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financial facelift

Lucy Lu/The Globe and Mail

It’s a familiar refrain from folks in their mid-50s with retirement in mind. Jake is age 55, Hannah 56. “We don’t plan to work past my wife’s 62nd birthday,” Jake writes in an e-mail. “We’ve both spent a lifetime of long hours and busy weeks and would really like to retire even sooner if possible.”

Jake earns about $80,000 a year in communications, while Hannah has a government job paying $64,000 a year. They have a mortgage-free house in Toronto and substantial savings. Hannah has a defined-benefit pension plan that will pay her $25,630 a year, including bridge benefit, falling to $17,560 a year at age 65.

“We have long aspired to be snowbirds,” Jake writes. Their plan is to spend their winters in a different locale each year “because we’ve always loved to explore.”

They are helping their son with his university education and would like eventually to help him with a down payment on a first home. Naturally, they are concerned about taxes and tax-efficient investing.

Their retirement spending goal is $60,000 a year after tax, indexed to inflation. Are they on track?

We asked Matthew Sears, a vice-president and financial planner at T.E. Wealth in Toronto, to look at Jake and Hannah’s situation.

What the expert says

Jake and Hannah are concerned about the income taxes they will pay when they retire and want to ensure their RRSP savings turn out to be “considerably more advantageous” than if they’d stuck the money under the mattress, Mr. Sears says.

“Along with tax-free compounding, the other benefit of an RRSP is lowering your average lifetime tax rate,” the planner says. Registered retirement savings plan contributions can be made during higher-tax years and then withdrawals can be made in low-tax years. Jake and Hannah should begin to withdraw from their RRSPs and/or locked-in retirement accounts as soon as they retire, he says. “This also helps smooth their taxes out throughout retirement.” Ideally, the funds in their tax-free savings accounts should be left to the last.

Mr. Sears’ projections assume they retire in January, 2027, live to age 95, and get maximum Canada Pension Plan and Old Age Security benefits at age 65. The assumed rate of return on their investments is 4 per cent and the inflation rate 2 per cent. He also assumes they continue to contribute $6,000 a year (the current maximum) to their TFSAs throughout their lifetime.

Once they begin collecting CPP and OAS, they will have surplus cash flow so they will be able to save additional funds, the planner says. These funds should first be contributed to their TFSAs, with any surplus funds invested in a taxable account.

Jake and Hannah also ask where they should invest now that they have maxed out their TFSAs. They have yet to open a taxable investment account.

“Their portfolio construction and investment choices could help with the tax implications of holding investments in a taxable account,” Mr. Sears says. For example, instead of holding interest-bearing securities in their taxable accounts, they could hold stocks and stock funds. Capital gains are taxed more favourably than interest income. As well, dividends on Canadian stocks are taxed more favourably than dividends on foreign stocks.

They have their accounts at several different institutions, some managed by an adviser and some managed by themselves, he notes. This can make it a bit harder to manage their asset mix. “Consolidating the accounts would help in simplifying their investment strategy.”

Their asset mix of their investment portfolio – excluding the substantial cash in the bank – is 21.1 per cent cash, 1.2 per cent fixed income, 55.1 per cent Canadian equities, 17.2 per cent U.S. equities and 5.4 per cent international equities.

“As they approach retirement, they should review their mix to ensure it is appropriate,” Mr. Sears says. They should also review whether they have the mix of equities, fixed income and cash suitable for when they need to start drawing from the account. “Their current portfolio is in line with a growth investor,” the planner says, “but they have missed some opportunities by leaving Jake’s TFSA mainly in cash.”

Depending on how much they would like to assist their son financially, they could consider gifting him funds he could contribute to his TFSA each year. They could gift him additional funds he could invest himself. The funds would be his, taxed in his hands, and eventually used toward the down payment for his first home.

Can they meet their retirement goal?

Easily, Mr. Sears says. In the first year they are both retired – 2027 – their lifestyle expenses will be $67,570 with inflation. They will need after-tax income of $33,785 each, or before-tax income of about $39,130. Hannah’s bridge benefit of $8,070 can be split with Jake, giving them a bit of flexibility as to whose account they draw funds from. “But they both need to draw from either their locked-in funds (LIRAs) and/or their RRSP accounts.”

To take funds from their LIRAs, they first will have to convert the LIRAs to life income funds, or LIFs. At the same time, they could unlock half the funds and transfer them to their RRSPs, the planner says. When a LIRA is unlocked, at least half of the money must go to a LIF, which has mandatory minimum withdrawals, and the other half can go to an RRSP or RRIF. By choosing to transfer the LIRA/LIF funds to the RRSP instead of a RRIF, they aren’t forced to take an annual minimum RRIF withdrawal, which could affect their tax planning if they don’t need all the RRIF funds.

They will still need to top up the cash flow with some additional RRSP withdrawals until they begin collecting CPP and OAS at age 65, the planner says. For example, in 2027 Jake will have minimum LIF withdrawals of $2,422. Hannah will have pension income of $25,630 and a minimum LIF withdrawal of $6,049. She should then top up her income by taking $7,451 from her RRSP account. Jake should top up his income by taking about $36,708 from his RRSP, Mr. Sears says.

When they are both collecting government benefits – in 2031 – they will have surplus cash flow of $27,280. “This continues to increase going forward,” Mr. Sears says. At age 95 they will leave an estate of $3.4-million – plus their house.

Can they afford to retire even earlier?

Mr. Sears ran projections with retirement beginning in 2023. “This is also achievable with their current $60,000 a year spending goal,” the planner says. They will leave investment assets of $1,909,530 – plus their house.

Client situation

The people: Jake, 55, Hannah, 56, and their son, 18

The problem: Can they afford to retire at Hannah’s age 62 or even earlier and still help their son with a down payment?

The plan: Continue saving first to their TFSAs, then to their RRSPs and finally to a taxable account. After they retire, convert their LIRAs to LIFs and begin drawing from their RRSPs to supplement Hannah’s pension.

The payoff: A clear view of how well set they are to achieve their financial goals.

Monthly net income: $9,130

Assets: Bank accounts $150,000; house $1.5-million; his RRSP $485,000; his LIRA $59,000; her spousal RRSP $236,000; her LIRA $286,000; his TFSA $90,000; her TFSA $97,000; registered education savings plan $76,000; estimated present value of her pension plan $136,285. Total: $3.1-million

Monthly outlays: Property tax $460; water, sewer and garbage $350; home insurance $115; utilities $220; maintenance, garden $190; car insurance $180; other transport $165; groceries $500; clothing $150; gifts, charity $175; vacation, travel $650; dining, drinks and entertainment $270; personal care $40; sports, hobbies $20; subscriptions $10, pet expenses $125; health care $160; life insurance $25; phones, TV, internet $400; TFSAs $1,000; her DB pension $505; professional association $70. Total: $5,780. Surplus goes to unallocated spending and saving.

Liabilities: None

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

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