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Forced into retirement
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A few years ago, a Montreal executive we’ll call Leonard was making $350,000 a year. Then, in a corporate restructuring, he got a pink slip and moved to the ranks of the unemployed.
He spent a year sending out resumés to no avail. Now, at the age of 58, he has come to the conclusion that he will not be able to find a new position in his former field — communications.
Family Finance asked Montreal-based financial planner Caroline Nalbantoglu, head of CNal Financial Planning in Montreal, to work with Leonard. “The bad news is his inability to replace the job he lost,” she says.“The good news is that, so far, he has not had to encroach on his savings thanks to a freelance contract and employment insurance. But his EI runs out in April and he will then have to live off his savings.
“However, this year, he can withdraw $10,000 to $15,000 from his RRSP and, with no other income, pay little or no tax. Then, for the next two years he can use his savings to defray the remainder of his expenses.”
Leonard is financially secure for now. At 60, he will receive $216,000 from the sale of company shares. The payout will be taxed as capital gains. After tax, he will net about $164,000. He will be in the top tax bracket at that point. He should not make any RRSP withdrawal in that year, Ms. Nalbantoglu advises.
At age 65, he can access what would be full Quebec Pension Plan benefits of $11,840 with a 36% reduction for early application or hold out to age 65 for the full benefit. The full introduction of QPP early application penalties that are being phased in will not have been completed so there is a small incentive to take the benefits early. Yet there should be no need to do so.
Leonard can do several things to increase and secure his income. First, he needs to make sure that his portfolio has a foundation of blue chip stocks that pay secure and rising dividends.
Shares of many public utilities, pipelines and financial institutions that pay dividends of 4.5% to 5.5% would be appropriate.
There should also be some bonds. Bond prices and total returns tend to rise when stocks fall, thereby stabilizing the portfolio. Federal and provincial bonds are readily bought and sold but have very low current yields.
Investment-grade corporate bonds with current yields of 3.5% to 4.5% are more complex and may not be as readily traded as government bonds.
Corporate bonds can be bought as Exchange Traded Funds with very low management fees, typically one quarter of one per cent per year. To reduce the likelihood that bond prices will fall when, eventually, interest rates rise, Leonard can use ETFs with short term corporate bonds.
A couple of these ETFs ladder corporate bonds with maturities of one to five years and one to 10 years. They are worth investigating.
Among Leonard’s registered investments is a variable annuity with a current value of $317,000. The annuity has a guaranteed annual withdrawal of 5% or $19,000 at age 65 no matter how the assets inside the annuity perform.
If he ever takes out more than $19,000 in a year, the guarantee is no longer valid. The contract is expensive with an annual 2% annuity fee on top of the management fees for the mutual funds it holds. It’s pricey, but in Leonard’s situation, the security is valuable.
65 and onward
When he reaches 65, Leonard’s income will be $19,000 from the annuity, $12,300 from other assets, $7,226 from Old Age Security, currently $6,480 and assumed to rise at 2% per year, and $13,616 from QPP benefits, also inflated at 2% per year.
All this will produce after-tax income of $52,142 per year.
Leonard’s current expenses, $48,828 per year, will have risen to approximately $59,600 per year at an annual inflation rate of 3.0% per year. In fact, government pension inflation adjustments tend to lag the actual rise of CPP, Ms. Nalbantoglu notes.
Leonard’s non-registered cash savings can offset the approximately $3,300 shortfall, the planner advises.
Leonard’s savings will be depleted if he continues to generate what amount to cost overruns.
To produce more income, Leonard could downsize his $800,000 house to something in the $450,000 to $500,000 range and liberate equity of perhaps $300,000 to $350,000, depending on selling costs and the cost of replacement housing.
Leonard wants to buy a small condo in California. That could — depending where he buys, how much he spends, and how the depressed real estate market performs — produce a hefty expense or a tidy profit. The condo has to be regarded as both risky and a luxury, for Leonard would not occupy it for much of the year.
Leonard also has to rationalize his investments, which include several quite speculative stocks. He needs to prepare his assets for a long period in which his career, now fallow, has to be supported by earlier harvests.
“Leonard has some difficult decisions to make,” Ms. Nalbantoglu says.
“Fortunately, he has enough savings and breathing room to allow him to decide what he wants to do and how to do it.”