Case Study: 60 Years Old, Lots of Cash, No Portfolio – The Income

Tim emailed me regarding his father in law’s financial situation.  Basically, his father in law is single, no retirement savings, but a ton of equity in real estate which he’s going to liquidate soon to fund his retirement.  Tim realizes that I’m not a financial advisor, but he wanted my opinion anyways.  Here is more about the situation below, perhaps you can chime in with your opinion.

My Father-in-law (Dave) is currently finalizing a sale of an investment property that has appreciated to from his $600k purchase price to a selling now of approximately $1.2 million. The property is fully owned with no mortgage.  The appreciation will be subjected to capital gains tax as this is not a primary dwelling.

My Father-in-law just turned 60 years old and has no pension and limited cash savings other then this ‘paid-for’ land asset.  He only has experience investing in real estate and now that he is ‘retired’ with no fixed income, his priorities have also changed.

  • Debt: None
  • Dependent Children:  None, two adult children.
  • Retirement Status: Has been retired for several years, funded by the sale of another property, but that money is running out – just turned 60
  • Marital Status: Divorced
  • Employment: He was a business owner – did not have salary, thus no CPP.
  • Portfolio: Zero portfolio holdings/RRSP’s or savings of any kind.
  • Other Income: None.

House hold expenses:

  • Property taxes $4500/yr
  • phone/internet/tv $140/mth ($1,680/yr)
  • House/car insurance $250/mth ($3,000/yr)
  • Utilities Gas/H2O/Hydro $265/mth ($3,180/yr)
  • Food $400/mth ($4,800/yr)
  • Misc spending $200/mth  ($2,400/yr)
  • Gas $200/mth ($2,400/yr)
  • Travel $6,000/yr
  • Home Maintenance $3,000/yr
  • Medical Insurance: $2,000/yr
  • Unexpected Expenses: $3,000/yr

Total: $31,960

There could be rental income later on in retirement but for now there is nothing. He does have other land assets – primary dwelling which he does not yet want to sell -it is fully owned. Worth $500k or so. No other plans for future employment. Would like spending cash for travel but MOST IMPORTANTLY wants to have the money invested in a way that he cannot easily access the capital to spend on frivolous items – just have a regular income off the principal investment to play with and live off.

None of this money to be left to the children – so every last penny of this million dollars will be spent. It would likely be preferable to the have current primary residence (approx $500k) as the last remaining asset at death for the children if possible.

Okay – here’s the question, Let’s say you wake up tomorrow morning, sign into your online savings account and BAM! $1 million dollars  – your journey is over – you retire, and now with no fixed income where do you invest your wad of cash to keep it working for you long into your golden years (& beyond?)

The Nest Egg

With $0 in retirement savings, the father in law (Dave) will have to depend on the sale of the investment property to pay for his regular expenses.  With the sale price of $1.2 million net of all costs and $600k being capital gains, there will be substantial capital gains tax to be paid.  According to Tom, the father in law had very little or no income on the year of the sale.

With around $600k capital gains ($300k added to income), Dave will owe approximately $120k income tax (assume Ontario).  Normally in this situation, I would suggest a large RRSP contribution, however apparently, Dave hasn’t drawn a salary (only dividends) for most of his working years thus most likely very little RRSP contribution room is available.

Thus, the proceeds from the sale of his property would be approximately $1.08 million, but we’ll call it an even million in case there are other fees from selling that we aren’t aware of.  With a million dollars in cash, how can a 60 year old ensure that his money will cover his expenses and last for the rest of his life?

Income Generation

According to Sherry Cooper, BMO’s chief economist and author of The New Retirement, a portfolio can survive a 4.2% annual withdrawal rate (increasing annually for inflation) for 30 years with a high certainty of success.  This withdrawal rule was popularized by William Bengen’s research, a MIT grad and CFP, which also suggests that a 50/50 equity bond asset allocation be kept, even during retirement.

Assuming that Dave will live until 90, 4.2% withdrawal from the $1 million in cash will result in the cash flow of $42,000 per year adjusted for inflation annually.  As the portfolio will be non registered, if we assume that 50% of the income will be from dividends (Canadian sources) and 50% from bonds with an average portfolio yield of 4.0%, he will owe approximately $2,200 income tax.

This results in an after tax income of approximately $40,000. As this more than enough to cover all of Dave’s expenses of $32,000 / year,  it will likely result in leaving a nest egg behind for the children which is great news for Tim. :)

In addition to this, when Dave turns 65, he will qualify for old age security.  Assuming that Dave meets the qualifications for maximum OAS, it will mean additional cash flow of $6,200/year in 2009 dollars.  When that time comes, Dave will only be withdrawing 2.78% (including income tax) from his portfolio to meet annual expenses.

