Ellen and Ethan appear to enjoy the best of all possible worlds.
He has a government job with a good salary and an enviable pension plan. She is a professional with her own corporation – and all of the attendant tax advantages. He is 51, she is 48. They have two children, 11 and 12, whom they intend to help through university.
Their question is not how to grapple with debt or competing demands on a limited income, but rather which of a wealth of alternatives is the best way to save for retirement. Compared to the nearly $170,000 a year they are spending now, their retirement spending goal is modest– about $80,000 a year after tax.
“The question is in which vehicle would it be best to focus our savings, and when would it be possible for us to retire?” Ethan writes in an e-mail.
Adding to their choices is Ethan’s defined benefit pension plan, which has a supplemental savings component allowing him to contribute more if he chooses.
We asked Kurt Rosentreter, a senior financial adviser, financial planner and chartered accountant at Manulife Securities Inc. in Toronto, to look at Ethan and Ellen’s situation.
What the expert says
Ethan and Ellen can easily retire before they are 65, Mr. Rosentreter says. If Ethan retires at 60, for example, his pension will pay $61,692 a year. He will get another $6,324 a year in Canada Pension Plan benefits. When Ellen turns 60, she will get $4,452 a year in CPP benefits. They also will be entitled to Old Age Security (OAS) benefits, Ethan at 66 and Ellen at 67.
“Total pension and government cheques add up to $72,486 in guaranteed income – all of it indexed for inflation over their entire lives,” Mr. Rosentreter says. Because they will be able to take advantage of the new pension-income-splitting tax credit, putting them in a lower tax bracket, their taxes will be relatively low, he notes. “Life is good for this couple,” the planner says. “We have not yet even considered the $1-million they have in savings or the value of their house.” If they invested their savings very conservatively in guaranteed income certificates earning 2 per cent a year today, it would add another $20,000 a year in interest income so they wouldn’t even have to touch their capital.
“It gets even better,” Mr. Rosentreter says. Ethan’s supplemental savings plan allows him to contribute extra money to his pension that he can use when he retires “either to buy a bigger pension or increase the inflation indexing, adding to his annual cash flow.”
Mind you, the planner questions whether people who are living so well now will be able to get by on $80,000 a year after tax. “It may be a stretch to believe they can live off two-thirds less than they are today.”
As for the most effective way to save, Ellen pays a low corporate tax rate – about 15 per cent – on money she earns through her corporation as long as it is left there. “So as long as she continues to be employed, they should strive to leave all of her income in the corporation,” Mr. Rosentreter says. That way, Ellen can defer paying tax at her personal rate until the money is withdrawn. Next, they should take full advantage of their tax-free savings accounts (TFSA) because they offer tax-free gains for life.
Given the size of Ethan’s pension, he may want to focus less on RRSP contributions at this point because when he is forced to convert his RRSP to a registered retirement income fund at age 71, the RRIF withdrawals may push him into a higher tax bracket and cause his OAS to be clawed back. As well, the $40,000 in income Ellen currently withdraws from her corporation puts her in too low a tax bracket to benefit much from RRSP contributions.
Instead of making RRSP contributions for himself or Ellen, Ethan should take full advantage of his employer’s supplemental savings plan. While his basic pension is only partly indexed to inflation, the supplemental plan allows him to increase the inflation component. “This is a sweet deal and will provide solid peace of mind in retirement,” the planner says. "While the children will not get the pension as an inheritance, they will get the real estate and the million-dollar investment portfolio."
Ethan, 51, and Ellen, 48, and their two children, 11 and 12.
They would like to know the most tax-effective way to save for early retirement.
Ellen should leave as much of her earnings as possible in her corporation, thus deferring paying higher income taxes until she is retired. Ethan should take full advantage of his employer’s supplemental pension plan. Both can ease up on RRSP contributions.
The ability to retire at age 60 with their target retirement spending goal of $80,000 without ever having to touch their capital.
Monthly net income
Home $685,000; his RRSP $256,000, TFSA $15,200; her RRSP $248,000, TFSA $15,580; corporation savings $498,000; value of his pension plan $1.1-million. Total: $2.8-million
Housing $1,505; transportation $910; groceries $915; child care $3,800; clothing $720; gifts, charitable $140; vacations $1,700; discretionary $500; clubs $395; hobbies $400; personal $500; entertainment $750; grooming $100; subscriptions, health care $375; telecom $210; pension contribution $855. Total: $13,775