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Bert is age 62 and hoping to retire by the end of next year from his well-paying job in finance. He earns a base salary of $170,000 a year plus a substantial bonus. His wife, Lois, who is a year older than Bert, retired a few years ago. They have a mortgage-free house in the Greater Toronto Area and two adult children, aged 30 and 31.
Bert has a defined benefit pension plan not indexed to inflation that will pay about $89,000 a year. Lois has a defined contribution pension plan worth about $120,000. They also have other savings and investments.
Short term, they plan to travel extensively, setting aside a travel budget of $20,000 a year and sometimes more. They’re also budgeting $10,000 a year for minor home renovations and replacements.
Their questions: “Can we meet our target after-tax income of $120,000 a year with a life expectancy of age 95 and still use $250,000 to invest in a vacation property or gift to the children?” Bert asks. “How and when should we draw down our savings to minimize tax? When should we commence Canada Pension Plan benefits?”
We asked Andrew Dobson, a certified financial planner (CFP) at Objective Financial Partners Inc., based in Markham, Ont., an advice-only financial planning firm, to look at Bert and Lois’s situation. Mr. Dobson works remotely out of London, Ont.
What the Expert Says
Bert and Lois should be able to meet their spending goal of $120,000 a year after tax even if they make a one-time outlay of $250,000 for a gift or a down payment on a vacation property, Mr. Dobson says. If all goes well they’d leave an estate of about $3-million in today’s dollars, half of that being the value of their house.
“I note that Bert did want to ensure that he knew how much he could stretch his budget,” the planner says. This would be important if they decided to buy a vacation property, which could involve a further outlay and continuing expenses. The budget could likely be raised to $130,000 to $135,000 a year if their asset allocation and expected returns remain consistent throughout retirement, he says. “I always caution against pushing the budget to the maximum, but the numbers do support a higher budget.”
Bert’s defined benefit pension of $89,000 plus their government benefits will cover a very large percentage of the after-tax budget.
“I would note that if maintaining a budget at the higher level is important, they should review this in conjunction with the survivor benefit for Bert’s pension,” he says. If Bert predeceases Lois at an early age, Lois would have to lower her lifestyle spending materially if the survivor pension was less than 60 per cent.
Mr. Dobson assumed a 5.25 per cent rate of return on the couple’s non-registered stock portfolio, 4 per cent on their registered accounts and an inflation rate of 2.1 per cent.
Bert in particular has large, deferred capital gains on his stocks that he will have to realize at some point and pay tax on them. “I mention this because at their desired retirement age, they have a limited number of years in which to do this before they move to a higher tax bracket.”
At some point they will convert their registered retirement savings plans to registered retirement income funds, and Lois will convert her locked-in retirement account – her DC pension – to a life income fund.
Once they each reach age 72, they will get their pension, their government benefits plus the mandatory minimum withdrawals from their RRIFs and Lois’s LIF. “They’d also have potential capital gains if they needed cash from their non-registered sources,” Mr. Dobson says.
“A potential strategy to explore with regards to large expenses beyond the base $120,000 annually could be to realize capital gains on their non-registered portfolios prior to the start of other retirement income, which once started, cannot be cancelled or reversed; for example, Canada Pension Plan and Old Age Security benefits and RRIF/LIF withdrawals.”
By realizing capital gains on their portfolio before drawing on other income sources, they would trigger taxable gains in lower-income years, and diversify their investments. Bert has two concentrated holdings that represent about 35 per cent of his portfolio.
As well, if Bert has flexibility over the timing of his pension start date, he may want to consider deferring it to the year following his full retirement because he could use this as an opportunity to trigger capital gains before he starts drawing pension income, the planner says. Bert could live off these gains in the first year of retirement, gift money to their children or spend more on travel. He’d be realizing gains and paying tax at a rate that could be punitive if triggered later, the planner says.
Once Bert begins drawing his pension, he can split it with Lois. “Keep in mind that defined benefit pension income can be split prior to age 65, whereas income from RRIFs and LIFs cannot be split until the account holder is age 65,” Mr. Dobson says. Splitting the pension income with Lois could help on the capital gains tax, which will mostly be attributable to Bert as the beneficial owner of the large holdings, he says.
The planner’s calculations assume that Lois converts her RRSP to a RRIF and her LIRA to a LIF, starts making minimum withdrawals next year and continues until the accounts are depleted. Bert is assumed to start his RRIF withdrawals in 2025, his first year without employment income.
Also, starting RRIF and LIF withdrawals with minimum payments could help increase Lois’s taxable income so that the overall income can be more effectively equalized. Lois would claim her full RRIF income while taking 50 per cent of Bert’s eligible pension income. The RRIF withdrawals likely won’t be large, the planner says; for example, a 4 per cent minimum withdrawal would be required when they each turned age 65 based on the year-end balance of the account.
“The key to this strategy is not necessarily to spend all the additional income from the RRIFs and LIFs, or the capital gains, but rather to pay some tax early and divert surplus proceeds to annual tax-free savings account contributions or a special vacation,” Mr. Dobson says.
The optimal tax strategy would be to have most of the couple’s net worth in their primary residence – usually a tax-free disposition when the second spouse dies –and in maxed-out TFSAs that are left to grow and compound. These may be drawn on in the later stages of the plan, as the RRIFs and LIF are eventually depleted by the couple’s early to mid-90s.
As for government benefits, “I would consider deferring CPP to age 70 and potentially taking OAS at 65,” Mr. Dobson says.
The people: Bert, 62, Lois, 63, and their two adult children.
The problem: Do they have enough to support a retirement spending budget of $120,000 a year after tax even if they give $250,000 to their children (or buy a vacation property)? In what order should they withdraw their funds?
The plan: A lump-sum gift or expenditure would not undermine their spending goal. When Bert retires they should split his pension income. They should draw on their RRIFs and Lois’s LIF to supplement his pension, deferring CPP to age 70.
The payoff: A comfortable retirement that could include an equally comfortable estate.
Monthly net income: $14,250, excluding bonus.
Assets: Cash $40,000; GICs $21,000; his non-registered stocks $370,000; her stocks $40,000; her mutual funds $50,000; his TFSA $105,575; her TFSA $102,000; his RRSP $121,820; her RRSP $454,000; her defined contribution pension (LIRA) $121,500; residence $1,750,000. Total: $3.2-million.
Estimated present value of Bert’s DB pension: $1-million.
Monthly outlays: Property tax $300; home insurance $175; utilities $350; cleaning $350; garden $35; car insurance $395, fuel, oil, maintenance $270; train, road tolls $280; groceries $700; clothing $210; gifts $330; charity $250; vacation, travel $1,665; other discretionary $560; dining, drinks, entertainment $250; personal care $200; club memberships $20; sports, hobbies $125; subscriptions $60; life insurance $25; phones, TV, internet $430; reserve for big ticket items $835; RRSPs $350; TFSAs $385; Bert’s pension plan contribution $850; Bert’s share purchase plan $535. Total: $9,935. Lifestyle expenses may be underestimated. Surplus goes to saving.
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Some details may be changed to protect the privacy of the persons profiled.