Can Pat afford to spend more on travel without jeopardizing her long- term financial security?

With her 60th birthday approaching, Pat is looking to map out her future to see whether she can spend a little more. She has some pension income, some savings and a mortgage-free, lakefront house in small-town British Columbia.

“I’m new to the financial planning world,” Pat writes in an e-mail. She is recently widowed with two adult children who are financially independent. Her challenge is to balance future needs – possibly for assisted living – with shorter term goals such as building a new deck “and occasionally vacationing in a warmer climate during the winter.”

Pat’s income is $5,390 a month from her late husband’s defined benefit pension of $3,260 and $2,130 in disability pensions. At age 65 her disability pensions will end but she will receive a work pension of $1,080 a month plus government benefits, depending on when she decides to take them.

“After expenses, I stash whatever money remains in my savings account,” Pat writes. “When tax season arrives, I make a plan with my bank whether to invest money in an RRSP or tax-free savings account,” she adds. “I need help understanding what type of retirement I can expect with my limited resources, and how I can make informed financial decisions that align with how I want to live my life in the future.”

At some point she plans to sell her house and perhaps buy a condo apartment in town. Her retirement spending goal is $50,000 a year after tax.

We asked Warren MacKenzie, head of financial planning at Optimize Wealth Management in Toronto, to look at Pat’s situation.

What the Expert Says

Pat wants to know whether she can afford to travel more and spend some time down south over the winter.

Pat could easily spend more, Mr. MacKenzie says. Because her lifestyle is modest, she could spend an additional $1,000 a month for the next decade and still have enough to pay for an assisted living home if she needs one at age 70, he says. Pat has a chronic health condition that could worsen over time.

If she can continue living on her own to age 80, she can safely spend even more – up to $2,000 a month more – without putting her long-term financial security at risk, the planner says.

“With $47,000 in her tax-free savings account and $87,000 in registered retirement savings plans, Pat’s spending decisions will be more important than her investing decisions.” The big contributors to her financial security are her modest spending goals, a mortgage-free home she values at $515,000, and her indexed pensions, including Canada Pension Plan and Old Age Security benefits.

Based on conservative assumptions – an average investment return of 4 per cent with inflation of 2 per cent – Pat has enough income and capital to maintain her long-term financial independence, the planner says. There are some things she can do to reduce her income tax and increase her investment returns, he notes.

Even with her disability, Pat might live to age 95, “so it’s important that she manage her resources wisely so that she will always be able to live in a nice retirement home.”

Pat wonders if she can immediately afford to spend $10,000 to build a new deck. “She should definitely build the new deck and consider this an investment rather than an expense,” Mr. MacKenzie says. “This is the best kind of investment, one that will increase in value while also increasing her enjoyment of her home.” She can use funds from her savings account.

At age 65 she will need to decide when to take her CPP and OAS benefits. If she increases her spending by $1,000 a month, her private pension income will still be sufficient to meet her needs, so she will not need OAS and CPP to make ends meet, the planner says. “Unless her health has deteriorated, it makes sense to delay starting CPP and OAS until age 70.” By doing this, her monthly CPP payments will be higher by 42 per cent and OAS payments by 36 per cent.

Pat sees two long-term possibilities. In the first scenario, her health does not deteriorate, in which case by age 70 she’ll sell her house and use the proceeds to purchase a condo in the nearby city for $500,000. Then at around age 80, she’ll sell the condo and move to a retirement home costing $6,000 a month in today’s dollars.

The second scenario is that by age 70 her health has deteriorated, in which case she’ll sell the lakefront property, immediately move into a retirement home, and use the house proceeds to fund the expense, the planner says.

If she is enjoying her condo but needs more cash to maintain her lifestyle for a few more years, she could use a reverse mortgage, he says. Suppose, for example, she wants to spend $12,000 a year more than what she is getting from her pensions. She would set up a reverse mortgage and over five years borrow $12,000 a year, for a total of $60,000.

The average amount outstanding on the mortgage over the five years would be about $30,000. At 5-per-cent interest that would cost about $10,000. “So when she goes to sell the condo, she needs to repay the mortgage and interest – about $70,000,” the planner says. In the meantime, assuming inflation of 2 per cent, her condo has risen in value by about $50,000. “So she clears about $20,000 less on the sale but she’s been able to enjoy her condo for another five years.”

In the first scenario, if Pat’s health has not deteriorated and she increases spending by $2,000 a month, by age 95 she’ll have used up most of her capital, although she’ll still have pension income and government benefits. In the second case, if her health deteriorates and with retirement home costs starting at age 70, she’ll have used up most of her capital by age 85.

All of Pat’s savings are invested in guaranteed investment certificates that will mature over the next three years. Over the longer term, a well-diversified portfolio can be expected to significantly increase her rate of return and the capital available to maintain her lifestyle, the planner says. Because Pat’s basic lifestyle needs are covered by indexed pensions, she can afford to take some investment risk, he adds.

Each month Pat moves money from her chequing account to her TFSA. The main benefit of a TFSA is to shelter income from income tax. Since she is not earning interest on her chequing account, and she is earning almost no interest on the GICs in her TFSA, she’s not getting the full benefit of the TFSA, Mr. MacKenzie says. However, she has $38,000 of RRSP contribution room. She’d be better off contributing about $10,000 a year for the next four years to her RRSP, he says. By doing this, she’ll receive tax refunds totalling more than $10,000. Her RRSP contributions will grow on tax-free basis. When she eventually takes income from her registered retirement income fund, the income will be taxable, but it will not be sufficient to put her into the Old Age Security clawback zone.

Client Situation

The person: Pat, 59

The problem: Can she afford to spend more on travel without jeopardizing her long-term financial security?

The plan: She can spend anywhere from $1,000 to $2,000 a month more because her income will rise when she starts collecting her pension and government benefits. Shift to a diversified portfolio to improve investment returns and keep up with inflation.

The payoff: Financial security – and the confidence to spend more and enjoy retirement.

Monthly net income: $4,530

Assets: Savings account $20,080; TFSA $47,340; RRSP $86,640; estimated present value of two pensions $1-million; residence $515,000. Total: $1.67-million

Monthly outlays: Property tax $85; home insurance $165; electricity, heating $220; maintenance, garden $210; transportation $235; groceries $300; clothing $200; gifts $200; vacation, travel $300; dining, drinks, entertainment $540; personal care $45; subscriptions $45; health care $170; phones, TV, internet $300; TFSA $200. Total: $3,215

Liabilities: None