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Michael and Mary's retirement spending goal is $97,000 a year after tax.

JOHN WOODS/The Globe and Mail

After raising two children and paying off their house and cottage, Mary and Michael have amassed substantial savings and investments, thanks in part to Michael’s second career as a self-employed consultant. Michael is 61, Mary is 58 and retired.

Now, with $550,000 in his corporate account, Michael would like to greatly reduce his workload. Their goal is for an active retirement with summers at the cottage, winters skiing in British Columbia and travelling abroad in the shoulder seasons, Michael writes in an e-mail. He has a defined benefit pension from his previous employer that is paying $60,095 a year, falling to $57,745, indexed to inflation, when the bridge benefits ends at the age of 65. He is splitting the pension income with Mary.

Michael and Mary wonder when they should start taking Canada Pension Plan and Old Age Security benefits, which assets to draw on first to achieve tax efficiency, and how long their savings will last. Their retirement spending goal is $97,000 a year after tax. They’re also interested in strategies to minimize tax “when we pass on the cottage and investments to the kids.”

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We asked Jeffrey Ryall, a financial planner and associate portfolio manager at Cardinal Capital Management Inc. in Winnipeg, to look at Michael and Mary’s situation. Mr. Ryall also holds the chartered financial analyst designation.

What the expert says

Michael and Mary are in a great financial position heading into Michael’s second retirement, with their goals being fully funded to the age of 95 and beyond, Mr. Ryall says. The strength of their financial position can be attributed to their work pensions, government benefits and their savings relative to their lifestyle needs. In addition to Michael’s defined benefit pension, Mary has a defined contribution pension with a market value of $61,000.

The biggest risk to their retirement plan is the premature death of Michael, which would result in a reduction of his DB pension payable to Mary, as well as the loss of his government benefits. Mary would get two-thirds of Michael’s pension. “Aside from this risk, their main obstacles are managing tax efficiency throughout retirement and estate considerations.”

First, Mr. Ryall looks at the couple’s income sources. Michael’s pension income covers half of their lifestyle needs of $97,000 after tax. Upon Michael’s retirement from consulting, they will have to draw additional income of $60,500 to cover their lifestyle spending needs. Mary should start drawing an annual income of $41,500 (before withholding tax) from her DC pension or registered retirement savings plan, the planner says. Until they start collecting government benefits, the remainder of their lifestyle needs will be drawn from their corporation ($10,500 a year) and their non-registered account ($8,500).

The most significant retirement decision for Michael and Mary is when to start their CPP benefits, Mr. Ryall says. “This is a personal decision and is often influenced by cash-flow needs, and health and family history.”

Their corporation could also play a role in this decision, depending on whether they plan to wind it down over the next 10 years or so to save taxes and legal fees. If they withdraw the corporate funds while collecting government benefits, it would push them into a higher tax bracket and possibly result in an OAS clawback, the planner says. “The ideal strategy would be one or the other: corporate withdrawals; or CPP and OAS plus RRSP withdrawals.”

The trade-off in winding down their corporation early is their RRSPs continue to grow tax deferred so when they begin making mandatory minimum withdrawals, their minimum withdrawals exceed their needs, increasing their tax liability.

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An alternative, where they would tap into their RRSPs earlier, would be to keep the corporation and shift their corporate investments from bank deposits to at least some dividend-paying stocks, Mr. Ryall says. “If they are comfortable with some investment risk, they could consider using an estate freeze, or partial freeze, to transfer the corporation’s future growth to their beneficiaries in a tax-efficient manner.” If Michael and Mary are risk-averse, they could consider using corporate-owned permanent insurance to efficiently transfer wealth to their estate, he says.

By postponing CPP benefits to the age of 70, Mary and Michael would get an additional 8.4 per cent annually, up to a maximum of 42 per cent more. They could also defer OAS benefits from 65 to 70, gaining an additional 7.2 per cent annually, up to a maximum of 36 per cent more. “A dual deferral of CPP/OAS increases their benefits substantially, so that upon Mary’s 70th birthday, their entire retirement lifestyle would be fully funded solely from CPP, OAS and Michael’s DB pension,” Mr. Ryall says.

Again, the greatest risk to their financial situation is the premature death of one of the spouses, the planner says. The risk is slightly greater if Michael dies first because the survivor benefit of his DB pension would be reduced, his OAS would stop and the CPP survivor benefit top up would be limited to the survivor’s maximum CPP entitlement. Michael’s life insurance – about $290,000 – could help alleviate some of the concerns, but coverage declines as he approaches age 73.

As for their investments, Mr. Ryall assumes a moderate nominal rate of return of 4 per cent (2 per cent a year after inflation), more than sufficient to meet their needs, he says. Their RRSPs are invested mainly in stocks. His forecast assumes they both keep contributing the maximum each year to their tax-free savings accounts. Prioritizing RRSP withdrawals early in retirement reduces future estate taxes upon the second spouse’s passing, he says. If they decide to hold on to the corporation, the planner recommends they tweak their investments to hold fixed-income assets in their RRSPs and growth-oriented investments in their TFSAs and corporate account.

With these assumptions, the future value of the estate at Mary’s 95 would be $4.1-million, or $2-million in today’s dollars, Mr. Ryall says. The projected estate surplus raises the question of whether they want to help their children now, or maximize their estate. As well, the planner cautions the couple against an overemphasis on tax-efficiency.

Another significant estate tax consideration relates to owning two properties, the family home and the cottage, he says. The cottage will be subject to capital gains tax when the estate is settled. “Cottage succession planning can be complicated, given sentimental attachment, time/maintenance commitments, and financial obligations of the heirs,” Mr. Ryall says. “I would encourage them to have open family discussions from time to time because plans can change as the children’s lives evolve.”

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Client situation

The people: Mary, 58, Michael, 61, and their two children, 25 and 29

The problem: When should they begin collecting government benefits? How can they withdraw their savings and arrange their estate in the most tax-efficient way?

The plan: Withdraw from the RRSPs first. Consider postponing CPP and OAS to the age of 70, especially if they plan to wind down the corporation. Decide whether they would like to help their children financially now or leave a larger inheritance.

The payoff: A good understanding of the pros and cons of their decisions.

Monthly net income: $7,250 or as required

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Assets: Non-registered $163,000; her TFSA $86,000; his TFSA $82,000; her RRSP $406,000; his RRSP $315,000; her DC pension $61,000; estim. present value of his DB pension $1.24-million; corporate account $550,000; residence $450,000; cottage $400,000. Total: $3.75-million

Monthly outlays: Property tax $470; home insurance $155; utilities $365; maintenance $170; vehicle lease $640; other transportation $980; groceries $1,000; clothing $155; vacation, travel $2,000; dining, drinks, entertainment $350; personal care $80; club membership $60; pets $80; subscriptions $30; health care $90; health insurance $30; life insurance $70; phones $250; TV, internet $180. Total: $7,155. (TFSA contributions come from savings, investments.)

Liabilities: None

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

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