Have Giovanni, 41, and Tiyana, 37, underestimated spending and jeopardized their retirement plan?

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The couple hopes to achieve financial independence by the time Giovanni is 55 and Tiyana is 51.Andrej Ivanov/The Globe and Mail

Despite their relatively young age, Giovanni and Tiyana are looking to the day nearly 15 years from now when they can hang up their hats and retire.

Giovanni is 41 and earns $167,500 a year plus a bonus. Tiyana is 37 and earns $146,000 a year plus a bonus. Both work in financial services and both have defined benefit pension plans partly indexed to inflation.

They have a house in Montreal with a money-losing rental unit and a big mortgage.

Short term, their goal is to take full advantage of their unused RRSP and TFSA contribution room. Longer term, they hope to achieve financial independence by the time Giovanni is 55 and Tiyana is 51.

“When could we realistically stop working?” Giovanni asks in an e-mail. “How should we think about the mortgage and rental property given the high payments and negative cash flow?”

Their retirement spending goal is $85,000 a year after tax, rising with inflation.

“What decumulation strategy should we follow if we retire before our defined benefit pensions and Quebec Pension Plan benefits begin?”

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We asked Matthew Ardrey, portfolio manager and senior financial planner at TriDelta Private Wealth in Toronto, to look at Giovanni and Tiyana’s situation.

What the expert says

Giovanni and Tiyana have done a lot of work to set themselves up to retire early, Mr. Ardrey says. They have solid savings, which they continue to build, a property with rental income and low lifestyle expenses relative to their income. “Though retirement remains a little under 15 years away, they want to make sure that their plan can become a reality.”

Their house is a duplex, 60-per-cent principal residence and 40-per-cent rental. The mortgage is more than 70 per cent of the property’s value. At their existing payment schedule, it won’t be paid off until 2046, well past their target retirement dates, the planner says.

“Carrying that debt into retirement would work against the low-stress lifestyle they’re aiming for, so accelerating the payoff before Giovanni stops working is worth prioritizing where the numbers support it,” Mr. Ardrey says.

That raises the question they’ll keep running into over the next several years: Should they put extra dollars toward the mortgage, or into non-registered savings? “The answer comes down to the hurdle rate, the after-tax cost of carrying the mortgage, since 40 per cent of the interest (the rental portion) is tax-deductible, versus the realistic after-tax return available on non-registered investments,” he says.

His forecast assumes that their savings continue to flow to the non-registered account once they have caught up with their tax-free savings account contributions. This implies the after-tax return edges out the after-tax borrowing cost, but not by a wide margin, Mr. Ardrey says. “That gap is worth retesting at every mortgage renewal, since a rate move in either direction could tip the answer.”

It’s also worth being honest about the non-financial side, he says: Debt tolerance is personal, and for some people carrying a mortgage into retirement is simply uncomfortable regardless of what the spreadsheet says.

“Where Giovanni and Tiyana land on that emotionally should carry real weight in the decision, not just the math.”

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Tiyana and Giovanni are saving the maximum amount to their RRSPs and Giovanni contributes to a spousal RRSP for Tiyana. Because both have defined benefit pension plans, their RRSP contribution room is limited. In addition, together they are saving $5,000 a month to their TFSAs. Once the TFSA contributions are caught up in a few years, the additional funds are assumed to be saved to a non-registered account.

Though they plan to retire early, Giovanni and Tiyana also plan to defer their pensions until they can be taken without any early retirement penalties. Current estimates for their pensions and their unreduced payment dates are $5,000 a month for Giovanni at age 61 and $4,000 a month for Tiyana at age 60. There is partial indexing for both pensions.

With early retirement, Quebec Pension Plan payments will be lower for both. Based on the figures provided, estimated QPP at 65 is 65 per cent of the maximum for Giovanni and 55 per cent of the maximum for Tiyana. This is because of a combination of starting benefits before 65 and having fewer years of high contributory earnings than someone who works to a more traditional retirement age, the planner says. They’d get full Old Age Security benefits, subject to clawback.

“With no income in the early years of retirement, this is an excellent opportunity for Tiyana and Giovanni to withdraw from their registered assets at lower tax rates,” Mr. Ardrey says. This leaves more tax-advantaged assets in their non-registered accounts and TFSAs for later in retirement when they will be getting company and government pensions. “As they get closer to that point, it would be worth revisiting the order of withdrawals each year, keeping the OAS clawback in mind.”

Their investments are in growth exchange traded funds. This produces an expected rate of return of 6 per cent. “As they approach retirement, they move to a balanced mix with a 5.5 per cent rate of return,” the planner says. This is to reduce the volatility risk in the portfolio.

They are spending $68,000 a year, after debt and savings are subtracted, and plan to increase that to $85,000 a year to accommodate more travel in retirement.

“Based on these assumptions, they are able to achieve their retirement goal,” Mr. Ardrey says.

“To truly understand the risk in this forecast, we need to move beyond the straight-line projection, as we know that life and investments rarely ever move in a straight line,” he says. To ensure the viability of this plan, he stress tested it by using a Monte Carlo simulation, which introduces randomness to a number of factors, including returns.

“In this plan, we have run 1,000 iterations with the financial planning software to get the results. We look at the 75 per cent and 50 per cent levels to determine where risk due to return rate variance may affect the success of the plan,” he says.

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In their volatility stress test, the results are positive, with a 100-per-cent success rate. “The bigger risk to this plan is not return variance, but nearly $2,000 a month in spending that is unaccounted for,” he says.

“Though this is of little consequence now, as Giovanni and Tiyana approach retirement, having a good handle on what they are spending becomes more important,” he says. “The risk is that as they go into retirement, they are not spending $85,000 a year but something more like $115,000. If their expenses are several thousand dollars more than expected, what once looked like a rosy retirement may not actually be,” Mr. Ardrey says.

“Tracking actual spending for a year or two against the $85,000 target, rather than relying on an estimate, would let them confirm this number while there is still time to adjust.”

Client situation

(Income, expenses, assets and liabilities are provided by applicants.)

The people: Giovanni, 41, and Tiyana, 37.

The problem: How soon can they retire?

The plan: Retire at 55 and 51 as planned, deferring pensions and drawing on RRSPs first. Begin shifting to a more conservative portfolio five years in advance. Track spending for a year or two to see if their retirement spending goal is realistic.

The payoff: A roadmap to financial independence.

Monthly after-tax spending (planner’s estimate): $21,620.

Assets: Cash $14,800; non-registered $27,100; Giovanni’s TFSA $55,000; Tiyana’s TFSA $57,500; Giovanni’s RRSP $605,000; Tiyana’s RRSP $76,500; spousal RRSP $12,500; Tiyana’s locked-in retirement account $59,000; duplex residence $1,264,000. Total: $2.17-million.

Estimated present value of Giovanni’s pension is $412,000 and Tiyana’s pension is $281,000. That is what someone with no pension would have to save to generate the same retirement income.

Monthly outlays: Mortgage both units $5,760, property tax $630; home insurance $160; electricity heating $65; maintenance, garden $300; transportation $490; groceries $600; clothing $200; loan $335; gifts $110; vacation, travel $1,250; other discretionary $85; personal care $45; dining, drinks, entertainment $710; pets $65; sports and hobbies $305; subscriptions $15; other personal $150; health care $65; life insurance $65; internet $35; RRSPs $1,165; TFSAs $5,000; pension plan contributions $2,090. Total: $19,695. Unallocated surplus: $1,925.

Liabilities: Mortgage $908,000 at 4.59 per cent; interest-free Greener Homes Plan loan $35,000. Total: $943,000.

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