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
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?
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.