Annuities are a blessing and a curse for couple whose income has dried up during pandemic

In Alberta, a couple we’ll call Barry, 61, and Marissa, 63, are suffering from the virus-driven financial meltdown. Barry, formerly a contractor in the building industry, has been feeling the effects of corporate spending cutbacks. Business has dried up. Marissa, a clerk in office administration, recently lost her job. Their present combined income, less than $1,000 per month, does not cover allocations of $3,345 per month. They are running down financial assets of $871,650 built over decades of work. They worry that even with Old Age Security and Canada Pension Plan benefits they will be unable to maintain their modest standard of living. Their goal is $5,500 per month after-tax income in retirement.

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Family Finance asked Eliott Einarson, a Winnipeg-based financial planner with Ottawa’s Exponent Investment Management Inc., to work with the couple.

Cash and future income

Barry and Marissa have $87,310 in cash and chequing accounts earning virtually nothing, $53,700 each in TFSAs invested in low interest GICs, $676,940 in RRSPs, a $300,000 home and an old car they think is worth $10,000. Add personal effects with an estimated value of $40,000 and their assets total $1.2 million.

They have a problem of their own making — actually the result of exceptional conservatism in structuring their retirement income. Most of their retirement income will come from life annuities that start when each is 65.

“They’ve locked themselves into life annuities with no downside and no upside either,” Einarson says.

Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with the couple. His analysis focuses on unwinding their tangle of properties to build a secure income stream.

“All but 12 per cent of their net worth is real-estate based,” Moran explains. “That’s a lot of concentrated risk.”

Liberating equity

To make the Central America plan work, they need to cut some ties to Canada. They need only one property to live in here, and could sell their house and keep the cottage for use in summer.

Their home has a $261,000 mortgage with a 2.69 per cent interest rate. Their gross rental income from renting a basement suite is $1,150 per month. Their mortgage costs them about $1,200 per month. They expense some of the mortgage interest and property taxes. It’s just about a break even.

They rent the cottage when they are not using it for a 1.9 per cent annual return on their equity.

If they sell their house, they would liberate $314,000 equity. Some cash could go to TFSAs, the balance to pay down other debt. At present, their combined TFSAs have a value of $38,390. The present lifetime contribution limit of $69,500 per person leaves about $100,000 of room. Canadian equity or balanced funds could produce three per cent per year after inflation. RRSPs with a present value of $139,465 but no further contributions growing at 3 per cent per year after inflation for seven years to Harry’s age 65 would have a value of $171,532. That sum, still growing at three per cent after inflation, would support payouts of $7,630 for 36 years to Fiona’s age 95. TFSAs would probably be used for new house construction costs.

Their three rental properties in Ontario, have average returns on original price of 10.3 per cent, but their present average return on equity is 5.8 per cent. We’ll assume they keep the properties. They generate $3,598 per month after costs.

Spending half the year in Central America with a cushion of cash from selling their principal residence in Ontario and using $285,250 of the net proceeds after five per cent selling costs and paying off the mortgage is doable. They would use the money to build their new home on their existing lot in Central America and add it to their existing $115,000 reserve. But they would continue to have expenses that exceed their income.

Costs and income

The couple’s present living costs, $5,091 per month, are covered by rental income and Fiona’s fees. We assume those sources of income would continue in the half-year the couple spends in Canada. But there are costs that can be trimmed. Out-of-country health insurance costs $400 per month, airfares $500 per month. They could shop for less-expensive health coverage for their six-month stays in the sun. Airfares are a wild card. We can only assume that airlines will resume scheduled and affordable service.

They could cut costs by ending $736 per month for life insurance, Moran suggests. They could put the policy on a premium holiday, meaning that premiums would be paid by cash value already accumulated.

The couple’s assets and income flows can maintain present spending until Harry reaches 60, retires with Fiona, and takes Canada Pension Plan benefits. The early start means Harry would only receive $4,480 per year, 64 per cent of the $7,000 he would have gotten by waiting until 65. CPP would be taxed like other income at 12 per cent and thus contribute $330 per month to income, raising it to $5,421 per month. That is above their $4,000 monthly target after-tax income and sufficient if they have only one house in Canada to support. They would still have rental and other income in Canada.

At 65, Harry can add OAS at a present rate of $7,362 per year and annual RRSP/RRIF payouts of $7,630. Using the same 12 per cent tax rate based on total income reduced by pension and age credits, and splits of eligible income, their income would rise by net $13,190 per year or $1,100 per month to $6,521 per month. They could afford to taper down their work-based Canadian income.

At 65, Fiona could add her estimated $11,200 annual CPP and $7,362 OAS to family income. That’s $18,562 before tax and $1,360 per month after 12 per cent tax based on income splits after various credits. Family after-tax income would rise to $7,880 per month

Andrew Allentuck