-Todd Korol/The Globe and Mail
Gary and Geraldine have good professional jobs but look forward to the day seven years hence when they can retire from work. By then, their daughter will be in her mid-20s and out on her own. Gary is 53, Geraldine is 49. Together they earn about $240,000 a year.
"Geraldine and I are good savers," Gary writes in an e-mail. "But neither of us has a defined benefit pension plan to fund our retirement," he adds. "Knowing that our income will need to come from our portfolio returns, we want to make sure we have a solid plan in place before pulling the plug in 2023." They do have defined contribution pension plans at work to which both they and their employers contribute.
They own their Edmonton house outright. They like travelling and plan to do more of it when they retire. They'll need a new vehicle at some point and are planning for $100,000 in home renovations some time over the next few years. Their desired after-tax income when they retire is $100,000 a year.
Geraldine and Gary were hurt by the 2008 financial crisis and are concerned about preserving capital to cover unforeseen expenses and to help their daughter get established. "We would like to know if our retirement goals are realistic and sustainable without drawing down significant amounts of our estate capital."
We asked Stephanie Douglas, a portfolio manager at Avenue Investment Management in Toronto, to look at Gary and Geraldine's situation.
What the expert says
Gary and Geraldine have done an excellent job of saving and are in good shape financially, Mrs. Douglas says. They've taken full advantage of their registered retirement savings plans (RRSPs), tax-free savings accounts (TFSAs) and registered education savings plan (RESP). They have also both participated in their company's defined contribution pension plans. When they retire, their investable assets will make up 85 per cent of their total net worth, with registered assets accounting for 45 per cent of that. "How they withdraw from these accounts will be key in preserving their wealth," Mrs. Douglas says.
Once they have retired, he at the age of 60 and she at the age of 56, they should convert their personal RRSPs to registered retirement income funds (RRIFs) and their work pension plans to life income funds (LIFs). (Life income funds are tax-deferred plans that pay out your registered pension plan, locked-in RRSP or locked-in retirement account assets over a number of years. With a LIF, you control your investment options, but payments are determined by a government formula.)
"This will allow them to withdraw a larger percentage of their required cash flow from their registered accounts in the early years, while allowing their non-registered accounts to grow," Mrs. Douglas says. Non-registered accounts are taxed more favourably than registered accounts, which would be fully taxable to their daughter when they die. This way, they can leave a larger estate. "If they decide to wait until 72 – when mandatory minimum withdrawals begin – to tap their RRIF and LIF accounts, their Old Age Security benefits could be clawed back because of their high income," she notes.
If Geraldine and Gary want to maximize their CPP and OAS benefits, they could put off collecting them until each turns 70, Mrs. Douglas says. That way, they will get 36-per-cent more OAS and 42-per-cent more CPP. (She assumes they will get the average CPP benefit.)
"This would certainly help reduce the amount they have to withdraw from their non-registered accounts after age 70," she says. They should consider their life expectancy when deciding whether to put off collecting these benefits. Their minimum RRIF/LIF withdrawals will provide them with roughly $50,000 in after-tax income for the first 10 years, so they will have to withdraw another $50,000 a year (net of tax) from their non-registered accounts to meet their spending goal. The amount they will have to withdraw from their non-registered accounts will decrease once Gary starts collecting Old Age Security and Canada Pension Plan benefits. The numbers assume a 25-per-cent tax rate.
"With a conservative return of 3 per cent a year, dividends and investment gains on their portfolio will be enough to cover the shortfall and allow their non-registered assets to grow," she says. To ensure their goal of capital preservation, she does not suggest they withdraw any more than $100,000 a year, indexed to inflation. If they stick to their plan of withdrawing $100,000 a year, they will still have an estate value of about $5-million when Gary turns 95, she estimates. Included in her calculations is a future inheritance of $800,000.
In their registered pension plans, Gary and Geraldine can choose only from a prescribed number of mutual funds. After they have retired and converted their RPPs to life income funds, they may want to look for lower-fee options. They are paying 1.5 per cent a year to their financial adviser to invest $1.4-million of their savings (some registered, some not) in pooled funds.
As well, it would be more tax-efficient if they moved some of their fixed income exposure to their registered accounts and used their non-registered accounts to buy stocks and other equity investments, she says. As their retirement date draws nearer, she suggests they increase their exposure to fixed-income investments to guard against a pullback in the stock market.
"After they retire and are living off their investments, I suggest having at least seven to 10 years' of living expenses in fixed income, preferably high-quality Canadian corporate bonds," Mrs. Douglas says. In their case, this would be roughly $1.3-million adjusted for inflation.
"For Gary and Geraldine, this would mean having … at least 30 per cent of their investable assets in fixed income, depending on their risk tolerance." This would give them enough time to recover if there was a stock market correction without having to sell their equity investments.
Finally, the couple has a significant amount of cash sitting in the bank. They would be better off holding a smaller amount of cash and buying a guaranteed investment certificate with at least a 2-per-cent interest rate to keep up with inflation, Mrs. Douglas says. They could use a line of credit for emergencies.
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The people: Gary, 53, Geraldine, 49, and their daughter, 17.
The problem: Is retiring at 60 sustainable without drawing down significant amounts of capital?
The plan: How they withdraw from their savings is critical. They should start with registered savings, leaving non-registered investments to grow. Consider switching to lower cost investments and fine-tune portfolio to ensure it is tax-efficient. Hold at least 30 per cent in fixed income.
The payoff: Peace of mind that comes with financial security.
Monthly net income: $14,370
Assets: House $650,000; his RRSP $303,215; her RRSP $385,925; his RPP $419,625; her RPP $31,185; his TFSA $31,515; her TFSA $33,940; RESP $49,330; non-registered joint investments $1,085,265; cash $101,834. Total: $3.1-million
Monthly distributions: Property tax $355; utilities $400; home insurance $95; maintenance $335; garden $85; transportation, gas, car insurance, maintenance, parking $620; groceries $1,250; child expenses $300; clothing $165; gifts $40; vacation, travel $1,165; dining, drinks, entertainment $490; grooming $115; pets $115; sports, hobbies, clubs $140; subscriptions $50; other personal discretionary $510; doctors, dentists, drugs $150; vitamins, supplements $165; life insurance $180; disability insurance $160; cellphones $185; phone, TV, Internet $185; RRSP contributions $1,500; TFSAs $915; pension plan contributions $2,120. Total: $11,790. Surplus cash flow $2,580 goes to saving.
Liabilities: None
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