Goodbye retirement?

Still not convinced?

Cathie Hurlburt, partner at Integrated Planning Group and senior planner at Assante Financial Management, recently told a client he couldn’t quit his job—ever, unless he altered his lifestyle. He’s half of a wealthy Vancouver couple in their late 50s with an $11- million net worth, including a home, boat, and several cars, and RRSPs.

What’s the rub? Their sky-high expenses that include plans to continue supporting two adult children. They have no pension (other than the husband’s CPP), and Hurlburt’s calculations conclude inflation plus the costs of late-life medical care would leave them strapped for cash.

“If they want to retire within two to five years, they have to do two things,” she explains: “Cut their greedy kids off and move into a smaller home.”

Right now, this couple has a daughter in university, and a son living rent-free in a $700,000 condo they own. Hurlburt suggested they force the son to pay rent or get other tenants. This could net them at least $1,000 in cash flow each month, once maintenance, condo fees and taxes are deducted.

Secondly, she suggested they downsize from their $4-million, 4,000-square-foot home, to a $1.5-million condo. This would save them $16,000 in annual property taxes, as well as costs for landscaping, cleaning the pool and maid service. The $2.5 million netted from the sale could then be put into a portfolio, including fixed-income annuities, and tax-efficient investments.

It took Hurlburt four meetings to convince them of these changes. She showed them the hard truth—if they continued to spend between $16,000 and $22,000 a month, they would run out of money quickly. Also, they want to travel, so she asked why they needed a big house if they weren’t planning on being home two-thirds of the year.

The wife is currently working on getting the spending down to $10,000 a month, and they hope to sell the house within the next couple of years.

When clients are in trouble, some think advisors can wave a wand and magic financial troubles away. So how do you really temper expectations? Start by ensuring their goals are realistic.

“We can’t always make them choose the right avenue, but we can show them the consequences they’ll have to face,” says Hurlburt. “Be blunt. They either spend less, save more, or they’ll have to jump off a bridge together at 75.”

Save their retirement

Some experts say clients need 70% of their pre-retirement incomes to maintain their lifestyles after age 65. Others dispute this figure, saying 50% is enough.

In reality each case is different, since clients’ situations are in flux. Kids move out (or back in), mortgages are paid off (or new ones on trophy homes foolishly entered into), late-life divorce (or ill-advised May-December couplings) crop up. These factors make retirement goals a moving target, so plans must be revisited often.

But if you’ve done your due diligence and provided earnest advice over the years, your clients are probably in the clear, right? Not always.

Horror story

A 65-year-old couple makes a combined $90,000 yearly. Their retirement goal is a 60% replacement ratio, or $54,000 a year.

They’ve saved 5% of their income in RRSPs since they were 30. Now they have about $400,000 in savings and investment plan returns.

As soon as they begin drawing back, their annual income would be about $17,000, assuming the purchase of an indexed annuity. Add that to $12,000 from CPP and $6,500 from OAS and their joint annual income is $35,500—only 40% of their gross pre-retirement income.

To reach their $54,000 goal, they need an additional $400,000, assuming a 3% rate of return. This means they should’ve saved twice what they did—10% a year—to avoid running out of money.

How can they make up the difference? Perhaps they liquidate assets like their home.

Or, let’s say they decide not to buy an annuity, and try to make up the difference with investments. They’d need to withdraw about $35,500 of their savings in year one of retirement to meet 60% replacement ratio. Assuming annual inflation of 2% and an annual rate of return on their investments of 3%, they exhaust their savings by age 77.

To have their money last until they’re 90, they’d need to generate annual returns of at least 10%.

Source: Jill Wagman, managing principal, Eckler Ltd.

Maybe they spent too much and didn’t tell you; maybe they lost a large source of income—the point is they’re in trouble.

So how do you break this difficult news? Show how the changes will affect their goals in a chart. Include their assets, accumulated cash flow, total net worth, and how these figures change each year until they’re in the red.

Then suggest how they can recuperate that lost income on the quick.

Perhaps your client is one of many boomers fit enough to work past 65. Every extra year she works is one less she’s retired, says Alan Wainer, partner at Crowe Soberman LLP.

Wainer notes the effect is twofold: the client makes more money and adds more to her savings; plus she’s keeping busy and has less time to spend any earnings.

If the client’s not fit enough to commute to a job, Wainer suggests working from home or opening a consulting business. Expenses are usually minimal, including registering the business, and liability insurance if he hosts clients at home. But, some of the costs related to her work space are tax-deductible, including utilities, home insurance and mortgage interest. So if a client is self-employed, earns an extra $10,000 and spends $3,000 on the business, she can deduct that on her tax return.

