Retirement savings: Couple, 70, wonders how to make them last
Monday Makeover looks at a 70-year-old couple wondering how much they can safely spend each year without depleting their savings.
Carl and Donna are ready for some fun. So, at age 70, they are planning a $9,000 trip.
This is a luxury they can certainly afford. They have more pension income than their $29,000 of basic living expenses, plus $619,000 in savings and a $350,000 Toronto home.
They have obviously managed their finances well to achieve such a high level of savings. Only part of the money came from a recent inheritance, and the sale of a second property. More significantly, they have not spent lavishly on their family home. They raised only one child and delayed drawing on savings.
Now they wonder how fast to spend their savings, yet not run out.
Cynthia Kett of Stewart & Kett Financial Advisors Inc. proposes a simple and conservative rule of thumb that any of us could use to pace the use of our savings to last a lifetime.
First she took into account the tax Carl will owe as he gradually draws down the $224,000 now in his registered retirement savings plan (RRSP). She deducted 20 per cent for tax, the rate most retired Ontario couples will pay if their taxable income is evenly split and totals no more than $79,500 a year.
Then Kett divided $573,000, her estimate of their net savings, by 25 – the number of years between age 70 and 95. This will limit the risk of running out of money, as only about an eighth of Ontario residents who reach age 70 are expected to live to age 95. (An eighth of men could reach 94, and an eighth of women 97.)
(Note: A life-expectancy calculator is available on the website lifeinsurancecanada.com. It provides the age that half of those of a certain age will attain. Then the expected lifespan of the half who survive can be tested, and so on.)
By Kett’s formula, Carl and Donna could comfortably spend an additional $22,200 from savings and investment income the first year. They could increase spending each following year in line with the rise of consumer prices, just like a government pension plan.
Only two possible hitches could arise. They could live longer than about 87 per cent of those their age, or their investment returns could disappoint.
But Kett, who is both a Chartered Accountant and Certified Financial Planner, set a modest investment target – the same as the annual rate of price inflation, plus enough to cover the taxes on the investment income.
So, if inflation were to average 3 per cent over the next 25 years, Carl and Donna’s savings would need to earn 3.75 per cent a year.
If inflation were to average about 2 per cent, which is more than during the past 20 years, they would have to earn 2.5 per cent on investments.
That lower inflation amount is about all that a retail investors can now obtain investing directly in long-term Government of Canada bonds. So Kett would encourage Carl and Donna to continue including corporate shares in their portfolios.
Kett cautions that some of the $22,200 in 2013 dollars that Carl and Donna could withdraw each year would be needed to offset a decline in the purchasing power of Carl’s $18,000 company pension.
Unlike the $25,600 of income the couple receives from Old Age Security and Canada Pension Plan pensions, his company pension amount is fixed for life with no promise of annual adjustments.
In a world of 2 per cent inflation, a 70-year old retiree with a fixed pension would need an RRSP equal to about four times their annual pension and an annual investment return of 2.5 per cent to compensate for the loss of purchasing power over a 25-year period.
So Carl could either dedicate some of his RRSP to supplement his pension, or the couple could accept a gradual decline in purchasing power over the years.
It will be up to Carl and Donna to decide whether to actually spend as much as the limit revealed by Kett’s suggested formula.
They might wish to leave more than the value of their home to their heirs. They might wish to plan for major expenses such a home renovation, car purchases or the cost of help in the event of a disabling disease or injury.
They might also wish to save some capital in case Carl were to die before Donna, since she would lose his OAS pension, some of his CPP pension, and $6,000 of his company pension, Kett points out.
She recommends that Carl convert his RRSP to a registered retirement income fund (RRIF) before the end of the year he will turn 71, rather than purchase a life annuity from a life insurer.
“That will give them the maximum flexibility from a cash flow perspective,” she points out. The savings inside the RRIF could be transferred tax-free to Donna if Carl were to die, or to heirs if they both were to die.
“I wouldn’t recommend an annuity because interest rates are very low right now…(it) will generate relatively modest retirement income...(and) also the annual amount cannot be changed after the fact.”
Kett noted that Donna plans to use part of her inheritance to pay for their trip. She suggested that Carl repay her from his non-registered savings, and that Donna invest the money as she will pay less tax on investment earnings.
They should also make maximum use of the right to split income from Carl’s company pension and, in future, the income from his RRIF withdrawals.
The client
Carl and Donna, 70
Their situation
The retirees have nearly enough government pensions to pay their basic expenses, plus Carl’s $18,000 company pension, plus $619,000 in savings they would like to spend on some fun, but not so fast it could run out.
The strategy
Assume Carl will be able to use only 80 per cent of his $220,000 in registered retirement savings after tax, and after the adjustment, simply divide the total of all savings by 25 – the number of years that only about an eighth of 70-year-old Ontario residents might live. Limit annual withdrawals of capital and interest to a 25th of savings, or $22,200 per year.
Assets:
Home $350,000
Retirement savings $224,000
Non-registered investments $344,000
Tax-free savings $51,000
Three cars $20,000
Total: $989,000
Liabilities: $0
Annual income
Old Age Security $12,516
Canada Pension Plan $13,100
Company pension $18,000
Investment income $10,220
Total $53,826
Annual expenses
Property taxes $2,300
Shelter $9,666
Household operation $4,900
Medical $200
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