Nick, 65, and Heather, 64, want to ‘die with zero.’ What should they do in retirement?

Nick is 65 years old and retired. His wife, Heather, is 64 and self-employed, earning about $40,000 a year in a line of work that she enjoys.

Although they own three investment properties, they are renting their residence at the moment and looking to buy a B.C. waterfront property for about $1.2-million.

“As of this year, we are considered first-time home buyers again,” Nick writes in an e-mail. So as well as having a First Home Savings Account of their own, they also want to open FHSAs for their three children to help them with down payments on their first homes.

They wonder whether Heather can afford to fully retire and when they should start drawing Canada Pension Plan benefits. Nick is already getting Old Age Security. He also asks if they should invest in a whole life insurance policy to further diversify their investments. They already have a grab bag of diversified investments, including stock-and-bond exchange-traded funds, private mortgages and real estate investment trusts.

Their retirement spending goal is $148,000 a year after tax.

We asked Warren MacKenzie, an independent financial planner in Toronto, to look at Nick and Heather’s situation. Mr. MacKenzie holds the chartered professional accountant designation.

What the Expert Says

“Nick and Heather’s main goal is enjoy financial security in their retirement with no fear of running out of money,” Mr. MacKenzie says. In addition they would like to help their children purchase their first homes. They also want to buy a waterfront property so they will have easy access to their sailboat.

They plan to contribute $40,000 to a First Home Savings Account for each of their three children, “a sensible way to help their children get a head start,” the planner says.

Another estate goal, according to the planner’s questionnaire, is to avoid any legal complications or possible conflict between their heirs. “To reduce the possibility of a conflict, they have appointed a lawyer rather than one of their children act as their executor,” Mr. MacKenzie says.

“Assuming an average investment return of 5 per cent a year with inflation running at 2 per cent a year, the projections show that they can achieve their spending goals,” the planner says. He further assumes that they sell all the rental properties by the time they buy the house. Nick says they plan to sell them over three years to minimize the capital gains tax.

After buying a new house, their basic lifestyle spending will be $70,000 a year, plus about $60,000 in mortgage payments and about $20,000 a year for a whole life insurance policy. The forecast assumes that by age 85, they will sell their sailboat and expenses will fall by $10,000 per year.

“Nick and Heather understand that while long-term projections are never totally accurate, they can give an important warning of potential problems,” he says. Regularly reviewing their plan would give them time to make a small spending adjustment, for example. “Over a 10- or 15-year period a small reduction in spending would be enough to offset a significant loss,” Mr. MacKenzie says.

Based on reasonable assumptions, the projections show that they can achieve their goals and possibly leave an estate of about $1-million in dollars with today’s purchasing power, he says.

Their asset mix is about 23 per cent interest-bearing investments, 45 per cent stocks and stock exchange-traded funds and 32 per cent real estate. The mix is reasonable, but they hold a large proportion of stocks in their registered retirement savings plans (RRSPs), the planner notes. Instead, they should hold their stocks in their taxable account so that they can take advantage of the lower rate of tax on capital gains, he says. “Capital-gains-producing investments held in RRSP accounts lose the lower tax benefit because all withdrawals are 100-per-cent taxable.”

As a do-it-yourself investor, Nick has done reasonably well, earning an average return of 7.5 per cent a year, Mr. MacKenzie says. “They should have a plan for how the portfolios would be managed if anything happened to Nick.”

The overall portfolio is unnecessarily complicated, with investments spread out over a dozen different RRSPs and registered retirement income funds (RRIFs).

They have $100,000 cash in the bank, a $33,500 line of credit at 6 per cent and $57,695 in other loans at 3.6 per cent. “It makes no sense to have cash in the bank earning almost nothing and also have about $90,000 of debt where the interest is not fully tax deductible,” the planner says.

