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A couple we’ll call Charles and Emily, both 33, live in Alberta with their two-year-old twins. Charles brings home $7,600 per month from his job in manufacturing. Emily, a civil servant, gets $400 per month from the Canada Child Benefit but expects to return to full-time work in a few years when the twins are four. Their goal is retirement at age 49 when the twins will be 18. Their goal: retirement income of $7,000 per month for the four decades that would follow. The time horizon is long but the opportunities for growth are large. Not only do they have to manage careers and savings, they also need long-term investment strategies to get there.
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Projections of income and asset returns for such long periods are inherently speculative. We have to make assumptions about their incomes, future asset returns, future interest rates, future tuition rates for their children and the health of each partner. However, the planning process is useful for folks who consider early retirement.
Family Finance asked Eliott Einarson, a financial planner who heads the Winnipeg office of Ottawa-based Exponent Investment Management Inc., to work with Charles and Emily.
A high rate of savings
The couple’s issues centre on the effect of caring for their children — the two-year break Emily is taking off from work and, of course, the need to build education savings for the twins. They save $1,500 per month in Charles’s RRSP, $416 per month to their RESP, $1,000 per month ($500 each) into their TFSAs and $200 to general savings. They live on $5,084 per month ex-savings. Their goal is to add a few thousand dollars more to their budget for travel. If and when Emily returns to work, her income will provide that $2,000 per month. She was earning $90,000 per year before taking time off to raise their children. Even half that salary would provide a few thousand dollars of additional savings.
Their portfolio reflects fundamental caution: They have no debts, cash on hand of $45,000, a $380,000 home, non-registered investments of $172,000, $221,000 in their TFSAs, $387,000 in RRSP savings, $18,000 in RESPs, and a couple of cars they value at a total of $50,000. Emily will have a modest defined-benefit plan with a present commuted value of $82,000 and expected benefits of $10,320 at 65. Their present net worth is $1,355,000, which is impressive at their age.
Quitting at 49
Retirement at 49, just 16 years from now, would be dicey. However, if Charles and Emily maintain their present rate of savings, their $387,000 RRSP balance with $1,500 monthly contributions for 16 years will rise to $994,730 assuming three per cent average annual return after inflation. That sum would support annual taxable income of $41,250 for 41 years to age 90 with all capital and income exhausted at the end of this term.
Non-registered investments presently worth $172,000 growing at $18,000 per year starting in three years when Emily has returned to work can grow to $542,140 by their age 49. That capital still generating a three per cent return after inflation would pay $23,480 to their age 90.
Thus, at age 49, they would have $64,730 from registered and non-registered investments. After splits of eligible income and 11 per cent average tax, they would have $57,600 per year or $4,800 per month. On top of that, their TFSAs, with a present value of $221,0000 and $12,000 annual contributions would grow to $603,800 by their age 49 and then pay $25,038 per year, bringing total monthly income after tax to $6,887 or $82,638 per year, close to the $7,000 monthly post-tax target.
At 65, each partner can add OAS at a present rate of $7,707 per person per year, estimated CPP benefits of perhaps $8,000 per year for Charles and $7,000 for Emily plus her DB pension with estimated benefits of $860 per month or $10,320 per year. That would push base income at 65 at the least to $130,502 or about $115,000 annually or $9,500 per month total after 15 per cent average tax on all but TFSA cash flow. This number is speculative, for we do not know OAS and CPP benefit schedules three decades from now nor, for that matter, what the tax tables will be. However, these projections indicate that the couple can have a retirement income in excess of their $6,600-$6,700 minimum expectation.
A backup plan
Our couple has professional qualifications. If they maintain their skills to early retirement and then remain members of their professional associations, chances are they can return to work if necessary. Indeed, having active and valid credentials is a backup plan for their retirement.
Working 16 more years means the children’s RESPs will be well funded. With a present value of $18,000 and $4,992 annual additions plus Canada Education Savings Grant contributions of the lesser of 20 per cent of annual contributions or $500 per year capped at $7,200 per beneficiary should grow to $153,300 in 16 years when the children are 17, again assuming a three per cent average annual return after inflation. These contributions would provide each with $76,650 for post-secondary education, probably more than enough for one and even two degrees if they live at home.
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These asset-growth estimates for retirement and RESPs reflect six per cent growth of capital and dividends since 1975. Take off three per cent for average inflation and you get three per cent average returns.
Over long periods, it usually pays to take a little more equity risk. Just one per cent more growth compounds to huge gains over decades. For example, on $100,000 with no annual additions nor taxes, three per cent for 40 years becomes $326,280. At four per cent, it grows to $480,200. At five per cent, it’s $704,125. Putting a sum aside for this kind of growth with acceptable but sensible risk can be immensely profitable. They should take advice or study hard. It would be worth it.
“They can have a secure retirement based on savings, investments and government pensions,” Einarson concludes. “Managing risk is key.”
Retirement stars: Three *** out of five
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