Finding financial freedom

After 30 years of "doing it hard", Susan and Fred are mortgage free. The pair, 52 and 50 respectively, reached the milestone this year, the culmination of disciplined money management built around a string of property buys which they have now divested.

The Palmerston North couple – both teachers – continue to work full time. Their two grown children are no longer financially dependent. Their asset sheet is strong and looks set to improve barring any unforeseen turn of events.

In addition to their private house (worth $600,000), the pair own a beachfront property valued at $250,000 which they regard as a form of "compulsory savings" – also mortgage free and bringing in $6000 to $7000 a year rent.

With a combined annual pre-tax income of $146,600, Susan and Fred (not their real names) anticipate being able to save $3200 a month for retirement or $38,000 a year.

To celebrate their financial freedom, they have earmarked $20,000 for home renovations and another $20,000 for a big trip overseas. They plan to finance both on a revolving line of credit which they intend to pay off by the end of 2010.

When the spending splurge is over, the couple are determined to buckle down and set about the business of saving for retirement.

What they want to know is how much they will need to save from late 2010 to retirement so they can maintain their current lifestyle when they are no longer working.

They also want to know what investments will help pad their retirement war chest without risking any of their hard-fought gains and whether they could safely bow out of the workforce before 65.

After struggling with tenancy issues and property management debacles, they are reluctant to get back into the property market.

"We're pretty adamant, having suddenly smelled the roses, if we are going to finance our retirement, it is done through savings. I don't want to start going out on property limbs if I can avoid it," says Fred.

The couple say they want to make the most out of life while they are healthy enough to enjoy it. A few years back Susan had a major health scare, which continues to serve as a reminder of the fragility of life. "Essentially, we're saying: 'We'll have a bit of fun in the sun and the rest of my income will move toward retirement but we don't want to shut down entirely so we can't enjoy the next 10 years, we've had enough of that for the last 30'," says Fred.

For an expert opinion, MoneyMakeover consulted James Smith, of financial advisory firm Bradley Nuttall in Christchurch.

To start, Mr Smith asks the couple to reflect on their desired lifestyle in retirement, when they want to stop working and how long they might reasonably expect to live. Fred and Susan say they would ideally like to be in a position to give up working, if they wanted to, at age 60 but both are prepared to continue working till age 65.

The couple live on a lifestyle block and portray themselves as people who eschew the material for the meaningful and would be happy spending their leisure days travelling in a camper van or else volunteering overseas.

"I'm prepared to go bush in Borneo or go to an orangutan sanctuary and work for nothing. That's the type of thing that we see as richness of life as opposed to money in the bank. We recognise there is a finite time your body can do that and that's between 55 and 65." Fred speculates the couple could live off $30,000 a year but would be more comfortable with $50,000 to give them some options.

Mr Smith delivers the following projections: Assuming their current capital produces a net return of 5 per cent per annum, Fred and Susan would have to accumulate $1 million in investable assets by age 60 in order to deliver them $50,000 a year.

If the couple were prepared to settle for $30,000, starting at age 65, they would require $600,000 in investable assets. With NZ Superannuation, the couple could expect another $24,000 per year after tax which would lower their necessary investable assets to $120,000.

If both wanted to retire at age 60 with a net annual income of $30,000, they would have to save $270,000 to get them through to age 65. The couple say they could go either way.

"We're flexible enough to see there are huge opportunities to live a whole lot of different lifestyles and we're not locked into any one of those. We're not money-oriented in that we have a pretty balanced perspective on things. I'd say, in monetary terms, we could move up or down the salary scale happily knowing that we'd be trading off one for another" – time or money, says Fred.

ONE scenario the couple have considered is selling both their properties (for $800,000), downsizing to a smaller beach-front home and investing the rest.

If they could rebuild or buy another property for $400,000 that would leave them with a potential $400,000 to invest. If that were the case, Mr Smith says, the couple could retire at age 60 on an income of more than $30,000 per year.

And if they stick to their targeted savings goal of $3200 a month, the couple could save up another $300,000 between 2010 and 2018 which could be invested.

Given their conservative risk profile and reluctance to get involved in any high-return investments, Mr Smith says it is unlikely the couple will be able to retire at age 60 on $50,000 per year.

Still, if they are able to put aside $38,000 a year from 2010 onwards and restructure their property assets, they should have no difficulty meeting the lower income goal of $30,000 at age 60.

"By virtue of your property assets, you are in a reasonably strong financial position and should be able to allocate some future saving towards enjoying holidays and other activities," says Mr Smith.

With their spending splurge out of the way in 2010 or sooner, Mr Smith suggests the couple direct some of the savings into investments other than property. "This will help you reduce your reliance on property, therefore diversifying your savings," he says.

Mr Smith says the couple's beach-front property produces marginal returns. Based on current rental revenues, it yields only 2 per cent per annum. If they were willing to part with the property, Fred and Susan could reasonably expect to make higher returns with another investment vehicle.

As Fred and Susan are not keen on the stockmarket, Mr Smith proposes a mix of cash deposits, fixed-interest securities and some shares.

"Given that you are naturally conservative, the proportion invested in shares will not be significant, however, shares should still be included to provide a diversified pool of assets and protection against the future effects of inflation," he says.

With respect to insurance, Mr Smith suggests the couple review their life insurance policies. When they were heavily mortgaged, they each took out life insurance policies of $300,000 per person. Now that they are mortgage free, Mr Smith says that level of coverage is probably no longer necessary. He says Fred might want to consider income protection insurance instead while retaining a scaled back amount of life cover on Susan.

On the whole, Mr Smith says the couple are in good shape but would benefit by "clearing clutter, establishing some clear priorities and focusing on savings goals".

AT A GLANCE

"Fred" and "Susan" Income before tax: $146,600; Assets: $600,000 home, $250,000 bach; Debt: $20,000, revolving line of credit; Household spending: $2600 a month; Fixed expenditures – Rates: $1771 a year Phone: $90 a month Electricity: $240 a month Home/contents/car insurance: $285 a month Life insurance: $127 per person a month Medical insurance: $140 a month Car registration: $33 a month Recycling: $70 a month

* No person or entity (including Bradley Nuttall and The Dominion Post) will be responsible or liable for any errors, omissions or inaccuracies in this article or liable to anyone for any loss, damage, injury or expense suffered or incurred as a result of reliance on the information provided and opinions expressed in the article. Disclosure documents are free and available upon request.

* Are you interested in being the subject of a free Money Makeover? E-mail: amanda.morrall press.co.nz

- © Fairfax NZ News