The Problem: A film editor finds his income imploding as technological changes make some services redundant. If he is forced into retirement, will he have enough to support a modest lifestyle?
The Solution: Downsize from two bedroom condo, add the savings to other financial assets and plan for capital depreciation by age 90. Strategic use of RRIFs and TFSAs mean retirement should be secure.
In B.C.?s lower mainland, a divorced dad we?ll call Bob, 61, is struggling to make ends meet on $3,700 a month income after-tax income. It?s just a shadow of what he made a decade ago before technology ate into the skills that once give him a mid-six figure income. In the last few years he has had to adjust to a less cushy way of life. His problem ? plan a retirement within his means.
?I worry that the money will run out,? Bob explains. ?Even if I try to keep working, my income is going to decline because of changes in technology. What can I do??
Bob?s work has been film editing. He has put in 30 years, mostly as in independent contractor working on documentaries. Now he wants to know when he can quit working. At some point, he figures, the lack of business will force him to accept retirement as a fact of life. But if he can get a $2,500 monthly income after tax, he figures he can have a satisfactory life after he winds down his business. Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Bob.
?The internet has changed the way independent contractors like Bob earn their money. The process cannot be stopped and Bob is a realist to acknowledge that he cannot maintain his business in an environment when he is being replaced by software.?
Mr. Moran says it can be done, it?s just a matter of investment management.
Bob has two children, both adults and both with jobs. One still lives with him but plans to move out next year. Then he could sell his two bedroom condo, downsize to a one bedroom unit, and invest what could be a $200,000 difference in price.
Managing the balance sheet
On the plus side, Bob has no debts. His total net worth is $1,072,000, but 57% of that is his $620,000 condo. He has $452,000 in financial assets.
The invested assets are mutual funds with respectable track records. His average annual investment income, which is retained within his RRSPs and TFSAs, is $13,600. Bob can increase the income he gets from his investments by using a capital depletion payout model which adds return of capital to income generated by invested assets. If the funds sustain a 3% after-inflation return on his capital, he could draw $22,870 a year from Registered Retirement Income Funds and the TFSA until his age 90. That would be a 68% increase in the payout rate.
If Bob waits to age 65 to draw his Canada Pension Plan benefits, as he should given the 7.2% annual penalty for taking benefits before 65 (his cost would thus be a reduction of 28.8% if he cashed in this year, his 61st), he can expect $7,200 a year. That would push his pension income up to $30,070 before tax. If Bob continues to work until he is 65, he can add present income of $1,600 a month or $19,200 a year, for total pre-tax income of $49,270. Old Age Security would add $6,553 a year and partially compensate for eventual loss of his self-employment income, leaving pre-tax gross income without any employment income from age 65 onward of $36,623.
Assuming that Bob pays 10% average tax, he would have $2,747 a month to live on. His payout rate from his RRIFs, which he would have to distribute beginning in his 72nd year, would rise every year, for RRIF rules specify minimum distributions of about 7.4% at age 72 rising to 20% a year of remaining RRIF balances at 94 and thereafter. On the other hand, starting distributions early at age 65, when RRIF minimum payout are still below 5% and allowing for zero tax on any distributions from Bob?s $39,000 of TFSAs, his tax rate should be low and stable for many years, Mr. Moran suggests.
Retirement budget
Bob?s living expenses, currently $3,724 a month, include $1,295 monthly savings for his RRSP and his TFSA. He pays property tax of $160 a month. In B.C. property taxes for homeowners 55 and over can be deferred until sale of the property. If savings and the property tax are eliminated, then Bob?s cost of living would be $2,269 a month. That would be supportable by his age 65 take home income.
After his adult child moves out, Bob could sell his two bedroom condo, worth an estimated $620,000, and purchase a one bedroom condo for $200,000 less. If he gets 3% after inflation on that harvested capital, he could add another $6,000 a year to his income. Most of that could go into a TFSA each year. His condo fees would tend to be lower, as would property taxes whether paid or deferred. Given the state of the property market in B.C., taking a profit now is a sensible move, Mr. Moran says.
The $6,000 boost to income would push retirement income after age 65 to $42,623. After 12% tax on total income excluding any payouts from his TFSA, which would be tax-free, Bob would then be left with $37,508 a year, well ahead of his target $30,000 after-tax income. He could reinvest the surplus to create a savings buffer. Assuming that he maintains a 3% after-inflation return, the annual result, if growing within a TFSA, subject to the $5,500 annual contribution limit, and the additional $500 growing outside but subject to tax, would generate about $250,000 by the time Bob is 90.
The TFSA would be a reserve for another eight to ten years of expenses after his capital depletion payout model exhausts his other financial assets. Keeping the larger condo for later downsizing could produce a similar result decades hence and, either way, there would be no tax on the sale of a principal residence or the TFSA payout. The difference ? the TFSA can be tapped for small sums and cuts Bob?s high allocation to real estate.
?His income is shrinking and retirement is inevitable, but his situation is far from hopeless,? Mr. Moran says.
Need help getting out of a financial fix? E-mail andrewallentuck@mts.net for a free Family Finance analysis
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