Can Michael and Lisa enjoy their desired lifestyle if he steps back from full-time work?

Michael and Lisa wanted to retire early.Spencer Colby/The Globe and Mail

Michael and Lisa earn a combined salary of $350,000. Michael, an account executive, also gets an annual bonus and car allowance. He has substantial registered savings. Lisa, a government employee, has a defined benefit pension plan indexed to inflation that will pay her $126,000 a year at the age of 61.

So it’s fair to say they want to retire early mainly because they can. He is 50, she is 51.

They have a teenager living at home and a house in Ontario with a mortgage balance outstanding.

“I want to retire at 55,” Michael wrote in an e-mail. He’d continue to work part-time.

“My wife could retire early, but she would incur a penalty [a lower pension] if she retires before 61,” he adds.

Their retirement spending goal is $100,000 a year after tax, indexed to inflation.

“We’re paying off our mortgage aggressively and will have it fully paid off in four years,” Michael wrote. “Should we be investing that money instead with a focus on our tax-free savings accounts?”

Most of Michael’s investments are in dividend-paying stocks. “Should I be diversifying my investments into bonds as I approach retirement?”

We asked Matthew Sears, a financial planner and associate portfolio manager with CWB Wealth in Toronto, to look at Michael and Lisa’s situation. Mr. Sears holds the chartered financial analyst and certified financial planner designs.

What the expert says

In preparing his forecast, Mr. Sears assumes Michael retires in January, 2028, and works part-time for another four years to 60. Lisa retires at 61.

“Meeting their retirement goal at Lisa’s age 61 is very achievable,” thanks to her retirement, he says. At 65, they’d each be getting Canada Pension Plan and Old Age Security benefits. As well, Michael can tap his registered retirement savings plan.

That would sustain their $100,000-a-year spending goal, the planner says.

“When accounting for Michael’s RRSP accounts, they’d be able to sustain about $120,000 a year in today’s dollars,” Mr. Sears says.

Indeed, their $100,000-a-year goal seems “very reasonable” given that their current spending – excluding debt repayment and savings – is about $81,100 a year.

The forecast assumes they live to the age of 95, earn an average rate of return of 5.45 per cent on their investments and inflation averages 2.2 per cent.

“Michael’s savings will be needed because they do have some shorter- and longer-term goals that aren’t accounted for in this spending forecast, such as a new car and a renovation project for the house,” the planner says.

Should they be paying off their mortgage aggressively or investing in their TFSAs?

“There isn’t what I would consider a right answer to this question,” Mr. Sears says. “Typically, it comes down to either opportunity cost or how someone may feel about carrying debt.”

They both have a fair amount of TFSA contribution room, which would allow them to invest in a tax-sheltered account, the planner says. If they think that they could earn a higher return through investing than they are paying on the debt, it is typically better to invest. They are paying 4.3 per cent on their mortgage and credit line.

“With Michael’s plans to retire [from full-time work] in four years, it may be prudent to pay down the debt faster and eventually divert any surplus cash flow toward their TFSAs, Lisa’s new car or the house renovation,” Mr. Sears says.

“Having the debt paid off before Michael retires helps their cash flow and allows them to be less reliable on their savings until Lisa retires,” he says. Without the mortgage payments, Lisa’s salary would cover their lifestyle spending.

Once Michael retires, and if the debt is paid off, they might consider some tax-planning strategies, Mr. Sears says. During the years that Michael is retired and Lisa is still working, there isn’t an income-splitting opportunity with Lisa’s salary. Michael should then look at drawing some of his RRSP down, even if the funds aren’t needed for those years. This will use up any available tax credits that he may have, and also smooth some of the income tax he will pay on the withdrawals. The funds could then be used to top up their TFSAs, fund the new car or pay for the renovations they are planning.

Once Lisa retires, her retirement will be eligible to be split with Michael. With an estimated pension of $126,000 a year, Lisa could split up to $63,000 with Michael in her first full year of retirement. In the first full year of retirement (assuming the debt is paid off), their expenses will be $125,445. Michael will be withdrawing about $25,000 from his RRSP to cover the difference between Lisa’s pension and their retirement expenses.

Should Michael diversify his investments as he approaches retirement?

To manage investment risk, broadly diversifying an investment portfolio by asset class, geographic region and investment style is recommended, the planner says.

“Michael should focus on determining his portfolio’s long-term target allocation, as this is the most important piece for the investment decision,” Mr. Sears says.

Several providers of exchange-traded funds had online questionnaires that Michael could look at to help determine the right mix. Alternatively, he could look for an investment counsel firm that would draft up an investment policy for him. This will help determine his allocation to cash, fixed income or fixed-income alternatives and equities. “To do this, Michael and Lisa should review their risk tolerance and risk capacity.”

client situation

The people: Michael, 50, Lisa, 51, and their daughter, 14

The problem: Can they afford for Michael to step back from full-time work in four years and still enjoy their desired lifestyle?

the plan: Their spending goal is easy to meet. Michael works part-time for another few years after he retires. He draws down some of his registered savings in his lower-income years before he has to start withdrawing from his RRSP/registered retirement income fund. He moves to a more diversified portfolio, depending on their risk tolerance and capacity.

The payoffs: Goals achieved.

Monthly net income: $15,658

Assets: $10,000 bank account; houses $1,400,000; his TFSA $5,000; her TFSA $2,000; his RRSP $728,666; her RRSP $30,000; present value of her defined benefit pension $1,489,724 (calculated, earned pension to date of $90,000/year indexed at 2 per cent); child’s registered education savings plan $87,000. Total: $3.75-million.

Monthly outlays: Mortgage $3,208; property tax $675; water, sewer, garbage $100; $400 home insurance; electricity, heat $600; security; $500 maintenance; transportation $600; groceries $900; clothing $400; dry cleaning $100; line of credit $896; credit cards $500; vacation, travel $200; dining, drinks, entertainment $700; $100 personal care; pets $250; sports, hobbies, club memberships, subscriptions $215; vitamins $50; communications $475; RRSPs $2,000; TFSAs $400. Total: $13,269. Surplus $2,389.

Liabilities: Mortgage $149,322 at 4.3 per cent, variable; line of credit $113,485 at 4.3 per cent, variable. Total: $262,907.

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Some details may be changed to protect the privacy of the persons profiled.

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