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financial facelift

Freddie, almost 60, plans to support his children through college and university while in retirement.Christinne Muschi/The Globe and Mail

Freddie is at a turning point. He’ll be 60 this year and he’s decided to leave his professional career – and $148,700 salary – to travel, teach part-time and do some volunteer work, including helping out with the local hockey club. He’ll get a year’s bonus.

It’ll be a big change, shifting from saving to spending. The numbers tell the story. Freddie has amassed $3.8-million of assets, yet he spends less than $30,000 a year – and that’s with joint custody of his two teenage children.

“I have been investing in dividend stocks for the past decade to collect the cash flow,” Freddie writes in an email. “Thank you John Heinzl.”

His main concern is how to draw down his savings in the most tax-efficient way. He plans to support his children through college and university and give them a gift when they graduate.

He doesn’t plan on that being his last contribution to their future. “Will I have enough to live to 93 and leave [an inheritance] to my children?” Freddie asks.

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

What the Expert Says

With a $3.8-million net worth, Freddie is in the top two per cent of all Canadians, Mr. MacKenzie says. While Freddie has earned an above-average salary over the years, “the real key to his financial security is the fact that he saves a lot each month.”

Freddie’s questions are mostly related to maximizing investment efficiency and minimizing income tax, the planner says. “This shows that, after years of saving and building wealth, it’s difficult for him to shift gears. He has to recognize that he is now at a time of his life when he can start to spend more.”

Freddie’s retirement spending goal of $80,000 per year after tax is more than twice what he is spending now. So even if he lives to age 100, he is likely to leave well over $1-million in dollars with the same purchasing power as today to each of his two children, Mr. MacKenzie says.

If it is important for him to minimize income tax and be certain about the amount he leaves his heirs, Freddie could also consider using a whole life insurance policy, where the death benefit grows tax-free and the amount is guaranteed.

For Freddie, it would make more sense to give his two children advances on their inheritance now while they are young and need the money to get started, Mr. MacKenzie says. “By giving them money in stages, Freddie will reduce his taxable income and be able to enjoy seeing how his gift helps his children.” A gift of money may also give his children experience in investing.

If Freddie’s goal is to maximize the size of his estate, there are several steps he should consider, the planner says.

In the years before he collects Canada Pension Plan and Old Age Security benefits, his only income will be the interest and dividends from his non-registered investments. He will be in a lower income tax bracket than after he begins collecting CPP, OAS and the required withdrawals from his registered accounts. In those early years, he should fund all his living expenses with taxable withdrawals from his registered accounts, the planner says. By drawing down his registered accounts, the amount of tax he will eventually have to pay on the mandatory withdrawals (starting in the year he turns 72) will be lower because there will be less money in the accounts.

“If he delays withdrawing from his RRSP until he needs to turn it into a registered retirement income fund (RRIF) at age 71, the RRIF will be larger, and the larger payments will come into income at a time when he is also collecting CPP and OAS, the planner says. “This will put him into a higher tax bracket and into the OAS clawback zone.”

Freddie has $660,000 in defined contribution pension plans ($600,000 from a previous employer and $60,000 with his current employer). These can be converted into a locked-in RRSP and then to a life income fund, or LIF, the planner says. He also has $833,000 in a personal RRSP.

“Because he wants to maximize flexibility and liquidity, Freddie should first convert his defined contribution pension plan to a LIF immediately upon retirement and withdraw the maximum amount allowable,” Mr. MacKenzie says. (A LIF has less flexibility than a RRIF because with a LIF there is both a minimum and maximum amount that can be withdrawn each year.)

Depending on the rate of return and the balance of the LIF at the end of 2023, it is projected that, in 2024, Freddie will be able to withdraw about $45,000 from it, the planner says. In addition he should convert his RRSP to a RRIF because he will need the additional money. He could withdraw about $30,000 a year from his RRIF. He will also take about $45,000 a year from his non-registered/cash account.

“Altogether this will be sufficient to cover his projected living expense of $80,000 a year, a tax-free savings account contribution of $6,500 and projected income tax of $33,000.” By the early conversion to a RRIF, at age 65 he’ll get the benefit of the federal pension deduction.

Given that Freddie has more than adequate liquid resources, and assuming that he expects to live until at least his mid 80s, he should delay CPP and OAS until age 70. By doing this, his CPP payments will be higher by 42 per cent and his OAS payments will be higher by 36 per cent.

With his investments, Freddie’s asset mix is 85 per cent in mostly individual Canadian stocks, 6 per cent in bonds and 9 per cent in cash. As such, Freddie is exposing his savings to more stock market risk than is necessary, the planner says. “One important decumulation strategy is to have an asset mix which will provide the required cash flow each year without having to sell equities when they have fallen in value,” Mr. MacKenzie says.

Freddie is considering giving each of his children a gift of $10,000 upon graduation. He could help them more financially, while also saving income tax, by arranging to give each child an advance inheritance of $250,000 toward the purchase of a first home, the planner says. This could be done after they are employed and demonstrate they are financially responsible.

“By removing $500,000 from his non-registered account, he will reduce his taxable income by about $25,000, (assuming an average rate of return of 5 per cent),” the planner says, “and at his average marginal tax rate of 45 per cent, it would reduce his tax by more than $10,000 per year.”

Client Situation

The Person: Freddie, 59.

The Problem: How to draw down his savings in a tax-efficient manner. Can he afford to support his children through university, give them a gift on graduation and leave an inheritance?

The Plan: Begin drawing on his registered savings immediately upon retiring, converting his locked-in funds to a life income fund and a registered retirement income fund. Give children an advance inheritance from his non-registered accounts.

The Payoff: Efficient use of his considerable assets.

Monthly net income: $8,570 (after tax, CPP, EI, group benefits)

Assets: Cash awaiting investment (inheritance), $320,000; non-registered investment accounts, $1,200,000; TFSA, $100,000; RRSP, $833,000; defined contribution pensions, $660,000; registered education savings plan, $220,000; residence, $500,000. Total: $3.8-million.

Monthly outlays: Property tax, $230; home insurance, $100; heat and hydro, $150; maintenance and garden, $200; transportation, $85; groceries, $500; children’s expenses, $100; clothing, $100; gifts and charity, $200; vacation and travel, $150; dining, drinks and entertainment, $110; personal care, $10; sports and hobbies, $100; subscriptions, $130; communications, $210; RRSP and TFSA, $930; pension plan contributions, $620. Total: $3,925. Surplus went to saving and unallocated spending.

Liabilities: None.

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