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Tuesday, July 22, 2014
Trinidad & Tobago Guardian Online
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Retire early with benefits
Lawrence is a 50-year-old general manager with a pharmaceutical company and earns $15,000 per month. Based on his years of service he now has the option for early retirement with an incentive after tax of $176,250. He will continue to receive his medical benefits and the company has offered to give him his age 60 pension today.
He can get a full pension of $8,000 per month or a reduced pension of $6,000 with a tax-free lump sum of $250,000. He has a small private annuity that matured one month ago but is too small to generate a pension so he will receive an after tax refund of contributions of $80,000. He also has savings in a money market account of $60,000.
His mortgage balance is $355,271 and will be paid off in 10 years at $4,125 per month. The three-bedroom house in which he lives with his wife Juliana sits on 8,000 square feet of land and is valued at about $1,200,000. Lawrence also owns one lot of land a couple miles from his house valued at $350,000. He has 36 payments of $750 remaining on a land loan (APR 8.25 per cent.)
Lawrence is not certain if he should take up the retirement offer. If he does, his challenge will be to cover monthly expenses of $5,000 plus his loan payments and continue to support his wife and 12-year-old daughter Victoria. His retirement plan was to build on the land and generate a rental income. An estimate from his builder put his construction cost in the vicinity of $500,000 for two apartments, which could yield $5,000 per month; the project will take six months to complete.
Lawrence is seeking our advice on the following:
• Should he take the package, if so, should he take the lump sum and the reduced pension or the full pension?
• Should he clear off his loans or instead use the money to build the apartments?
• Should he sell the land and use the money for another real estate deal?
• Does he need to go back out to work after retirement?
Nick’s assessment and recommendations
Lawrence’s primary objective is to secure his retirement income; preferably from sources that are predictable and increasing to cope with the ravages of inflation. He has two pieces of real estate: one is his primary residence and the other a vacant lot that he can sell and take a profit or develop it to provide rental income.
If he decides to accept early retirement, he will see a drastic cut in his pay from $15,000 to $8,000 and possibly $6,000. If he continues to work he will pay off his mortgage in 10 years, have some money saved (Table 2) and collect a handsome monthly pension.
If he takes the offer to retire today with the incentive he has to seriously consider how he will make up for the shortfall in his earnings especially if he opts for the reduced pension.
Lawrence will still have the option to take the same pension lump sum when he is 60 years old and this, added to his savings, will be a sizeable nest egg. Money today is more valuable than money in 10 years so even though he will have some cash at his disposal in the future he may have lost 50 per cent of his buying power using the past as a guide. Conversely, both his home and the vacant lot could double in value.
Focusing on holding cash over the long haul will invariably lead to a loss of real wealth. Converting cash into an asset that will preserve wealth and produce income should be his objective. Based on the numbers given (illustrated in Table 1) Lawrence will not have sufficient cash to take care of all of his needs therefore he has to choose the best strategy to accomplish his goals.
Regardless of which decision he makes, Lawrence can and should completely repay the land loan from savings to improve his monthly cash flow and save on interest cost. If he accepts early retirement and takes the full pension without the pension lump sum, he can use only his incentive money plus his annuity proceeds and pay down his mortgage debt. He can then approach his bank to reduce the payments; based on 10 years and the implied interest rate of 7.0 per cent (Refer to Tables 2 & 3).
Table 3 gives a few scenarios illustrating the transition from current employment to life with a pension (full and reduced) then including rental income.
If he chooses to take the incentive: $176,000, the annuity: $80,000 and the pension lump sum: $250,000 totaling: $506,000; he will have enough to cover the construction cost of $500,000. In the time he takes to complete the apartments he will need to take care of the shortfall in monthly bills of ($3,375) by using some of his money market savings after he pays off his land loan of $23,846 ($60,000 - $23,846 = $36,154).
Over the next 10 years the mortgage will be repaid on schedule and he will see a drastic increase in his cash flow after that. If mortgage interest rates increase he can cover this by increments in his rental income. His overall net worth will also increase significantly because of his savings from monthly surpluses and to a greater extent the appreciation of his property values.
So to answer Lawrence’s questions as to what he should do, I would say he should seriously consider taking the package with the additional pension lump sum, clear off only the small loan, let the rent cover the mortgage payments and not sell the land but develop it for cash flow. If he wishes to go to work it would be because he is too bored at home and could make a couple dollars to take Victoria out for ice cream. (Details were modified to protect client’s identity)
Nicholas Dean (Cer-Fa) is a financial coach and mentor who is the managing director of the Financial Coaching Centre. He can be contacted at:
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