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Calvin and Carol.The Globe and Mail

A decade or so ago, Calvin and Carol inherited a farm property that has risen substantially in value over the years. Even before the windfall, they were in solid financial shape. They raised three children, paid off their house and bought a family cottage.

“Our house and our RRSPs were all through savings,” Calvin writes in an e-mail. “We contributed as much as we could each year and were mortgage-free on the house by the time our kids went off to university.” The inheritance paid off the mortgage on the cottage.

Today, at the age of 58, they are debt free and proceeding as originally planned. They hope to pass on to their children an inheritance of $1-million each.

With a net worth on paper of $5.2-million – most of it illiquid real estate – Carol and Calvin are wondering whether they can retire soon and how long they can hang onto their small-town Ontario house and nearby cottage. In the meantime, they plan to give each of their three children a $100,000 down payment on a house.

Calvin brings in $105,000 a year in financial services while Carol earns $47,000 a year in communications. They also have some income from the farm. They recently sold part of the property and have about $800,000 sitting in the bank.

“We think we have enough money to fund our retirement needs, but want to know that we can bridge the shortfall in living costs from investments until we start collecting Canada Pension Plan and Old Age Security,” Calvin writes. He plans to retire at the age of 60 and Carol at the age of 62. He will be entitled to a defined benefit pension of $15,600 a year; she will get $7,200 a year. Neither pension is indexed. Their retirement spending goal is $90,000 a year after tax. They also ask about investing and tax planning.

We asked Warren MacKenzie, head of financial planning at Optimize Wealth Management in Toronto, to look at Calvin and Carol’s situation. Mr. MacKenzie holds both financial planning and accounting designations, including chartered professional accountant (CPA).

What the expert says

With a net worth of about $5.2-million, Calvin and Carol will certainly enjoy a financially secure retirement, Mr. MacKenzie says. But with almost 50 per cent of their capital tied up in a farm property, they wonder whether they will have sufficient cash flow until CPP and OAS payments begin.

They plan to hold onto the property for about 15 years, the planner says. When they sell it, they expect to add about $3-million to their non-registered investment portfolio. That amount assumes the property rises in value in line with inflation and is after subtracting capital gains tax.

Calvin has a 43-per-cent marginal tax rate, so it makes sense for him to maximize his RRSP contribution while he is working, the planner says. But upon retirement, when he is 60, Calvin should turn his RRSP into a registered retirement income fund and use withdrawals from the RRIF as a source of funds until OAS and CPP kick in. “Since Calvin will have no other source of income during these years, he will be able to withdraw these RRIF payments at a relatively low rate of income tax.”

Because of his larger RRSP and higher pension income, Calvin will be in a higher income tax bracket than Carol. Later, when the proceeds from the sale of the farm are invested, some or all of his OAS will be clawed back. “At that time they should consider a spousal loan to split the income, thereby moving more income to Carol, where it will be taxed at a lower rate, while also reducing Calvin’s income so the OAS clawback is minimized.”

They do not have tax-free savings accounts, so to minimize tax on investment income, one of the first things they should do is to open TSFAs in each of their names and move $63,500 from their high-interest savings account to each of their TSFAs, Mr. MacKenzie says. That is the maximum allowed for people who have not yet contributed.

Their risk profile suggests that about $400,000 of their liquid capital be kept in high-interest savings accounts to provide for the down payments they want to give to their children, as well as their own living expenses to the age of 65, the planner says. Their TFSAs and the balance of their cash should be in a well-diversified portfolio of bonds and dividend-paying equities.

Calvin and Carol know the distribution of an estate can sometimes lead to disagreements among heirs, so they plan to sell the family cottage as well as the farm before they pass away. If, in time, they find they have a substantial surplus, they could consider giving their children some of their inheritance in stages, the planner says. That way, the parents would enjoy seeing the good their money can do. The children would get the money when they are younger and likely to need it most.

As well, “It would give the parents an opportunity to see if the inheritance is being used wisely,” Mr. MacKenzie says. It would give the heirs an opportunity to learn about investing “and make their mistakes with small amounts of money rather than with the entire inheritance.” Leaving a smaller estate would also reduce income tax and probate fees.

In terms of investments, about 10 per cent of the couple’s net worth is in large capitalization equities, about 67 per cent is in real estate and 23 per cent is in cash or guaranteed investment certificates (GICs). This asset mix provides good inflation protection, and given that the real estate is expected to generate capital gains, it is relatively tax-efficient, Mr. MacKenzie says.

“However this makes the portfolio overly concentrated in real estate and therefore largely illiquid,” the planner says. With so much of their assets in Canada, the couple have little in the way of protection against the possibility of a fall in value of the Canadian dollar. This could hurt them if they plan to spend winters down south.

In total, they have $715,000 in RRSPs. Calvin’s $515,000 RRSP is 100 per cent in equities and Carol’s $200,000 RRSP is 100 per cent in GICs. “Taken as a whole, their RRSPs are 72 per cent invested in equities and 28 per cent in GICs.”

With the same overall asset mix, they could change Calvin’s RRSP to include some fixed income and Carol’s to include some equities. This would give Calvin some “dry powder” so that in the next market downturn he would be able to strategically rebalance by adding to his stock holdings when they are less expensive.

They ask whether they should defer taking their CPP until the age of 70, Mr. MacKenzie says. “The answer – assuming they are both in good health and are likely to live well into their 80s – is yes.” Because they have other sources of income, it makes sense to delay the start of CPP until 70. By doing so, their monthly benefits will be 42 per cent higher than if they started at 65.

Client situation

The people: Calvin and Carol, both 58, and their three children

The problem: How to best finance their early retirement years and when to start collecting CPP and OAS benefits.

The plan: Open TFSAs, rejig long-term savings to get a better balance, consider giving children part of their inheritance when the farm property is sold.

The payoff: A smooth transition of wealth through the generations.

Monthly net income: $10,415

Assets: Bank accounts $801,000; GICs $100,000; his RRSP $515,000; her RRSP $200,000; estim. present value of his DB pension plan $210,000; estim. present value of her DB pension plan $100,000; residence $450,000; cottage $350,000; farm property $2.5-million. Total: $5.2-million

Monthly outlays: Property tax $320; utilities $250; home insurance $165; maintenance $160; garden $85; transportation $685; groceries $720; clothing $210; gifts, charity $835; vacation, travel $1,250; dining, drinks, entertainment $1,460; personal care $70; pets $85; sports, hobbies $165; subscriptions $50; other personal $85; doctors and dentists $290; phones, TV, internet $200. Total: $7,085

Liabilities: None

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Some details may be changed to protect the privacy of the persons profiled.

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