Transforming Assets Into Retirement Travel

ANDREW ALLENTUCK

In a small town in British Columbia, a couple we'll call Bob and Ruth, 60 and 61, respectively, have retired to a tranquil life. Formerly employed as educators in several countries, they miss the travel they used to do.

"Our passion has been travel," Bob explains. "We would like to continue travelling, but we're concerned that our retirement income won't support a large travel budget."

What our expert says

Facelift asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Bob and Ruth in order to find ways to increase their retirement income.

"The problem in this case is planning," Mr. Moran says. "While they were still working, they based projections on a 7-per-cent interest rate. With rates of interest now between 3 per cent and 5 per cent, their retirement is not going as planned."

Bob and Ruth have put more than a quarter of their investment assets into rental condos with an estimated total value of $546,600. The rest of their investment capital consists of $149,300 of RRSPs, $692,300 of non-registered investments and $25,000 cash. The condos generate a pretax return of $12,600 a year, which is a yield of 2.3 per cent. It is questionable whether vacancy rates will rise enough to generate significantly higher rents. Not only are the condos underperforming as assets, but they constitute about 40 per cent of the couple's investments, not including their own house.

The condos are in Victoria. It's not the best time to be selling, but the couple should consider selling at least one of the properties and using the cash to generate a higher yield, the planner says.

Bob and Ruth like real estate as an asset category, so they can retain their preference for property but get a higher return and more liquidity if they select a real estate investment trust. They should research
REITs to ensure that their choice is able to resist the current recession, Mr. Moran suggests.

The balance of the couple's portfolio could be split between a fixed-income component of high-quality assets such as government and corporate bonds or bond funds or exchange-traded bond funds, and an equity component of common stocks. They already have more than a third of their financial assets in a blend of guaranteed investment certificates and investment-grade bonds purchased at attractive interest rates in the 1990s. Their equities are in mutual funds managed by a company that charges no sales loads and that has relatively reasonable fees, Mr. Moran says.

What is missing is a long-term strategy. They have sufficient investment funds to hire an investment manager, he says, which is especially important if they travel extensively because they will not be able to manage their assets as easily as if they were at home.

Bob and Ruth need to make the most of their investment capital, for they will not be receiving maximum benefits from Canada Pension Plan or Old Age Security. They spent nearly two decades out of Canada at various foreign teaching posts.

Old Age Security payments currently provide a maximum of $6,204 a year to beneficiaries resident in Canada for 40 years after age 18. Bob was out of Canada for 17 years, so his OAS, payable at age 65, will be pro-rated to $4,653 a year, Mr. Moran estimates. Ruth, who was born abroad and emigrated to Canada in 1982, has about a dozen years of residence in Canada. The formulas for payment of benefits are complex. If she receives any OAS payments at age 65, it would be about $2,800 a year, but the determination has to be made by Human Resources and Skills Development Canada.

Bob already receives $4,284 a year from the Canada Pension Plan. Ruth receives $792 a year. The benefits are linked to changes in the consumer price index and will rise with inflation. The couple also receive $15,300 a year in work pensions. Adding up their $12,529 public pensions at age 65, $12,600 of net condo rental income, and a projected total of $25,500 of income from their financial assets - assuming a 3-per-cent real return - the couple have what Mr. Moran projects will be $65,929 in pretax retirement income at age 65.

They could also spend more, by reducing savings from the present level of $12,240 a year. After all, they have no children to whom to leave money and no debts to pay.

The couple appear to have a potential retirement income about 30 per cent higher than they receive at present, Mr. Moran says. But when one spouse dies, the other will wind up with all income except for most public payments.

They would lose the tax-saving benefits of income splitting and the survivor could end up in a higher tax bracket. They may want to consult with a lawyer who specializes in wills and estates to revise their wills to include provisions for testamentary trusts that would provide a way around the loss of income splitting, Mr. Moran says. As well, in planning their affairs, they may want to consider making a charity or some good cause a beneficiary of their estate.

"It is clear that this couple have sufficient assets to live their retirement as they wish," Mr. Moran says. "If they can restructure those assets to boost their income, they can afford a good deal more of the travel they cherish."

Client situation

The People

Retired couple in early 60s living in B.C

The Problem

Excessive concentration in low-return condos restricts retirement income.

The Plan

Sell one condo, shift assets to fixed income, improve portfolio management.

The Payoff

Increased retirement income to finance travel.

Net monthly income

$5,148

Assets

House $593,000, 3 rental condos $546,600, RRSPs $149,300, non-reg invests. $692,300, cash $25,000. Total $2,006,200.

Monthly expenses

Food $800, restaurant $400, real estate tax $125, house insurance $208, car gas, maintenance $300, car insurance $276, trailer insurance $40, phone, internet $100, TV, satellite radio $57, utilities , house alarm $172, B.C. health care prem. $96, private medical ins. $169, magazines, hobbies $230, clothing $200, travel $500, house improvements $200, accountant $55, gifts & charity $100, misc. $100, savings $1,020. Total $5,148.

Liabilities
None.

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