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A couple in retirement. (iStockphoto)
A couple in retirement. (iStockphoto)

Retirement and RRSPs

Avoid the RRSP tax trap in your 50s Add to ...

For most, hitting your 50s is a period marked by expanding waistlines, mounting aches and pains and the first genuine bouts of nostalgia. It is also the time to get serious about establishing a retirement nest egg.

Most Canadians earn more money in their 50s than in any other decade, a statistic that, when combined with a honed investment strategy and a retirement game plan, can make for a very lucrative window of opportunity.

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Unfortunately, not everyone makes the necessary adjustments to their investing strategy at this milestone, which can prove to be a costly oversight. RRSPs serve as a good step in bridging the gap between expenses and government payments in retirement (see chart). But getting prepared for retirement is not as simple as opening an RRSP account and making an annual contribution.

“The industry has taught us to think about how much money we have accumulated in our RRSP. But it’s really all about the plan,” says Doug Dahmer, founder and chief executive officer of Emeritus Financial Strategies, in Burlington, Ontario.

Most Canadians don’t consider tax planning for retirement, even though taxes will remain their largest expense. RRSPS are just a savings vehicle. One of the biggest challenges for people in their 50s is to figure out how they will turn their savings into an efficient income stream, he says.

Many people put far too much money in their RRSPs, “and what they don’t realize is that they are building a huge tax trap for themselves in the future,” Mr. Dahmer warns, because every dollar coming out of the account upon retirement will get taxed. Spreading some savings out into different investing vehicles can reduce taxes on retirement income flow.

For example, if a retired couple needs to buy a new car for $30,000 and is relying on their RRSP investments, they may have to withdraw $45,000, depending on their tax bracket. That additional income can trigger a government clawback on OAS, pushing the cost of the car to more than $50,000.

Mr. Dahmer advises many of his clients in their mid 50s to stop contributing to RRSPs and instead maximize payments to their tax free savings accounts (TFSAs) and pay down their mortgages. Ten years before retiring, Canadians need to be asking themselves what they want to do and where, because only then can they know how much money they will need, he says.

Lifestyle considerations are essential, agrees Adrian Mastracci, president and portfolio manager at KCM Wealth Management Inc. in Vancouver. Among the questions he asks clients: How will you replace the fulfillment from your work? And what accomplishments do you envision during retirement?

Adrian Mastracci, president and portfolio manager at KCM Wealth Management Inc. in Vancouver, says that turning 50 is the time to ensure that each spouse will have similar assets at retirement. Balancing income streams in advance of retirement will ensure a couple pays the lowest possible tax, regardless of what happens to the government’s “income-splitting” rules. That means that before retirement, the lower-income spouse is better off doing more of the family’s saving and investing and the higher-income spouse should pay more of the household expenses, Mr. Mastracci says.

The goal is to accumulate investment assets of between six and 10 times your annual family income, he adds.

A couple retiring at 65 and planning to spend $75,000 a year, with a life expectancy of 95, will need $1.24-million in savings upon retirement, Mr. Mastracci calculates. This assumes they do not sell their house, receive two-thirds the maximum CPP/OAS payments ($25,000 a year) and achieve an annual return of 5 per cent, in an environment of 2-per-cent inflation.

The 50s “are the critical years for the big push to accumulate your nest egg. If you miss out on the finances during this decade, you may fall short of your family’s retirement goal,” he says.

Investors tend to be more risk-averse as they get closer to retirement. Yet, advisers say it’s important that investors don’t take their foot off the gas when they reach their 50s, especially in today’s low-interest environment. Many direct their clients to balanced funds that hold stocks and – to a lesser extent – bonds, as well as offer international exposure.

To maintain their purchasing power in retirement, fiftysomethings should make sure growth stocks are part of their portfolio today, says Marc Cevey, CEO of HSBC Global Asset Management (Canada) Ltd. He also likes dividend stocks, even though they may look expensive today, because yields are historically high. As a class, dividend stocks will continue to attract aging investors seeking income – in both the developed and developing world, he says, providing support to prices.

Meanwhile, some exposure to bonds will act as a cushion during any rough periods. HSBC continues to favour corporate bonds over government bonds, even though the premium that corporates traditionally offer above governments has narrowed. Default rates are low in North America right now because many companies have strengthened their balance sheets since the financial crisis. Among government bonds, a mix of international holdings with a range of maturities should offer slightly higher returns than Canadian bonds on their own, Mr. Cevey says.

EXAMPLE:

CPP yearly max (couple): $24,920

+ OAS yearly max (couple): $13,237

= Total gov’t payments: $38,157

– Avg retired couple yrly expend.*: $54,100

= Shortfall: $15,943

(*2009; all other figures are for 2014; Source: Service Canada, Statistics Canada)

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