Spend more or retire earlier in this bulletproof retirement plan
The following case study was a prepared a few months ago prior to our world getting rocked by the COVID-19 pandemic. Learn how Sam, can spend more or retire earlier with thanks to her bulletproof retirement plan.
A bulletproof retirement plan
The opportunity to listen and learn from others is invaluable in many cases. Sometimes, it doesn’t cost a thing. Such as reading this site and my case studies!
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A few months ago, a reader asked the following questions to me for the basis of today’s case study:
How do I know I have enough? I definitely think I do but I’m wondering if I could get some help with the numbers. What do you think or what would any of your financial expert friends think?
Here goes, some facts to help you with your exercise:
- I’m 60 now, planning to retire when I’m 65. I plan to receive $4,662.80/month from a defined benefit pension plan at that time after many decades of full-time work.
- If I take my CPP (should be $1,324.58/month) and OAS ($684.08) at the age of 65, I figure I’ll end up with about $80,000 before taxes (which is far beyond the $45,000 per year after-tax that I think I’ll need based on my estimated yearly expenditures).
- I’m concerned about OAS clawback. Should I put off CPP and/or OAS till I’m 70. My other concern however: I might not live beyond early 80s (family heritage plus diabetes issues now). Might as well take it now..?
- I have a sizable defined contribution pension plan worth $490,000; in an accelerated growth fund of PEPP (PEBA). I plan to convert this to a RRIF by December 31 the year that I’m 71 (variable pension benefits) and start withdrawing the mandatory amount of >5% when I’m 72.
- I have a small $16,000 RRSP in TD Comfort Balance Growth Portfolio.
- I have a small $5,000 GIC at TD earning 2.55% maturing September 11, 2020.
- I have a $77,000 TFSA and a $23,000 non-registered account, both at BMO SmartFolio in the “Balanced Portfolio”.
I know I have enough to retire but my real questions are:
- Should I take CPP and OAS sooner to avoid the OAS clawback? (I think so but not sure.)
- What order should I draw down my investments and why? Should I keep my TFSA “until the end”?
For what it’s worth I live and work in Saskatchewan (hence the PEPP accelerated growth fund from the Government of Saskatchewan); I own my home worth maybe $350,000-$400,000 now (?) and I have no debts. I aspire to live on my own and move into a smaller $250,000 valued-senior’s condo when I turn age 65, spend a bit of money renovating it (say $30,000) before I move in and spend the rest.
Thanks so much!!!
Wow, great details to work with.
My Own Advisor take on this bulletproof retirement plan
On the surface, without doing any detailed analysis, Sam is going to be just fine. I mean, that $490,000 defined contribution pension is near-gold considering she only plans to spend $45,000 or so per year in retirement. Without any debt, using one of my favourite, simple retirement calculators, that $490k alone will generate almost $30,000 per year (pre-tax) assuming a 5% return lasting until age 82 or so.
That income coupled with Sam’s “big bond” ($4,662.80/month pre-tax) from a defined benefit pension at age 65 and she’s definitely earning more than her planned expenditures.
But those are just my assumptions. I don’t want to offer any direct advice but I did want to help Sam out so I once again enlisted some help.
Owen Winkelmolen (no affiliation) is a fee-for-service financial planner (QAFP) and founder of PlanEasy.ca. He specializes in budgeting, cashflow, taxes & benefits, and retirement planning – working with both individuals and young families to help them with comprehensive financial plans from today to age 100.
Owen, detailed thoughts for Sam’s situation?
Professional take on this bulletproof retirement plan
Mark, to say the least, Sam is in a great position for retirement. With very reasonable spending expectations, a good defined benefit pension worth $4,202 per month in today’s dollars, plus Canada Pension Plan (CPP) and Old Age Security (OAS) in her future, she will have absolutely no trouble reaching her spending goal in retirement. On top of all this she also has a very healthy defined contribution pension plan (DCPP) currently worth $490,000.