The couple ask when they should begin taking CPP benefits. “They are both in good health and they live a healthy lifestyle,” Mr. MacKenzie says. “It is reasonable to assume that they will live to their mid-80s and beyond,” the planner says, “so it makes sense to delay the start of CPP until age 70.” By so doing the benefits will be 42 per cent higher than if they start CPP at age 65.

Since their income is below the OAS clawback threshold, they have decided to start their OAS at age 65 for cash flow reasons, the planner says.

By age 70, after they are both collecting CPP, the projections show that their net worth will be about $2-million. “If they make it to age 100, their net worth will have decreased to about $1-million in dollars with today’s purchasing power,” he says.

In 2031 their cash flow will consist of CPP benefits of $35,000, OAS benefits of $19,800 and their defined benefit pensions of $9,700, for a total of $64,500 a year. Their investment portfolios will be valued at more than $1-million and should be expected to grow by about $50,000 a year, Mr. MacKenzie estimates.

In addition, the cash surrender value of the whole life insurance policy, if they buy one, would grow by about $15,000 a year. With 2-per-cent inflation, the value of their home would be expected to grow by about $25,000 a year while the mortgage principal would be reduced by $30,000 a year. This equates to an increase in net worth of about $185,000.

Against this are basic spending of $81,000 a year, mortgage payments of $73,000 a year, life insurance of $18,000 a year and income tax of $29,000 a year, for a total of $201,000.

Until they start CPP at age 70, they will not have sufficient income to use up the lowest tax bracket. It would therefore make sense to withdraw an amount from their RRSPs and RRIFs that would be sufficient to bring taxable income up to about $58,000 a year each so that they use up all the room in the lowest tax bracket, Mr. MacKenzie says. Otherwise, Nick will be forced into a higher tax bracket later in life and may be faced with a clawback of OAS benefits.

Heather and Nick should aim to have equal taxable income so that one does not pay tax at a higher tax rate than the other.

They have non-registered funds on hand and they also have contribution room in the FHSAs and TFSAs. “They should move money from their non-registered account to their TFSAs and FHSAs,” the planner says.

Nick and Heather are budgeting to spend over $20,000 per year to purchase a whole life insurance policy. The insurance proceeds would be received on a tax-free basis at death but withdrawing all the cash surrender value would have tax consequences, he notes.

“Whole life insurance can be a sound investment, but if they have other lifestyle goals and are not focused on maximizing the size of their estate, they should reconsider this expense.”

Client Situation

The People: Nick, 65, Heather, 64, and their three children, 27, 29 and 31.

The Problem: Can they afford to buy a new home and help their children with down payments while still enjoying a comfortable retirement lifestyle?

The Plan: Buy the house. Defer CPP to 70. Nick draws from his RRSP/RRIF in the early years. Contribute to first home savings accounts for their children.

The Payoff: Financial goals achieved.

Monthly net income: $10,375.

Assets: Cash $100,000; his stocks and stock funds $175,000; her stocks and stock funds $175,000; his TFSA $191,365; her TFSA $86,185; his RRSP $770,750; her RRSP $122,030; his FHSA $6,625; her FHSA $6,625; investment properties $725,000. Total: $2,358,580.

Estimated present value of their combined, partly indexed defined-benefit pensions: $200,000. This is what someone with no pension would have to save to generate the same income of $340 a month for Nick and $420 a month for Heather.

Monthly outlays: Rent $3,000; home insurance $20; electricity $90; heating $25; transportation $755; groceries $1,500; clothing $35; line of credit $165; loan $180; gifts, charity $165; vacation, travel $925; other discretionary $150; club memberships $80; dining, entertainment $135; sports, hobbies $880; subscriptions $50; doctors, dentists $220; drugstore $110; health, dental insurance $230; life insurance $1,740; phones, TV, internet $115; TFSAs $100. Total: $10,670.

Liabilities: Rental property mortgages $433,150 at 4.85 per cent; line of credit $33,500 at 6 per cent; other loans $57,695 at 3.6 per cent.

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