A Journey to Financial Freedom
In 2020, during the height of the pandemic, new parents Paul and Elizabeth found themselves in a unique situation. Sheltering in place with their newborn, they decided to take a bold step with their investments. Energy stocks had been hit hard, and Paul saw this as an opportunity. He opened a tax-free savings account (TFSA), did his research, identified historically profitable, dividend-paying Canadian energy companies, and invested all his money.
Today, the couple’s TFSAs are worth $3.5 million and generate $12,000 in dividends each month. Paul, 48, and Elizabeth, 44, are looking to retire — the sooner, the better. Ideally, they would like to retire when they each turn 55 or even 50, just two years from now for Paul.
Financial Overview
Paul and Elizabeth have a combined, equally split, pre-tax annual income of $160,000. They are debt-free, pay off their credit cards each month, and, due to Ontario’s expensive real estate market, have chosen to rent rather than own. They have about $120,000 in two first home savings accounts but have no plans to purchase a home at this time. Their current monthly expenses are around $15,000, including a rent of $2,900. They aim to generate about $20,000 in after-tax income in retirement.
In addition to their TFSAs, Elizabeth has about $290,000 in two registered retirement savings plans (RRSPs). She has $250,000 in a self-directed RRSP fully invested in Canadian equities and $40,000 in an employer-supported RRSP fully invested in U.S. equities. If she and her employer continue contributions for the next 20 years, the predicted valuation at age 65 is $300,000 or $18,000 a year.
Paul has a defined benefit employer pension indexed to inflation with a commuted value of $250,000. If he retires at age 50, he will receive a reduced pension of $14,000 a year. At age 58, he will receive $40,000 a year, and if he retires at age 64, he will receive $48,000 per year.
“Would lower pensions be a net benefit to us?” asked Paul. “This would mean paying no tax, as our annual incomes would be below the individual amount for deductions.”
Retirement Planning and Strategy
Paul and Elizabeth also want to know how to structure Elizabeth’s RRSP withdrawals in the most tax-efficient way and when they should start taking Canada Pension Plan (CPP) and Old Age Security (OAS) benefits.
They have a self-directed registered education savings plan (RESP) for their son, currently valued at $70,000, and invested in Canadian energy stocks. “We maximize contributions each year and hope to grow it to at least $150,000 within 10 years. Is this a realistic goal and timeline?” asked Paul.
As the couple prepares to retire, they are looking to diversify their portfolio beyond Canada’s energy sector. “What is the right mix of investments to be able to generate about $20,000 per month? Is that even feasible?”
Expert Insights
Shifting focus from growth to diversification and preservation of assets as they start drawing down their investments will be a big mindset change for Paul and Elizabeth, said Eliott Einarson, a retirement planner at Ottawa-based Exponent Investment Management.
“An independent certified financial planner or portfolio manager can create a comprehensive long-term retirement income plan that will give them a clear view of their finances over the next 50 years. The plan will include how small changes in key assumptions, such as investment returns, inflation, and future income needs, can have major lifetime impacts,” he said.
“For example, if Paul and Elizabeth both retire when Paul turns 50, or even if Paul alone retires in two years and they use all their assets to generate $20,000 a month in after-tax, fully indexed income to age 95 leaving nothing for the estate, their investments need to achieve an average annual return of 7.22 per cent. If their assets only generate an average annual return of 6 per cent, they could be depleted by age 80. However, if they both retire when Paul turns 55, a rate of return of 6 per cent will meet their needs throughout retirement.”
Einarson said another option to retire at 50 is to plan for a 30 per cent reduction in annual income from age 70 to 95, which would be $14,000 net of tax in today’s dollars.
Portfolio Diversification and Risk Management
In terms of repositioning their portfolio to reduce risk, Einarson recommended a balanced mix of liquidity, income, and long-term growth. This could include cash to meet immediate short-term needs, a three- to five-year bond ladder to provide income and meet future cash flow needs as the bonds mature, and 70 to 80 per cent of the portfolio invested in dividend-paying equities diversified by sector and geographies for income and long-term growth.
If this is too conservative an approach for the couple, Einarson said that a 100 per cent well-diversified equity portfolio could also see them through retirement.
“Diversification, including diversification outside Canada, is essential. Using a portfolio manager, who can provide fiduciary oversight and build a transparent portfolio tailored to their goals and risk tolerance, to buy shares over time in up to 40 individual companies and possibly individual bonds will help create a more balanced portfolio, similar to how pension funds manage their investments.”
Final Thoughts
Einarson said a retirement plan will help them weigh the pros and cons of taking government benefits early versus deferring them. “The key is to complete the plan before making the transition.”
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