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Geoff, 61, and Lily, 59, are hoping to draw on their investments in a tax-efficient way.Christopher Katsarov/The Globe and Mail

Geoff and Lily have an enviable problem – a $1.2-million capital gain in their investment portfolio that they need to realize over time to avoid an even bigger tax hit in the future.

Geoff is 61, Lily 59. They have two children, 24 and 25.

Geoff earns about $55,000 a year working in communications, while Lily makes about $99,400 in health care. They plan to retire next June with a budget of $84,000 a year after tax, plus another $26,000 a year for travel over the next decade or so.

Lily has a defined benefit pension plan that will pay about $39,600 a year (adjusted for inflation) if she retires at 60. Geoff has a defined-contribution plan with a market value of $1,150,000 that he will convert to a locked-in retirement account, or LIRA, when he retires.

Before retiring, they want to buy a $300,000 mobile home and renovate the family home. After they retire they plan to travel extensively.

Their questions: Can they afford to retire in a year or so with their planned spending budget? Can they afford the renovation and the mobile home? What is the most tax-efficient way to draw on their investments?

We asked Warren MacKenzie, a fee-only financial planner in Toronto, to look at Geoff and Lily’s situation. Mr. MacKenzie holds the chartered professional accountant (CPA) and certified financial planner (CFP) designations.

What the Expert Says

“Geoff and Lily have worked hard, spent wisely and saved their money in order to enjoy a comfortable retirement,” Mr. MacKenzie says. They were also fortunate to have shares in a company before it went public, and that helped them pay for their house and accumulate substantial investment assets.

They’re like many people in their 60s, the planner says. “After a lifetime of saving and being frugal, it’s hard to know when to shift gears and start to enjoy what you’ve worked hard to accumulate,” he says. “It is very common for retirees to unnecessarily fear running out of money in their old age.”

Based on reasonable assumptions (an inflation rate of 2 per cent and an average rate of return of 5 per cent), they’re already on track to leave a few million in dollars with today’s purchasing power to each of their two children, the planner says.

In 2036, when they’re in their 70s, their pension income (Canada Pension Plan, Old Age Security and Lily’s private pension) will be about $105,000 a year. If they’ve earned an average 4-per-cent return, they’ll still have more than $4-million in registered and non-registered investments.

If they make only 3 per cent on their portfolio, they will earn $120,000. Their cash flow would therefore be $225,000 a year - without dipping into their capital.

“At their planned target level of spending, the total annual outflow, including income tax, will be about $180,000, so even when they’re in their 70s their assets will continue to grow each year.”

In their joint investment account, Geoff and Lily have about $1.2-million of unrealized capital gains. After they are no longer working, they plan to sell sufficient securities each year to trigger about $120,000 of these capital gains.

To trigger $120,000 of capital gains they will sell securities with a cost of $100,000 and a market value of $220,000, Mr. MacKenzie says. Because capital gains are 50 per cent taxable and the shares are jointly owned, they will each have additional taxable income of $30,000 that year. By spreading the capital gains over 10 years, the marginal tax rate on the taxable portion of gains will be 31.5 per cent versus 53.3 per cent if all the capital gains were triggered in one year, the planner notes.

“For the next 10 years, and from a cash flow point of view, they can certainly live off their dividends, Lily’s pension and $120,000 in capital gains each year,” Mr. MacKenzie says. “They don’t need any RRSP money to meet their cash flow requirements.”

From the point of view of reducing income tax, though, they should also take some money from their RRSPs and RRIFs (registered retirement income funds) during these years when their taxable income is relatively low, the planner says. In the future, when they’re collecting their stock dividends plus CPP, OAS, pension and mandatory minimum RRIF withdrawals, they’ll be in a higher tax bracket. “So even though they don’t need to withdraw from their RRSPs to supply additional cash flow, it does make sense to withdraw registered funds when they’ll be taxed at a lower rate.”

In 2025, the first full year of their retirement, Geoff will turn his locked-in retirement account, or LIRA, now valued at $1,150,000, into a life income fund, or LIF, and take the minimum annual payment, Mr. MacKenzie says. Their combined cash flow that year will be about $340,000, made up of about $40,000 of dividends, $40,000 from Geoff’s LIF, $40,000 from Lily’s pension, and $220,000 from the sale of securities. Their cash outflow will be about $145,000, consisting of $84,000 for basic lifestyle plus $26,000 for travel and $35,000 for income tax. Their cash flow surplus of about $195,000 will be reinvested. They should continue to use their non-registered investments to fund their TFSAs.

They plan to delay taking CPP until age 70. They will take OAS at age 65.

As a do-it-yourself investor, Geoff has been following a “buy and hold” strategy and is pleased that he did not panic and sell out in the stock market downturns of 2008 or 2020, Mr. MacKenzie says. The portfolio’s current asset mix is 100 per cent in equities, which means they are taking more risk than necessary to achieve goals, which “never makes sense,” he adds. “A better strategy would be to be in a goals-based asset mix where they take only as much risk as necessary to achieve their goals.”

While Lily and Geoff don’t need life insurance, if they want to save income tax and create a lasting legacy, they could consider using some of their surplus funds to pay for a whole life insurance policy where the beneficiary is their favourite charity, Mr. MacKenzie says.

As well, while they are alive and can enjoy seeing the good they can do, over the next 10 years they could give their children annual inheritance advances, the planner says. This way their children would receive the funds while they are young and can most use the help. It would also give the children an opportunity to learn how to manage money.

“For the rest of their lives, income tax will be one of their biggest expenses,” Mr. MacKenzie says. To save income tax they could help the children fund their own tax-free savings accounts. They could also give each child $8,000 a year (lifetime limit of $40,000) to open a First Home Savings Account. Contributions to the FHSA are deductible for tax purposes and income earned in a FHSA is not taxable. The funds can be withdrawn tax-free when the money is used to purchase a first home.

Client Situation

The People: Geoff, 61, Lily, 59, and their two children.

The Problem: How to draw on their investments in a tax-efficient way.

The Plan: Spread capital gains over a decade. Begin drawing on RRSP income as soon as they retire to avoid paying higher tax on it later. Consider giving an advance inheritance to their children and gifts to charity.

The Payoff: Getting the most from their money.

Monthly net employment income: $9,655

Assets: Bank accounts $45,000; guaranteed investment certificates, term deposits $370,000; non-registered stock portfolio $1,400,000; non-registered mutual fund portfolio $810,000; his tax-free savings account $195,000; her TFSA $185,000; his locked-in RRSP $1,150,000; her RRSP $270,000; estimated present value of her DB pension $1-million; residence $1,100,000. Total: $6.5-million.

Monthly outlays: Property tax $560; water, sewer, garbage $95; home insurance $130; electricity $90; heating $45; maintenance, garden $70; car insurance $470; other transportation $370; groceries $650; clothing $100; gifts, charity $200; vacation, travel $1,000; dining, drinks, entertainment $500; personal care $100; sports, hobbies $20; subscriptions $40; other personal $300; doctors, dentists $100; drugstore $10; health, dental insurance $235; communications $265; RRSPs $575; TFSAs $1,010; pension plan contributions $550. Total: $7,485.

Liabilities: None.

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

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