If work’s just not an option, try convincing clients to rent out part of their home. It’s not always an easy sell because people don’t want to live with strangers. Still, the added income is a bonus.

One of Hurlburt’s retired clients owns a two-bedroom condo free and clear. She rents out one room for $600 per month—which adds up to an extra $7,200 straight to her pocket each year.

If a client takes in renters, there are expenses including renovations and maintenance. But say your client spends $10,000 fixing up a basement. A two-bedroom unit in the Greater Toronto Area could fetch about $1,000 a month, so he recovers the costs within the year.

No land, no hassle, lots of cash

Then there’s downsizing from a house to a condo, which can offer significant capital, not only from the sale but also in the form of lower property taxes and maintenance fees.

Or the client could sell and move to a rent-controlled apartment.Getting a client to downsize or rent can be tricky. Focus on the positives (e.g. less responsibility because he won’t have to mow the lawn or shovel the driveway).

An influx of capital from selling a house can open doors for a cash-challenged couple, suggests Bruce Cumming, executive director, private client group and senior investment advisor at Dundee Wealth. One option is to set up a GIC or annuity ladder.

Say the couple nets $700,000 from the sale and needs $5,000 cash per month. Cumming suggests putting $60,000 in a money market account and setting up a $5,000 split systematic withdrawal. Put $60,000 in a one-year GIC, and another $60,000 in a two-year GIC. The remaining funds are put into a three-year GIC. This plan helps stretch income, and is best for couples in their mid-70s.

“A GIC has a double-edged sword,” explains Cumming. “It’s ultra safe, but you might run out of capital if you live a long time. It may not pay enough because it’s only 2% a year, but if you don’t run out of money, whatever is left over can go to heirs.”

If a couple is in their mid-60s, wants more cash flow and isn’t as worried about protecting capital, then a life-only annuity is an option. The cash flow (not rate of return) is close to 7%. It guarantees income for the rest of their lives and is also tax-advantaged, which can minimize and possibly eliminate OAS clawback. It’s also safe from market swings.

However, there will be nothing left for beneficiaries.

As an alternative, Cumming suggests a 15- or 20-year term certain annuity if a client is in poor health. That guarantees a higher cash flow while they’re alive.

If he has a 20-year term certain and passes away in year 16, the insurance company commutes the remaining four years worth of payments to a lump sum payment to beneficiaries.

And, in dire circumstances, don’t be afraid to go back into debt. If the couple is adamant about staying in their million-dollar home, says Cumming, they could take out a line of credit secured against the property. When they die, any outstanding balance is paid when the home is sold.

Protect yourself

If your client fails to meet his goals he’s bound to be upset. Hopefully not enough to sue, but it pays to be prepared.

This is where compliance is a must. Document and save each conversation you have, including what advice you provided and whether a client followed through. Provide him with these documents after every meeting.

And consider how much value you’re adding. Are clients listening? Are your methods working? If not, the relationship is eventually going to fail, says Jim Otar, author of Unveiling the Retirement Myth, so it’s best to cut that client loose. Focus instead on ones you can help.

“When I first started 18 years ago, I was optimistic, thinking I could help everyone,” he says. “But soon I saw I couldn’t and it didn’t feel right to keep servicing them half-heartedly and still earn money from them. Plus, I didn’t want to be the advisor on record [if they failed].”

And remember, most people only sue when there’s a surprise, says Hurlburt.

“If you’ve been telling your clients to save $100 a month and it would get them steak, and they did and now they’re going to live on cat food, you might be in trouble,” she says. “If you didn’t say anything over the years, shame on you.”

Ideas for cash-strapped retirees

Solution	Benefits	Drawbacks
Rent out part of your home	Guaranteed monthly income stream	You could wind up with tenants from hell
Downsize or move into a rent-controlled apartment	Capital from sale of home; fewer maintenance responsibilities space	Must adjust to living in a smaller apartment
Invest in a GIC ladder	Safe; can leave money for heirs	Could still run out of money
Invest in a life annuity	Higher cash flow; tax advantages	No money for heirs
Go back to work	Don’t have to cut back spending	May not be physically fit enough
Work from home or open a consulting business	Business costs are tax-deductible	You’re still working
Take a line of credit against your home	Instant cash	You’re in debt; could still run out of money
Cut frivolous expenses	Easy way to gain extra cash	May not have the retirement you’d hoped for