While there's no denying the only certainties in life are death and taxes, it's the latter that has this school teacher worried.
Shelley, 61, has worked in elementary schools for more than two decades and is looking forward to retiring this year. She and her 59-year-old husband Brian have no kids, no mortgage and little debt. She has a pension and he has RRSPs.
She admits, however, that she wonders whether she can afford to retire or whether the couple's portfolio is in the right place for this time in their lives. Shelley finds herself especially stumped by smart tax-bracket management.
"When I retire, I will receive a one-time payout of $38,600. Some of it will be able to go into a tax shelter, but I estimate $22,000 of it could be taxable.
"How do we best balance our retirement income to minimize the tax bite in what will likely be a modest but hopefully secure retirement?" Shelley asks. "Poor tax planning could really adversely affect our retirement."
There are other nagging concerns.
Shelley qualifies for a defined benefit pension from Ontario Teachers' Pension Plan as well as the Canada Pension Plan, which she started taking this year. "I don't know if I did the right thing taking my CPP while I'm still working," she says. "My pension is mostly indexed to inflation and will be reduced by 12 per cent when I qualify for OAS at age 65."
Her husband, meanwhile, who worked in the non-profit sector and was laid off several years ago, has had no income since his employment insurance ran out. However, the pair has worked hard to put away money in his RRSPs.
"We had an adviser look at it [the portfolio] to realign it so there is more fixed-income versus equity [funds]," she says. "It sounded like the right thing to do, but we still worry."
To help set Shelley and Brian on the right track financially, we presented their details to Stevan Dostanic, an investment consultant and fee-for-service financial planner at Astrolabe Financial in Ottawa, and Alain Quennec, financial adviser at Vancouver's Rogers Group Financial.
– Home valued at approximately $282,000 (no mortgage).
– RRSPs: About $225,000.
– Tax-free savings accounts: About $12,400.
– Universal life insurance policy for $50,000.
– Line of credit: $8,900.
Mr. Dostanic's tips
1. Revamp the portfolio to address proper asset allocation, investment income needs and risk tolerance. "The investment portfolio Shelley and Brian currently have in place has many issues," Mr. Dostanic says. "The overall weighted management fee is high, approximately 2 per cent, representing total fees paid of $4,500 annually. The cash component is too high, at 10 per cent. This represents cash, GICs and the cash components of the individual mutual fund positions. The 50 per cent allocated to equities is poorly diversified across regions, with the majority of the holdings in Canadian equities – 31 per cent of the total portfolio and 62 per cent of the equity component.
"They should increase their exposure to international equities and add an emerging markets component to their portfolio that is currently not represented by selling off some Canadian equity content," he adds. "A distribution of 15 per cent Canadian equity, 15 per cent U.S. equity, 10 per cent international equity, and 10 per cent emerging markets equity may be more appropriate."
Mr. Dostanic also notes that the asset allocation doesn't maximize potential tax savings, since Shelley and Brian are holding GICs outside of non-registered accounts.
2. Defer Shelley's retirement and retirement allowance to 2014. "The tax implications of this small step would be drastic," Mr. Dostanic says. "If the payment is received in 2013, Shelley will be taxed at the highest possible marginal rate – almost 40 per cent – given her earned salary and CPP payments received. If she waits until 2014, she will no longer have employment income and will be able to split her pension income up to 50 per cent with Brian. So she'll be able to keep a larger portion of the $38,620 that will not be sheltered in her RRSP, or rolled over to her RRSP given the $2,000 annual retirement gratuity that has been made available to teachers for every year worked prior to 1996."
3. Have Shelley split her pension income with Brian (up to 50 per cent). Doing so will help maximize the Pension Income Tax Credit and minimize taxes paid at retirement. The couple should also try to report the same level of taxable income on an annual basis, Mr. Dostanic says.
Plus, when Brian reaches 65, he should convert the RRSP funds to a RRIF to facilitate withdrawals.
Shelley should not have started receiving her CPP payments so early, Mr. Dostanic says. "She was and still is in a very high tax bracket, so a large portion of the payment is taxed at a high rate," Mr. Dostanic says. In addition to this, she continues to contribute the maximum annually to CPP. Annually she is receiving $8,634.36, yet she's contributing $2,356.20 and paying about $2,800 in tax on her received payment, leaving her with a net $3,478.16 (40 per cent of the gross payout).
"We recommend to the majority of our clients who are in the higher tax brackets to hold off on requesting CPP payments until after they have retired, as once the payments start they cannot be stopped," he adds.
Mr. Quennec's tips
1. Investigate whether Shelley's employer will split the retirement allowance. "I have seen some employers in the past split the retiring allowance into two portions: one paid near the end of December and the remainder paid in early January," Mr. Quennec says. "If this is possible, have the December portion be $16,608, with $12,000 transferred directly to RRSP as allowed due to her employment from 1990 to 1995, and the remainder paid out with some withholding tax. She will contribute $4,608 to her RRSP against her 2013 income.
"The point is to keep her 2013 income as low as possible," he explains, "to split the rest of the taxable retiring allowance into 2014, when her income will be much lower."
There's no point in Brian making RRSP contributions, Mr. Quennec adds, since his income is zero. In 2014, income will be low for each of them, as they will split Shelley's pension under the income-splitting provisions. Consequently, their tax burden will be low as well. If they need additional income, Brian can make an RRSP withdrawal.
2. Set up an emergency fund. Mr. Quennec suggests doing this by investing the TFSA funds into the highest potential return investments within the couple's risk tolerance. "It appears that Shelley and Brian have no spare emergency funds, so I would urge them to keep the TFSA invested in a high-interest savings vehicle, and that means less than 2-per-cent returns and fully liquid; no GICs. If they determine they have more than what they need for emergencies – I suggest around three to six months of expenses on hand – then the rest can be invested for the long term."
3. Go through an Investment Policy Statement (IPS) process with an adviser. This will determine the couple's overall risk tolerance, investment objectives, and target asset allocation. "This will drive what their expected return is to be," Mr. Quennec says. "Investing according to risk tolerance avoids most behavioural mistakes in times of unusual market activity. Investors get very cocky and self-assured when markets are high, increasing the equity portion; they also get depressed and sell equity when the markets are low. Having an IPS helps to maintain discipline and keeps the focus on the long term. Longevity stats show there is an approximate 25-per-cent chance that one of them will make it to age 95, assuming they are in normal health today."
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