Should Sam take her CPP and OAS sooner to avoid OAS clawback?
One unique aspect to Sam’s plan is that because her DCPP is regulated in Saskatchewan she has the option to convert these funds to a Prescribed Registered Retirement Income Fund (pRRIF) at retirement. Unlike other provinces where these funds would be placed in a locked-in account with both maximum and minimum annual withdrawals, (I know you wrote about your own locked-in account here), the Prescribed RRIF (pRRIF) only has a minimum annual withdrawal. This gives Sam more flexibility in retirement and there is no need to plan for unlocking of a LIRA/LIF in the future. If Sam wants to retire earlier this will be an advantage.
In retirement OAS clawbacks will definitely be a concern for Sam. With pension income, CPP, and mandatory minimum withdrawals on the pRRIF, Sam will certainly face OAS clawbacks in retirement. This clawback currently starts when net income reaches $79,054 for an individual and reduces OAS by 15% of every additional dollar of income above this threshold. Because OAS is a taxable benefit the net after tax impact of this 15% clawback is closer to 9.2% for Sam.
When we combine Sam’s marginal income tax rate of 38.50% and the after-tax impact of OAS clawbacks of 9.2% this means Sam will face a marginal effective tax rate of 47.7% in retirement. That’s quite high!
An additional $10,000 in retirement spending will require registered withdrawals of $19,120 ($10,000 for spending and $9,120 for tax and net OAS clawbacks).
Even with this higher tax and OAS clawback, Sam will have no issue meeting her retirement spending goal. In fact, I don’t think the right question is being asked. I think instead of thinking about OAS clawbacks I think Sam should be thinking about retiring earlier or spending more in retirement.
Sam is thinking about delaying CPP to age 70 but intends to take OAS at age 65. I think it’s worth pointing out for Sam and your readers Mark, the lower actuarial adjustment when delaying OAS makes it less attractive than delaying CPP.
“When it comes to deferring CPP instead of OAS – people need to consider this: CPP payments have a benefit bump of 42% if Canadians wait until age 70 to take their CPP benefit (versus 36% for OAS benefits starting at age 70).”
Sam would like to at least $45,000 in after-tax spending in retirement – again, not going to be a problem! With no mortgage payments on her home this is more than enough to meet her core spending and provide a generous amount for travel and hobbies in retirement.
Sam plans to delay drawing on her registered assets for as long as possible. Often this isn’t an attractive strategy, as it can mean increased marginal tax rates once withdrawals begin, but because Sam doesn’t need this income to support retirement spending, and seems to have maxed out her TFSA, we’ll see later on some options Sam should consider.
Sam has also planned to downsize her home at age 65 to a smaller home worth $250,000 in today’s dollars. She’s assumed $30,000 for renovation costs and we’ll stick with that. I’ve assumed up to $20,000 for selling and legal fees on the old property (~5% of the value). This adds a bit to Sam’s spending (age 65 – I’ve rounded up a bit) in the first year of retirement but this is more than covered by the proceeds of the sale. I would suggest any extra funds are used to maximize TFSA contribution room for the coming years.
Base Plan: Retirement Spending
Base Plan: Retirement Income
(Note: Although labelled as a “LIF” these withdrawals are actually from the pRRIF)
Base Plan: Net Worth
Base Plan: Success Rate
(Based on historical stock returns, bond returns and inflation rates)
As we can see this plan is bulletproof.
So with such a solid plan I’d like to offer Sam the opportunity to retire earlier or spend more in retirement.
Option 1: Spending More In Retirement
With her defined benefit pension, CPP, OAS, and registered assets, Sam has the ability to increase her spending level incredibly by 50% without greatly impacting her success rate.
Even after adding an extra $25,000 per year in spending this is still a very solid option. Sam will be able to dramatically increase her level of spending in retirement unless faced with a series of very poor investment returns early in retirement.
