Situation: Mid-60s couple with tight budget and poor investment returns faces years of costly illness
Solution: Move money from savings and GICs to bonds and dividend stocks, check public drug plan
In Ontario, a couple we’ll call Phil and Terri, each 64, have involuntarily moved into partial retirement. Phil was downsized out of his job in management for a packaged goods company last year and, with his severance fully paid out, receives Employment Insurance benefits of $2,188 per month before tax. Terri, who has a severe long-term illness, works part time in local government for $1,549 per month before tax. They add Terri’s Canada Pension Plan benefit of $649 before tax. Work and pension income per month before tax adds up to $4,386. On top of that, they add $310 interest from $371,000 total savings for total pre-tax income of $4,696 a month. Terri’s drug costs, now paid by her employer, could wreck their retirement finances after retirement.
When Phil’s EI runs out and Terri retires, their estimated incomes will be $1,134 CPP for Phil, Terri’s continuing CPP, $649 before tax, and her civil service pension of $1,200 per month before tax. They will be able to add two monthly Old Age Security benefits of $597 per person at 65. That will make their income before any investment returns $4,177 per month.
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Their income will be enhanced by what they can harvest from $285,000 in RRSPs, $18,000 in TFSAs, and $68,000 in cash savings accounts. The total of all accounts is $371,000. At 1 per cent interest, it earns $310 per month. That is actually a negative return after taxes and inflation. However, it boosts their pre-tax income to $4,487 per month. If eligible pension income is split and age and pension credits applied they will pay tax at an average rate of about 8 per cent and have $4,128 per month to spend.
Current expenses net of savings add up to $3,635 per month. Terri’s illness could devastate their retirement plans. Currently, the drugs, which cost $24,000 per year, are paid for by her employer’s health insurance. When she retires, she will lose that coverage. She could buy costly supplemental medical insurance with some drug coverage, though pre-existing conditions might not be covered. Their problem is maintaining their way of life when neither works and Terri’s drug assistance ends.
Family Finance asked Eliott Einarson, a financial planner in the Winnipeg office of Ottawa-based Exponent Investment Management Inc., to work with Phil and Terri.
“It’s going to be a close-run thing,” he explains. “The good news is that they have no debts.”
Their two cars are paid for. They have no dependents at home. They plan to sell one car. That will cut costs and add a few thousand dollars to the bank account. They would like to travel within Canada each at a cost of $1,000 per year and to take a larger trip for $4,500 maximum every three years. Putting it all together, they figure that they should be able to spend $4,000 a month. The bad news is that scheduled spending will eat up almost all their budget. It assumes no increase in drug costs which, at present, are charged to the employer’s health plan.
If Phil does not get another job, even part-time, then the couple will be walking a tightrope between $4,128 post-tax income and $4,000 monthly spending. It’s too close for comfort, Einarson says.
They can raise their income by increasing investment returns. If they focus solely on their $285,000 in RRSPs and $18,000 in TFSAs, the total, $303,000, could generate a fairly steady return in high quality bonds laddered with one to five or one to ten year maturities and a portfolio of mature company stocks that pay dividends and have some growth. Exchange-traded funds package these assets with fees as low as 7/100ths of one per cent of assets under management. An online account with a discount broker would keep investing costs down.
If we assume that Phil and Terri do move their RRSP and TFSA funds to bond and stock ETFs that, together, generate 3 per cent a year after inflation, then one year from now when they are fully retired, the present $303,000 of RRSPs and TFSAs would have a value of $312,090 in 2018 dollars, the precise amount depending on when interest is paid.
Annuitized to pay out all income and capital over the next 25 years to their age 90, the accounts could generate $17,400 per year or $1,450 per month. That would raise their total income from all sources to $5,627 per month or $67,524 per year. Allowing for 10 per cent average tax, they could have about $5,060 per month to spend, a 13 per cent boost. After age 90, they would still have income from Terri’s pension, CPP and OAS plus any money they might not have spent.
The switch to stock and bond ETFs could be done gradually as existing GICs mature. That would slow the increase in returns, but it would also give the couple time to learn the ropes of investing in stock and bond exchange trade funds.
Family Finance cannot recommend particular ETF managers, however, a search of the larger companies and comparison of their annual fees and performance would turn up candidates for investment. Broad market index ETFs that cover all U.S. large cap stocks, all major Canadian stocks, and Canadian government and senior corporate bond ladders with annual management fees below 25 basis points would turn up candidates for purchase.
There is a catch in this plan to improve financial security. That’s the cost of drugs for Terri’s long-term illness when her employee benefits end. Ontario’s Trillium Drug program may be of assistance. “May” is the operative word, for it has tests for income and the drugs involved. The program starts with an approximately 4 per cent deductible, so to qualify for coverage, Terri’s drugs must cost at least 4 per cent of expected annual gross income of about $67,524 less deductibles and adjustments. For seniors, the Trillium program provides coverage for all prescribed drugs for $100 a year, plus $6.11 per prescription filled.