Tough choices ahead for freelancer

via Investment Executive | March 2013

Ann, a freelance journalist who just turned 65, will have to make some decisions regarding her residence,
the length of time that she plans to continue working and how much she’d like to spend in retirement in
order to meet her goals.

“Financial Checkup” is an ongoing series that discusses financial planning options. In this issue,
Investment Executive speaks with Matthew Ardrey,
a certified financial planner (CFP), consultant and manager, financial planning, with T.E. Wealth
in Toronto; and Christine Butchart, CFP, registered financial planner, and branch manager with
Assante Capital Management Ltd. in Hillsburgh, Ont.

The scenario: Ann has just turned 65. She is a freelance journalist who plans to keep working
because she loves her job, but she doesn’t want to be dependent on that income.

Ann will start collecting old-age security (OAS) and Canada Pension Plan (CPP) benefits this month.
She has $450,000 in an RRSP, $28,000 in a tax-free savings account (TFSA) and $250,000 in a
non-registered account. Her money is invested 50/50 in equities and fixed-income. About two-thirds
of the equities are foreign, mainly in U.S. companies.

Ann owns her mortgage-free, $900,000 home in Toronto. She expects to sell her house and rent an
apartment for around $2,500 a month in today’s dollars when she reaches age 70 or 75. Her current
house expenses are about $12,000 a year, excluding major repairs.

Her employment income is around $50,000 a year and her non-registered investments produce
income of $10,000 (excluding capital gains) annually. Ann tends to spend about $60,000 annually
before income taxes and RRSP and TFSA contributions. RRSP and TFSA contributions are
transfers from her non-registered account. Major house repairs, major medical bills, a second-hand
car purchase every five years, investment and accounting fees, and income tax instalments have
been coming out of capital.

Except for the house and car, Ann has no insurance; her disability insurance coverage ran out once
she turned 65. She believes she would be content with basic nursing-home care should she need it.
She will be leaving whatever assets will be left over to her four nieces and nephews, but Ann isn’t
concerned if this ends up being very little. She has no desire to travel.

Ann thinks she should put aside some money – perhaps $100,000 – for major expenses (house,
medical, car purchase), but she also knows that she may have to start budgeting and reduce her
spending. She believes she could manage on $55,000 a year in today’s dollars before taxes and
major expenses fairly easily.

Ann wants to know if her plans to spend $55,000 or more a year to age 95 in today’s dollars are
reasonable if she puts aside $100,000 for major expenses but continues to pay taxes as well as
investment and accounting fees out of her other capital – and if she sells her house at age 75 and
rents thereafter. She would like projections on the following:

1. No employment income and an annual average real return of 2% (5% after fees and inflation of 3%).

2. No employment income and a real return of 0%.

3. Employment income dropping by $5,000 a year in today’s dollars, starting this year, and a real
return of 2%.

4. Employment income dropping by $5,000 a year in today’s dollars, starting this year, and a return
of 0%.

In all scenarios, Ann would like OAS and CPP to go up by 2% a year as she feels that measured
inflation will be less than the 3% she expects to experience.

The recommendations: Both Ardrey and Butchart say the only way Ann can meet her annual
retirement income goal of $55,000 after taxes in today’s dollars is if she works until age 70, gets an
annual average return of 2% and buys a condo that costs her no more to run in today’s dollars than
her current house does and that costs no more than $500,000 in today’s dollars.

Both advisors say that if Ann goes the rental route, she will add $18,000 in today’s dollars to her
annual expenses and, if she can’t reduce her other spending, she will run out of money.

Ardrey notes that a condo will not only keep Ann’s accommodation costs low, but it will give her an
asset that should appreciate. If Ann has to go into a nursing home, selling the condo would provide
the funds to pay for that.

Butchart’s projections show that even if Ann works until age 75 and gets a 2% real return, she would
run out of money by age 91 if she rents an apartment for $2,500 in today’s dollars.

The only other option, Butchart says, is for Ann to lower her after-tax spending goal to $45,000; she
could retire now and rent when she sells the house – as long as she gets an average 2% real annual
return. That option would, however, require much more restraint on Ann’s part than her current
commitment to reduce her spending to $55,000 from $60,000 a year.