Next up is the portfolio for the soon to be retired Dave.  As this article is a bit on the longer side, I decided to split it up into 2 parts.  Stay tuned!

As I mentioned above, I am not a financial advisor. The above is not meant as recommendations but merely for informational purposes only.

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FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.
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fern
12 years ago

Could you do a case study in me please please please? I have all my numbers at the ready + my goal. the question would be, could I retire before age 60?

Alan
12 years ago

Lisa
RE: Your idea of moving out and selling the Principle Residence to avoid Capital Gains tax can be extended to include ‘…then living in the other house and build up “Principle Residence” status for a few years”.
This is what I have done recently myself, I plan to be in my ‘new’ house for another 10 years, effectively reducing the capital gains payable since ownership of 16 years.
Plus, it’s nice and relaxing to be out of the Land-lording business!

Grand Admiral Jawn
12 years ago

These RRSP and sinking retirement funds things are a bad idea. It’s based on the assumption that you know when you’ll die. If you save enough money to live up to 85 years then what do you do after that? Go back to work? Some people have lived up to 120+ years. The gov will “graciously” give you a tax break now but will tax you in the future (it will be income taxed). This is great but only if you assume that taxes in the future are the same or lower than it is now. Now, look at the historical record of taxes. They only seem to go one way. UP!

To Dave:
Keep your property. Fight the urge to dabble in those other investments. It always seems greener on the other side.

Nathalie
12 years ago

capital gains would still apply for the time when he had not lived in the investment property. (e.g. if he owned it for 25 years as investment, then lived in it for 2 years, he would have to pay capital gains for the first 25 years pretending it sold at year 25, the last two years would be capital gain tax exempt.)

I agree with dividend investing or purchasing a large apartment building and hiring a property manager. This is much smarter then dying broke.. what a stupid concept. With the right planning you can pass it on to your children without touching the principle.

I can’t believe all the sheep investing in sinking funds and RRSP’s it’s so stupid. Most people don’t even realize that the government controls your retirement if you invest in their programs… They make the rules, they tell you when/how much to withdraw, they tax you to death. You can’t even borrow from your own RRSP’s to invest in something else without penalty/having to pay it all back.. why even give them anything to begin with? The paltry tax savings they dangle in front of you can easily be won by investing in something with much higher returns. We looked for the right rental property for 1.5 years and have a 30% R.O.I. from it right now (not looking at capital gains, that’s the cash flow after expenses). It takes time to find it but it happens.

Lisa
12 years ago

Just a quick thought, can your father in law move into the house 1.2 million dollar house for 1 year and sell his 500 k home first? The 1.2 million dollar home will then be his primary residence saving him thousands of dollars in taxes.

Bernie
12 years ago

Ms Save Money

You’re right about GM, although I’m not sure if they ever were a dividend aristocrat. Regardless, I never considered them a dividend grower. The key is diversification and due diligence with the fundamentals. There are still a lot of great dividend growers out there. I’m not giving up on them yet.

shane
12 years ago

Cannon fodder,
My apologies and yes you’re right. You do need basic information on the person like: male/female, date of birth, province of residence. Also, you need to know the type of annuity you want (registered/non/prescribed etc), when you want it to start (date), do you want a guarantee period (ie. 10 years), frequency of payments (ie. monthly etc). There’s alot of little details which is why it might be tricky to find a place online (of course i haven’t done a search) that does them instantly. We usually send away to insurance companies to do it. Here’s a link to an example quote that someone did… http://www.lifeannuities.com/samples.html

Cheers!

cannon_fodder
12 years ago

Shane,

If an annuity quote is ONLY dependent on prevailing interest rates, then why can a bank post their rates for savings/chequing accounts, term deposits, loans and mortgages and insurance companies (which also offer many of the above) can’t post annuity quotes? Do they ever factor in the age/health of a person?

I’m curious as to what other information you need to provide to get a quote.

Ms Save Money
12 years ago

Bernie,

I don’t know about investing in any stocks these days – let alone blue chip stocks. Because GM was considered blue chip until they went under.

shane
12 years ago

Hi Cannon_fodder,

To be honest i don’t know of any sites where you can get an instant annuity quote because they’re dependent on prevailing interest rates. As an advisor i usually shop them out to my insurance companies who take a day to get back to me with numbers. If you find a site though, let us all know! lol

Nathan,
First of all, sorry to hear that you had to go through the estate process and sorry for your loss. With most RRSP accounts people wil name beneficiaries thus by-passing the estate true. It’s when somebody either doesn’t name a beneficiary OR in the case of a non registered account (and not jointly held) where these accounts will typically go through the probate process and get caught up in fees etc. There’s definately ways around it luckily you found them because if you did the math it could have cost you and your family about $12,000 in probate fees. Well done on that!