Studying the market pays off for smart couples with 12% return and ‘bulletproof retirement strategy’

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Personal Finance Family Finance

But there are risks in the optimistic projections

Leo and Rose have spent years studying capital markets and have achieved an astonishing average growth of 12.4 percent with investments, almost entirely in North American stocks that they have researched and monitored closely. Leo and Rose have spent years studying capital markets and have achieved an astonishing average growth of 12.4 percent with investments, almost entirely in North American stocks that they have researched and monitored closely. Photo by Gigi Suhanic/National Post

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In Ontario, a couple we call Leo, 63, and Rose, 55, are retiring. Leo quit his job at a bank a few years ago while Rose continues to work. They bring home $8,400 a month. They have three children, two in their early 20s and one in their 30s. Their net worth is $4.45 million, including a $250,000 mortgage with a modest 1.9 percent interest rate.

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Email andrew.allentuck@gmail.com for a Free Family Finance Analysis

Leo and Rose have spent years studying capital markets and have achieved an astonishing average growth of 12.4 percent with investments, almost entirely in North American stocks that they have researched and monitored closely. They study markets and exercise the saving grace of all investments – diversification. Their investment horizon is multi-generational. It’s fundamentally conservative.

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Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, BC, to work with Leo and Rose.

Despite their strong finances, they are concerned about the effect of rising interest rates, they could increase the $1,200 they pay each month on their mortgage, which will run for another 20 years. Those fears are misplaced: Even if their mortgage payments double, they may be able to absorb the cost by making a few savings, extending the amortization period, or simply using some of their invested cash to pay it off in full.

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“Do we have enough for a long, comfortable retirement?” asks Leo. It is the fundamental question of every retiree.

the mortgage

Leo and Rose have a choice whether to keep or pay off the mortgage, Moran says. If they pay it off, they can borrow the amount back and invest it, minus any interest on the loan. But is it worth it?

They were able to tap $1,760,000 RRSPs for the $250,000 mortgage prepayment. It would be taxable, so that’s not attractive. They could cash in all of their $195,000 in TFSAs with no tax consequences, but if they borrow to replace tax-exempt investments, the borrowing cost would not be deductible. That’s not attractive. Finally, they were able to cash out $250,000 in taxable securities. However, their adjusted cost base on that account is $170,000, meaning they would have to pay taxes on the $80,000 profit. The load would be 30 to 40 percent, negating the advantage of the maneuver. It’s not worth it, concludes Moran. Better to bite and pay a little more interest if necessary.

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Build up retirement income

Retired, Leo and Rose want to spend $8,400 a month, as they have now. To achieve that, they would need $61,000 each or $122,000 in full taxable income. At that income level, they would pay an average of 18 percent in taxes, assuming the income is perfectly distributed.

When fully retired, the couple will have two fixed benefits, non-indexed, $6,540 per year for Leo and $10,200 for Rose. At age 65, Leo has an annual CPP of $12,000, up from $9,800 per year. Each will receive full age protection, $7,707 per year, and the proceeds of their investments.

Their RRSPs have a current value of $1,760,000. If the bills grow at four percent per year after a three percent inflation rate, which is easily within its average return for several decades, they can generate $90,700 per year from age 35 to Rose’s age 90.

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Their taxable investments, $305,000, growing at the same average annual return of four percent over 35 years, would yield $15,713 per year.

Their $195,000 worth of TFSAs with the same assumptions would make $10,046 per year.

Assuming Rose quits her job ASAP, they would have $90,700 RRIF income, $10,046 TFSA cash flow, and $15,713 taxable income. That works out to $116,459. Assuming a split of qualifying income, they would pay an average of 15 percent tax on all income except TFSA and would have $100,500 to spend per year. That’s $8,374 a month, just a few dollars short of their goal of $8,400 monthly retirement income.

Once Leo turns 65, his retirement, CPP, and OAS take effect. Their income would be his $6,540 pension, his $12,000 CPP and $7,707 OAS, their combined $90,700 RRIF income, $10,046 TFSA cash flow and $15,713 taxable income. That works out to $142,706. Without TFSA cash flow, they would pay taxes at an average tax rate of 18 percent and have $118,830 to spend per year. That’s $9,900 per month.

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Once Rose turns 65, they would receive Leo’s $6,540 pension, Rose’s $10,200 pension, his $12,000 CPP, her $9,800 CPP, two $7,707 OAS pensions, $90,700 RRIF income, $10,046 TFSA cash flow, and $15,713 taxable income to have. That’s a total of $170,413. After 20 percent average tax, they would have $138,340 a year to spend. That’s $1,530 per month.

Risk management

There are risks in these optimistic projections. First, risk: the 4% yield we’ve assumed doesn’t have bonds that act as shock absorbers when stock markets fall. However, the couple’s monthly budget allocates $1,000 to travel and entertainment, expenses that could certainly be shaved if dividend flows shrivel — an unlikely but possible event.

On the plus side, the couple has no contingent liabilities. Their children are almost gone, the remaining one, a student, will soon find his own home. The mortgage payment, now $1,200 a month, would rise to $1,489 if extended at double the current rate of 1.9 percent and would be $1,650 a month at five percent. It is easily affordable given their rising income.

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Much of their savings is locked up in their two rental homes — with a combined net worth of $1.26 million — and their $1,600,000 home.

Couples in their 40s with $3M in assets must diversify if they want to retire early

Robert and Elly both have fixed pensions upon retirement, but until then they are in the special position of using $10,269 a month in after-tax income to subsidize two rental properties.

Ontario couple must plug a leak in their finances before retiring

If Ella's mortgage interest doubled, her monthly payment would rise from $2,990 to $3,429.

This Ontario woman should use her money to get her mortgage under control on her way to retirement

Given the couple’s growing cash surplus and their interest in financial security, they could explore the cost of additional medical coverage and hospitalization. They could develop a plan for giving money to charities, and they could consider creating donation accounts for the education of future grandchildren. The plan and legal structure require that advice be sought from counsel experienced in trusts and estates.

“This couple has a bulletproof retirement strategy,” Moran says. “Their mix of defined benefit plans, significant savings, a history of expert portfolio management and clear knowledge of capital markets suggests a secure retirement income. Their vision is multi-generational. They have the wisdom to accept market volatility and stick to their allocations to mostly large-cap stocks in markets they know.

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email andrew.allentuck@gmail.com for a free Family Finance analysis

Retirement stars: five retirement stars ***** out of five

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This post Studying the market pays off for smart couples with 12% return and ‘bulletproof retirement strategy’

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