Both Ardrey and Butchart believe that even a $5,000 reduction may be difficult for Ann to achieve.
Neither advisor has a problem with Ann continuing to live in her house for now. However, Ardrey
says, the sooner Ann sells her house and frees up investible assets, the more financial flexibility
she’ll have, assuming she gets a 2% real return and the house’s value rises only with inflation.

However, Butchart thinks keeping the house until Ann is ready to downsize is “as good an
investment as any” as its value should at least keep pace with inflation.

Both advisors also think the assumption of lowering Ann’s expected employment income by $5,000
a year is sensible. Decreasing expectations would help cushion the blow if Ann finds herself with no
work – and anything she makes in excess of what she has anticipated in a given year can be
invested or spent.

The one thing Ann must do is maximize her TFSA contributions every year for as long as possible.
Both advisors suggest that Ann continue to make RRSP contributions as long as she’s working.

Ardrey says this won’t make a lot of difference in Ann’s potential retirement income but advises that
a spender like Ann put away as much money as she can. Ann will be less tempted to ask for
additional funds if it has to come out of her RRSP and possibly put her into a higher tax bracket.

Still, both advisors say Ann should take money out of her RRSP as long as it doesn’t push her into a
higher tax bracket or cause OAS clawbacks – and as long as she leaves it in her investment account
and doesn’t spend it. When Ann sells her house, her income will rise and she could experience OAS
clawbacks, so it’s a good idea to lower her RRSP assets and, thus, the minimum she has to take out
when she establishes a registered retirement income fund (RRIF).
Ardrey suggests waiting until the end of the year in which Ann turns 71 to estab
lish a RRIF, even if she isn’t working and has to take significant amounts from her RRSP.
It’s best, Ardrey explains, to keep the minimum to be withdrawn from a RRIF as low as possible.
Butchart agrees in general but advises establishing a RRIF now, with enough in it to create $2,000
annual income so Ann can take advantage of the $2,000 annual pension deduction.

The exact amount that comes out of Ann’s RRSP should be an annual decision, taken at the end of
the year when she knows how much she has made that year, what her business expenses were and
what her investment income, including capital gains, will be.

Neither advisor suggests that Ann buy additional insurance. The only thing she might consider is a
long-term care policy, but both Ardrey and Butchart say Ann has enough assets to be self-insured. If
she needs to go into a nursing home, she would be spending little more than the cost of that.

As a single person, Ann doesn’t have many ways to save taxes, outside of maximizing her TFSA,
deducting her business expenses and making sure her investments are tax-efficient, with interestbearing
securities in her RRSP. Ardrey does, though, point out that medical expenses can be
deducted for any 12-month period ending in the relevant taxation year. That’s something Ann should
discuss with her accountant whenever she has heavy medical or dental expenses. Ardrey also notes
that charitable donations can be carried forward for a number of years.

Butchart suggests that Ann look at the tax benefits of charitable-giving strategies, such as large
lump sums that continue to provide some income or gifting “in kind” of investments with significant
accrued capital gains.

Both advisors think Ann’s current investments’ asset mix is appropriate, but Butchart suggests
holding fixed-income in the TFSA because equities sometimes drop in value and she prefers that
Ann be able to write off any losses.

Both advisors would recommend more exposure to international equities. Says Ardrey: “By investing
primarily in U.S. stocks, Ann’s portfolio is ignoring the rest of the world – including not only Europe
and Japan but also emerging markets, which are growing much faster than the industrialized world.”
Butchart recommends an equities mix of 40% Canadian, 20%-25% U.S. and 35%-40% international,
with the some of the currency exposure hedged.

Ardrey suggests that a portion of the fixed-income part of Ann’s portfolio include mortgage funds and
that the equities include real estate investment trusts, preferred shares and/or other dividendproducing
equities to increase the overall yield.

Butchart adds that there are some low-cost fixed-income exchange-traded funds whose yields are
higher than for mutual funds.

Butchart would charge about $2,000 to develop a plan of this kind, while Ardrey estimates his fee
would be $1,500-$2,500.

© 2013 Investment Executive. All rights reserved.

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