A man we’ll call Chuck lives in Ontario. Now 50, he wants to retire at the age of 55. An engineer, he takes home $6,500 per month. He has no spouse, no children and no debts. Frugal, he has accumulated about $1.18 million in stocks in a variety of RRSPs, a TFSA and unregistered accounts — or at least he had, before markets crashed due to the coronavirus pandemic.
“I have been affected by the virus,” Chuck says. “At work, someone got the virus and we were all sent home. For retirement, my investments are down, maybe 20 per cent, but I hope they will bounce back. If not, I would work another year.”
Given Chuck’s time horizon, the coronavirus crisis will be in the rearview mirror by the time he has to retire. But whether his investments rebound and resume their previous trajectory is still uncertain.
Either way, Chuck has one essential question: “What income can I have when I retire at 55?”
Family Finance asked Eliott Einarson, who heads the Winnipeg office of Ottawa-based Exponent Investment Management Inc., to work with Chuck. While planning for a forty-year horizon has its challenges, Einarson says Chuck has some qualities that will make it easier than for most.
A frugal lifestyle
First among those is his commitment to savings.
“Chuck would be considered extremely frugal by most Canadians,” Einarson says. “He has no debts.”
Chuck spends $200 per week on groceries — mostly vegetables and fruit — he never goes to restaurants (a habit formed even before the province-mandated shutdown) and reads books from the public library, rather than buying them.
His financial assets were worth $1.175 million before the crash. Now they are $940,200. The income from those assets plus his Canada Pension Plan and Old Age Security would pay his present spending in retirement. Case closed? Not quite, for what to do with his fortune is yet to be clarified.
Chuck’s strength as an investor has been regular investing of his large income surplus over expenses. He puts $500 per month into his TFSA, $300 into his RRSPs — his company adds $1,383 including matching up to 7.5 per cent of his gross pay to a defined-contribution plan — and $2,500 in his non-registered investment account. He allocates savings to a handful of exchange-traded funds with low commissions. It is all by the book and consistent with his frugal ways.
“In the downturn, Chuck’s extensive diversification provided some cushion,” Einarson explains. “His choices of ETFs were mostly to balanced funds with 25 per cent bond content. In the downturn, diversified bonds mostly held their own and very short bonds due in a year or less actually gained a few per cent. Chuck still lost, but his cushion saved him from a more devastating collapse.”
Before the crash, Chuck’s RRSPs had a present value of $612,000. His own contributions from wages plus company contributions totalled $20,200 per year. If his capital and annual savings had grown for five years at three per cent per year after inflation, then on the brink of retirement at 55, the account would have had a value of $819,938. That capital could have then generated annual income of $34,440 for the next 40 years to his age 95.
Chuck’s TFSA had a present value of $92,000. With $6,000 in annual contributions and the same assumptions, it would have grown to $138,500 in five years, enough to generate $5,820 per year for 40 more years.
Other non-registered shares that had a value of $282,000 along with annual additions of $30,000 per year for five years would have grown to $490,970, and support payouts of $20,622 per year.
Finally, Chuck had $190,000 worth of shares in his company held in a non-registered account growing at per cent in value but no further additions will grow to a value of $220,270 in five years and then pay $9,250 for the next 40 years.
Adding up those cash flows would have left Chuck with just over $70,000 in pre-tax income at age 55. After 18 per cent average tax on everything except the TFSA income, he would have had $58,555 per year or $4,880 per month to spend in retirement, more than enough to cover the $3,200 or so in expenses he would incur once $3,300 per month in savings was discontinued.
Now, what impact has the crash had on his circumstances? With his starting capital depleted by about 20 per cent, the math shows that Chuck will only be able to generate $28,480 in annual retirement income from his RRSPs; $4,961 from his TFSAs; $17,875 from his non-registered shares; and $7,527 from his company shares.
That works out to about $58,000 in pre-tax income. After taxes of 15 per cent, he would be left with $50,760 per year or $4,230 per month, still enough to cover his reduced expenses, but about $600 dollars per month less than before.
In either scenario, at age 65, Chuck can add Old Age Security of $7,362 per year and estimated Canada Pension Plan benefits of $10,900 per year, giving him a significant boost in income. But the loss from the crash will have an impact.
“My market loss is tough, but I will have enough and — I have to say this — there’s no risk of getting hit by the OAS clawback. It’s a silver lining, I guess.”
Retirement stars: Five ***** out of five