With his health concerns, should Pablo, 59, take his pension as cash when he retires?

Pablo is 59 and earns $130,000 a year working in the education field. Irene is 56 and earns $110,000 as an administrator. They hope to retire in three or four years, sell their home and move from Alberta to British Columbia.

They have one child, 29, who is financially independent.

“We married later in life and now own two houses,” Pablo wrote in an e-mail. Both are mortgage-free. They rent the second home for $1,750 a month.

“Our plan in retirement is to sell both houses and buy a larger house on rural Vancouver Island with the money from the house sales,” Pablo wrote. Their retirement spending goal is $100,000 to $120,000 a year after tax.

Pablo has some health conditions that may shorten his life. “My first question would be, with my health issues, would it make more sense to take the pension as cash at retirement or to continue receiving monthly defined benefit payments?” he asked.

“My second question would be if we are ready to retire in three or four years.”

We asked Clay Gillespie, a portfolio manager at RGF Integrated Wealth Management in Vancouver, to look at Pablo and Irene’s situation.

What the expert says

Pablo is wondering if it makes sense to take his pension in cash in the form of a commuted value, Mr. Gillespie said. “Unfortunately, his pension does not allow it to be commuted past the age of 55.”

Pablo estimates that in three years his pension will generate about $39,500 a year in income. It is indexed at 60 per cent of the Alberta Consumer Price Index.

How can Ned, 70, avoid paying higher taxes when he moves from Calgary to Toronto?

Pablo’s life expectancy is 26 years and Irene’s is 30, Mr. Gillespie said. But as a couple, their joint life expectancy is 34 years.

“Life expectancy is often misunderstood,” the planner said. It is a median number indicating that 50 per cent of the population will die before a certain age and the other 50 per cent will die after this age. “This means that if you plan for your retirement income to last until your life expectancy, there is a 50-per-cent chance you will outlive your money. We have used Irene’s age of 95 for our illustrations. Irene has about a 25-per-cent probability of reaching 95 years of age.”

Because of his health concerns, Pablo should start his Canada Pension Plan benefit at age 65, but Irene should defer hers until age 70, Mr. Gillespie said. A surviving spouse is entitled to 60 per cent of the other spouse’s CPP benefit as long as the combined benefit does not exceed the maximum CPP. Pablo and Irene expect to get maximum CPP, so if Pablo predeceases Irene, Irene would lose both his CPP and Old Age Security, which has no survivor benefit.

“We recommend that both Pablo and Irene start their OAS at age 65,” the planner said. In setting up their desired income, they should be able to avoid any OAS pension recovery tax, also known as clawback.

“We estimate they can generate a net spendable income of about $113,000 a year, after tax and inflation, until Irene is 95 years of age,” Mr. Gillespie added. “I think they should be able to spend up to $120,000 a year in the early, more active years of retirement.”

Mr. Gillespie describes three stages of retirement, each with distinct spending patterns.

First, the go-go stage. This is the initial phase, in which individuals are typically very active. Energy levels are high, and retirees often strive to fulfill their retirement dreams, such as travelling and engaging in various activities. Spending is generally higher during this stage.

Next, the slow-go stage. As retirees age, their energy levels start to wane. Health may not be a major factor yet, but there is a noticeable decrease in activity levels. Spending begins to decline as retirees engage in fewer activities and travel less.

Finally, the no-go stage. In this final phase, activities are significantly restricted due to health and other physical or mental impediments. Spending is primarily focused on health care and essential living expenses.

With health issues looming, how can Steffen, 60, and Jennie, 57, optimize their savings?

 “This pattern supports the idea that retirees’ income does not need to increase with the rate of inflation throughout their retirement years,” the planner said. Retirees should enjoy the early years of retirement without assuming they will need to increase their income every year by the rate of inflation.

In his forecast, the planner did not include the equity of their principal residence in his calculations. “We are suggesting that this equity could be used later in life to help fund long-term care costs if they arise.”

Once they purchase their new home in B.C., the couple should consider getting a line of credit against it. This is not to be used for investment purposes; it is there in case they need to use some of their home equity to fund long-term care costs. “It is important to pick a lender that does not force you to requalify for the line of credit in the event one of them dies,” Mr. Gillespie said.

After they have the credit line in place, but before they draw on it for additional cash flow, Pablo and Irene should consider deferring their B.C. property taxes. (If they defer their property taxes first, they would not get a line of credit, the planner said.) The B.C. property tax deferral program allows eligible property owners, such as those 55 and older, to defer payment of their property taxes until they sell their house or upon death. The interest rate is set twice a year at prime minus two percentage points and is not compounded.

To guard against stock market volatility, Mr. Gillespie recommends Pablo and Irene transfer three years of expenses – over and above their pension income – to a fixed-income ladder.

“One of the greatest risks in retirement planning is having the stock market drop substantially just before or just after you retire,” he said. “If you are unlucky enough to retire when the stock market is performing poorly, and you need to generate income from your portfolio, you could deplete your capital at an alarming rate, ultimately reducing the chances that your portfolio will be able to generate your required net spendable income throughout your remaining retirement years.

Max and Peg have a paid-off home, indexed pensions and an investment portfolio. So why are they falling short of their goals?

“Thus, we recommend the following strategy: Invest one year’s income in a high-yield savings account that will be used for the first year’s income; invest one year’s income in a one-year bond or guaranteed investment certificate (GIC); and invest one year’s income in a two-year bond or GIC. Invest the remainder of your investments in a balanced portfolio.

“This strategy means that unless we have stock market decline that lasts more than three years, you should not be forced to take income from your investments while they are declining in value.”

Client Situation

The People: Pablo, 59, and Irene, 56

The Problem: Can they afford to retire in three or four years with at least $100,000 a year after tax?

The Plan: The principal residence can be sold or borrowed against if they need nursing care later in life. So they can choose to spend as much as $120,000 a year in their early retirement years. Set aside three years of spending needs in a GIC or bond ladder to guard against big drops in the stock market.

The Payoff: Reassurance that they should be able to meet their retirement goals.

Monthly net income: $12,500.

Assets: Cash, $17,000; his TFSA, $34,000; her TFSA, $67,000; his RRSP, $200,000; her RRSP, $680,000; his employer pension plan, $40,000; residence, $400,000; rental property, $600,000. Total: $2,038,000.

Estimated present value of his defined benefit pension: $1-million (assumes 4-per-cent interest rate), provided by applicant. This is what a person with no pension would have to save to generate the same income.

Monthly outlays (residence): Property tax, $370; water, sewer, garbage, $75; home insurance, $200; electricity, heating $250; maintenance, $200; car insurance, $285; other transportation, $575; groceries, $550; clothing, $70; gifts, charity $165; vacation, travel $1,000; dining, drinks, entertainment, $870; personal care, $50; pets, $300; sports, hobbies, $150; subscriptions, $100; health care, insurance, $740; phones, TV, internet, $280; RRSPs, $2,300; TFSAs, $2,030; pension plan contributions, $1,100. Total: $11,660.

Liabilities: None.

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Some details may be changed to protect the privacy of the persons profiled.