Option 1: Net Worth – Spending More In Retirement
But instead of just telling Sam she can spend more given her fixed income from pensions and government benefits, we want to ensure Sam is comfortable with this higher level of spending. So, we test this new withdrawal plan to see how it would perform over historical scenarios of stock returns, bond returns, and inflation rates. Each line in the chart below represents one starting year. It’s as if Sam retired in 1910, 1930, 1955, 1970, etc.
Not surprisingly, adding 50% more spending to the bulletproof plan changes things a bit. If faced with a series of poor or negative investment returns early in retirement Sam may experience some large drops in her portfolio value. To offset this risk, she could decrease some of that extra $25,000 per year discretionary spending in “down years”.
Option 1: Success Rate – Spending More In Retirement
Although historical scenarios are a good test of a retirement plan, it may not fully capture the variability we could expect in the future. We’ve all seen what COVID-19 has done to the markets recently.
Who could have predicted the speed and dept of this impact?
Still, because this extra $25,000 is really discretionary spending each year, Sam has the ability to cut back if she were faced with something worse than we’ve ever experienced in the past. She can always “revert back” to the base plan which has a 100% success rate.
Option 2: Retiring Earlier
Another major option Sam may want to consider is retiring earlier while keeping to her original spending goal of about $45,000 per year. Because the pension is available at age 65, this would require spending down some of her investment assets between now and when the pension begins – to avoid any early retirement pension penalties. This option leads to a dramatic decrease in investment assets between ages 60-65 but this decline stops after the pension begins.
This decrease in investment assets can be slowed down by taking CPP earlier (now, age 60). This may be attractive if Sam faces a recession in early retirement. If Sam experiences depressed investment values in the first 5-years of retirement (before her defined benefit pension begins), CPP at age 60 can help slow down the draw down on her personal investment portfolio.
The other big benefit of retiring earlier is that Sam could downsize now rather than waiting 5-years. Who knows what the future might hold?
Option 2: Net Worth – Retire Earlier
Again, this option is successful in all historical scenarios but faces some risk in early retirement if Sam experiences prolonged decreased asset values in early retirement. Her plan is still very successful by historical standards.
Option 2: Success Rate – Retire Earlier
A bulletproof retirement plan summary
Sam has an extremely solid retirement plan. She is very fortunate thanks to that defined benefit pension plan alone…
Given Sam’s sizable net worth coupled with modest spending plan, she should have a great deal of confidence knowing her plan can withstand even the most difficult historical periods including the one we are going through now. Her fortunate financial position means that she will face some big financial decisions around possibly retiring earlier or increasing retirement spending (or perhaps a mix of both which we could also explore with her).
As Mark always says on his site, assuming good health, many financial options in retirement are great problems to have.
Even with higher marginal tax rates and OAS clawbacks, Sam will be able to enjoy a high level of retirement spending without ever having to worry about possibly running out of money in the future.
Good luck Sam and let me know if you need some extra help – I’m here to help!
Owen Winkelmolen (no affiliation) is a fee-for-service financial planner (QAFP) and founder of PlanEasy.ca. He specializes in budgeting, cashflow, taxes & benefits, and retirement planning. He works with individuals and young families in their 30’s, 40’s and 50’s to create comprehensive financial plans from today to age 100.
A big thank you Owen for working through this case study. While there is no affiliation, feel free to reach out to Owen about running some numbers when it comes to your financial plan. I know he’s only happy to help.
We’ll have more case studies in the future.
More Retirement Case Studies!
The opportunity to listen and learn from others is invaluable in many cases. Check out these other retirement case studies from my dedicated Retirement page:
These millennials want to FIRE at age 50. Can they do it? What will it take?
Do they have enough for FIRE at age 52? With $800k invested and a workplace pension? Find out.
Disclosure: I (My Own Advisor) along with Owen, have provided this information for illustrative purposes. This is not direct investing advice nor should it be taken as such. Assumptions above are for general case study purposes only, including for Sam. If you have specific needs, please consider consulting a fee-only financial planner to discuss any major financial decisions.