55 plus a bridge benefit to 65.
“We are a frugal couple and only use about half of my current take-home pay,” he adds. If his plans for self employment do not pan out, or his income is minimal, “would we still be in good financial shape?” Elijah asks. “Or is early retirement a bad idea and we need to change plans or alter our finances now?”
Their retirement spending goal is $50,000 a year after tax, less than they are spending now.
We asked Warren MacKenzie, a Toronto-based fee-only financial planner, to look at Elijah and Ava’s situation. Mr. MacKenzie holds the chartered professional accountant and certified financial planner designations.
What the Expert Says
From a financial point of view, Elijah has no need to work part-time after he leaves his full-time job, Mr. MacKenzie says. “But in order to keep physically and mentally healthy, some volunteer work would be a good idea,” he says. “People who are active and volunteer in their community tend to enjoy a happier and healthier retirement.”
“The key to their solid financial position is that their monthly lifestyle spending is less than $3,000 (excluding savings), substantially lower than their net income,” Mr. MacKenzie says. After all deductions for tax and other benefits, they are able to save about $5,000 a month. “Saving money has been an important focus of their lifestyle,” the planner says.
First, the planner breaks down their income sources in the first full year of retirement, 2027, when their spending target will be $50,000 a year. With income tax and a contribution to Elijah’s tax-free savings account, the total outflow is projected to be about $64,000. Elijah will be getting a defined benefit pension of $45,045 a year, plus a bridge pension benefit of $10,400. To make up the difference, he will draw $8,555 from his capital, for total cash inflow of $64,000.
“In 2027 their investment assets are shown as about $850,000, so with a 5-per-cent expected return, the assets would earn $42,500 a year,” Mr. MacKenzie says, “so after drawing $8,555 a year from their investments, their net worth is still growing.”
Elijah can begin to receive his Canada Pension Plan benefit as early as 60 or he can delay until 70, the planner says. “If Elijah delays the start of CPP until age 70, the payments will be 42 percent higher than they would be if he starts at age 65.
In the first few years of retirement they will pay little income tax because, for tax purposes, Elijah can split his pension income with Ava starting at 55. Later, when he is 65, he can also split his CPP and his RRSP/RRIF (registered retirement income fund) income with Ava.
In 2037, when Elijah is 65 and receives the first full year of his pension, CPP and Old Age Security benefits, his income (assuming 2-per-cent inflation) will be about $78,000 a year. When this income is split, they’ll pay about $8,500 a year in income tax. (If the income was not split for tax purposes, their tax bill would be more than $14,000, he says.) The forecast assumes Ava’s income is limited to Old Age Security.
Elijah and Ava are concerned about the possible cost of nursing home care or assisted living in their later years. “With their pension income they will have more than enough for basic nursing care, but if they choose to move to an expensive retirement home (that offers assisted living), this will eat into their savings but not deplete them,” the planner says.
His forecast shows that they will not run out of money even if, starting at Elijah’s 81 and continuing to 100, they spend $6,000 a month each for a nursing home.
Assuming they sell their home in about 30 years, they would have about $4.5-million of investments, he says. “If they average a return of 5 per cent a year, the income on this amount of capital would be $225,000.” By this time, with inflation, they have about $95,000 a year from Elijah’s pension plan, CPP and their OAS. “So between the income from their investments plus their pension income, they’ll have a total coming-in of $320,000 a year,” the planner says. “This is more than enough to pay for their retirement home until age 100.”
Elijah is a do-it-yourself investor who has followed a buy-and-hold investment strategy. Their RRSPs and tax-free savings accounts are now almost 100 percent in stocks, Mr. MacKenzie says. “Now that Elijah is considering retirement, it’s time to reduce their exposure to the stock market, simplify and reduce the number of equity positions, and follow a disciplined rebalancing strategy,” he adds.
The historic rate of return needed to achieve their financial goal is 5 percent, the planner says. They can achieve this return from a lower-risk, more widely diversified portfolio.
“In short, they are now taking substantially more risk/exposure to the stock market than is necessary to maintain their lifestyle,” he adds. “In a serious market downturn, this could mean having to make a significant cutback on their spending.”
Client Situation
The people: Elijah, 51, and Ava, 50.
The problem: Can Elijah afford to retire from work early without jeopardizing their financial security?
The plan: Their spending is so low Elijah can go ahead and retire at 55. Take advantage of income splitting. Take steps to reduce the stock market exposure in their investment portfolio. Consider deferring government benefits to 70.
The payoff: A financially secure retirement with enough money to pay for assisted living or nursing home care in their old age if necessary.
Monthly net income: $7,955.
Assets: Non-registered portfolio $139,530; his TFSA $115,075; her TFSA $96,015; his RRSP $159,850; her RRSP $13,100; commuted value of his DB pension $1,430,880; residence $800,000. Total: $ 2.8 million.
Monthly outlays: Property tax $500; water, sewer, garbage $50; home insurance $150; electricity $100; heating $120; maintenance $50; transportation $195; groceries $500; clothing $30; gifts, charity $50; vacation, travel $400; dining, entertainment $200; personal care $30; club membership $15; pets $20; sports, hobbies $30; subscriptions $10; other personal $50; health care $70; communications $160; RRSPs $250; TFSAs $500; pension plan contributions $1,085. Total $4,565.
Liabilities: None.