Investing Exchange brings couples together with financial advisers in an exchange of opinion over saving and investment strategies.
In this exchange, we meet a professional couple in their late 30s and early 40s with a combined value of their RRSP accounts getting up to half a million. John and Julie have been great at saving, with a net worth of about $2-million. But their investing strategies have not taken into account the bite taxes can take out of their savings, not to mention their inheritance, a financial adviser warns.
With no debt, almost $300,000 in annual earnings and a net worth of about $2-million, John and Julie (whose names have been changed for this story) have had a great start on their savings compared with other people in their age bracket. But they have now reached a stage where they need professional advice.
John, 37, is a programmer in Toronto with an annual salary of $190,000. Julie, 41, is a senior administrative officer at a human resource firm and earns $90,500 in annual income. The couple want to have a holiday home abroad to retreat from Canadian winters. They have no existing health concerns or medical bills staining their finances.
They have been married for 15 years and have two daughters, aged 8 and 9. John and Julie like to spend on eating out wherever they want and believe in buying quality. However, their spending decisions are governed by sound judgment. "We shop around for deals before making a decision," John says.
They also like to travel, and hope to maintain their lifestyle in retirement.
"We take annual vacations out of the country at least once a year and take smaller vacations locally during the year [and] we would like to travel a lot when we retire," John says. "We envision being able to stay somewhere warm on a beach for the cold months and spend the rest of the time in Canada."
As for their future goals: "We have always wanted to be debt-free, leverage our wealth and secure our financial future both for our retirement as well as what we leave behind for our girls," Julie says.
John, who does most of the research for financial decisions that are made jointly, feels their RRSP savings will be sufficient to provide the retirement income they need. Julie has $176,000 in RRSPs while John has racked up $260,000 in his RRSP account.
Both committed savers, they have a combined cash savings of more than $300,000 with an additional cash cushion of $73,000 provided by a tax-free savings account (TFSA).
Since the couple own a fully-paid home in Toronto, currently valued at just more than $1-million, a portion of their savings also goes to their non-registered portfolio. John says their "portfolio has seen significant growth over the last 10 years" and is currently worth $235,000.
With no outstanding balances on loans or lines of credit, or other debts, the couple's goal is to educate their children well. To achieve that, they have squirrelled away $54,000 in the registered education savings plan (RESP).
Tina Tehranchian, a certified financial planner at Assante Wealth management Ltd. in Richmond Hill, Ont., reviewed the couple's financial details and their planning considerations.
"One area that they need to pay special attention to is tax efficiency of their non-registered portfolios," she says. "They are both in a high tax bracket and tax savings should be top of mind for them."
She has some suggestions on how to distribute their investments, keeping tax consequences in mind.
"Capital gains and dividends are taxed at a lower rate than interest income. So they should shelter their interest-bearing investments in their RRSP and TFSA accounts and hold their stocks and equity mutual funds in their non-registered accounts.
They can also use corporate class mutual funds to minimize the taxes payable on their non-registered funds. Switching between different corporate class mutual funds will not trigger any capital gains taxes, plus inside the corporate class structure, capital losses that may have accumulated in the fund from long ago can be used to offset capital gains taxes triggered by the fund managers when they take profits on certain positions. This will result in more tax deferral and much less capital gains distributions, half of which would be taxable as income in the year that they are received."
Ms. Tehranchian also feels the couple has too much savings in cash, which could be put to better use elsewhere. "Unless they are planning to buy a property with the over $300,000 in cash reserves they currently have, it seems prudent for them to reduce that cash reserve and invest some of it for the long term," she says. "Currently, the rate of return on cash, even in high interest savings accounts, is very low. On top of that, interest income is taxed at 100 per cent, which in their case, based on their marginal tax brackets, means 43 per cent for Julie and 48 per cent for John."
Ms. Tehranchian feels even if John and Julie want to be very conservative and have six months' worth of their salaries in cash reserves, $140,000 would be adequate.
The down side of being good at saving money, adds Ms. Tehranchian, is that their estate will have substantial tax liabilities down the road.
"All their RRSPs will be 100 per cent taxable as income on the second death and the securities that they own will hopefully continue to appreciate as strongly as they have in the past and will, therefore, generate substantial capital gains on the last death, 50 per cent of which would be included in the income of the last spouse to die and would be taxed at his/her top marginal tax bracket, causing shrinkage of their estate," Ms. Tehranchian says.
Another underused tool the couple could use for tax deferral is a universal life insurance policy, Ms. Tehranchian says.
This would have an additional benefit.
"Even though they may be too young to be thinking of estate planning, as a matter of fact, because they are good savers, they are likely to have a much higher tax liability on their estates and should start planning now."
Though their children are young now and they may think of life insurance only in terms of protecting their dependents, they should actually be looking at using life insurance to cover their eventual estate tax liabilities, too, she says. "The best time to do that is when they are young and healthy."
John and Julie also need to do some long-term planning for their retirement to make sure that they are able to have adequate income for their lifestyle needs, adds Ms. Tehranchian, who recommends "writing a cash flow projection for the type of lifestyle they desire to have in retirement" and engaging a financial expert to "help them calculate the savings, and the rate of return, the couple would need to reach their goals."