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financial facelift

Todd Korol/The Globe and Mail

Rose and Brad have enjoyed high-paying professional careers in the oil and gas industry, helping them to amass more wealth than they need for their lifestyle. Together, they earn about $500,000 a year before tax.

Brad, 60, likes what he does and plans to keep working to age 70. Rose, faced with the prospect of an alluring buyout package, is tempted to take it even though she’s only 48. She wonders to what extent the income she forgoes will be offset by lower income tax in the years ahead.

They have two teenage children, a mortgage-free house in the Calgary area, an investment property and substantial savings.

“My husband and I are confident that we have saved enough for retirement,” Rose writes in an e-mail. ”There may be an opportunity for me to take a voluntary severance package with my employer and we are interested in knowing what incentives there are for me to do so, such as a reduced tax burden in the future,” Rose adds. She expects she would get about 14 months’ salary.

If Rose leaves her job before she becomes eligible for early retirement at the age of 55, her defined benefit pension will not have vested and she will lose postretirement health benefits. “We would like to know if there are financial incentives … in the form of a reduced tax burden during retirement,” she writes. Their retirement spending goal is $100,000 a year after tax.

“What tax strategies are available to minimize our tax exposure in retirement?” Rose asks.

We asked Tom Feigs, a certified financial planner at Money Coaches Canada in Calgary, to look at Rose and Brad’s situation.

What the expert says

If Rose retires early, she will have “a significantly lower tax profile” than if she continues to work, Mr. Feigs says. Their original plan had been to retire together when Brad is 70 and Rose is 58. Her Old Age Security benefits would be clawed back by 90 per cent rather than clawed back fully, the planner adds. “This would also help Brad, who could split his pension income with Rose once he retires,” Mr. Feigs adds. This would secure about a third of his OAS benefits.

If Rose retires early, her effective income tax rate would fall to about 18 per cent for the rest of her life, the planner says. This compares with a rate of 30 per cent if she keeps working, falling to 29 per cent at 71. The OAS clawback is included in his calculations as a tax in the form of reduced government benefits.

“Age 71 is an effective tax-planning milestone because government entitlements have started paying out by then and all tax strategies have been implemented,” Mr. Feigs says. The OAS clawback starts at $79,845 of an individual’s taxable income. After that, 15 per cent of each taxable dollar above this threshold is taken back as reduced OAS benefits. The OAS benefit is reduced to zero when an individual’s previous year taxable income is more than $131,000 (indexed to inflation).

If Rose works to the age of 58, Brad’s effective tax rate would be 35 per cent while he is working, and 31 per cent when he retires. Each of them would face the full clawback of their OAS benefits.

If Rose takes a buyout this year, Brad’s tax rate would be the same 35 per cent while he is working, falling to 27 per cent at the age of 71. Brad’s effective tax rate would be lower because he would be able to split income with Rose.

“Rose can choose to retire early irrespective of other factors because their significant wealth assures this,” the planner says. “She wants to know how much this decision might reduce her tax burden.”

Mr. Feigs compares nine years of early retirement versus the same nine years employed.

Rather than earning more employment income for nine years at $200,000 a year, Rose’s early retirement income would come from her personal registered retirement savings plan and her locked-in retirement account (which will have been converted to a registered retirement income fund and life income fund, respectively). This would result in lower effective tax rates over the long term, the planner says. She would pay $628,000 less in income tax over those nine years, Mr. Feigs says.

“Based on the above analysis, I would advise Rose to go ahead with the voluntary severance offer,” Mr. Feigs says.

Rose anticipates the voluntary severance will be the equivalent of 14 months of income. She may be allowed to split the income over two years (2021 and 2022). She should inquire to see whether she can delay taking at least half of it until next year, the planner says. She should maximize her RRSP contributions this year and next.

In preparing his retirement outlook, the planner assumes the couple earn a rate of return on their investments of 5 per cent a year after fees, an inflation rate of 2 per cent a year and that both Rose and Brad live to age 95. Brad continues to earn $300,000 a year gross until he retires at age 70. He continues to contribute the maximum to his RRSP and they both top up their tax-free savings accounts annually.

Rose’s defined benefit pension plan will pay $26,100 a year, indexed to inflation, starting at the age of 62, the planner notes. In addition, she has a defined contribution pension plan (her locked-in retirement account, or LIRA) from a previous employer.

To take advantage of the lower tax rate she would enjoy if she takes a buyout, Rose should draw down both her personal and group RRSPs (approximately $50,000 annually starting in 2023) so they are both depleted by the time she begins collecting her defined benefit pension at 62, Mr. Feigs says. “This may seem counterintuitive as they could easily live on Brad’s income alone,” the planner says. The surplus funds can be reinvested in the non-registered account.

Once Brad retires, “the strategy is to replace his employment income with withdrawals from Brad’s RRSP (converted to an RRIF) while smoothing his tax profile over as many years as possible,” the planner says. Brad could start withdrawing at $90,000 annually and increase it each year by 2 to 3 per cent to keep up with inflation.

Mr. Feigs recommends Rose start drawing Canada Pension Plan benefits at age 60 and Old Age Security benefits at 65. She would have a reduction in CPP benefits but it would help spread out her taxable income over her entire retirement period, the planner says. Brad would start both his CPP and OAS after he retires at the age of 70.

Client situation

The people: Brad, 60, Rose, 48, and their two children, 12 and 14

The problem: To what extent would Rose’s lower income and higher OAS benefits offset the income she would lose by retiring early?

The plan: Rose retires this year and begins drawing down her personal RRSP and her defined contribution pension from a previous employer so that they are depleted by the time she begins drawing her DB pension at age 62.

The payoff: A way to measure the potential reduction in tax if she takes a buyout.

Monthly net income: $26,000

Assets: Bank accounts $60,000; her DC pension plan/LIRA $155,000; her RRSP $315,000; his RRSP $1-million; her TFSA $65,000; his TFSA $75,000; non-registered investment accounts $1.5-million; RESP $100,000; residence $900,000; rental real estate $310,000. Estimated present value of her DB pension $540,000. Total: $5.02-million

Current monthly outlays: cellphones $150; utilities/internet/subscriptions $1,000; property/vehicle insurance $700; life insurance $300; property tax $700; vehicle repairs $200; home maintenance $200; groceries $2,000; entertainment $500, allowance $200; dining out $750; clothing $200; gifts $100; computer/electronics $100; charity $100; sports $150 vacation/travel $500; vet $100; other $550; RRSPs $4,000; TFSAs $1,000; RESP $500; non-registered savings $12,000. Total: $26,000.Savings capacity drops if Rose chooses the buyout.

Liabilities: Mortgage on rental property $100,000

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