At age 33, with their $1.6-million Toronto-area house purchase closing soon, Justin and Nicole are mapping out their future – mortgage payments, children in a couple of years and even their eventual retirement from the work force. Nicole is a commissioned sales person earning $100,000 a year after expenses. Justin is a sales manager earning $85,000 a year. When their house closes, they hope to rent out the basement apartment for $1,700 a month.
“Neither of us has a pension plan,” Nicole writes in an e-mail. “We want to save for retirement so it feels like we do have a pension,” she adds. Their goals are to have an effective – and tax-efficient – savings plan and to use Nicole’s corporation, set up last fall, as an income source during her future maternity leave, to help her parents financially if need be, and to save for retirement.
Should they contribute to their tax-free savings accounts first, or their registered retirement savings plans? Is Justin paying too much in investment management fees? Should Nicole save money in her corporation or take it out as salary? Will they have enough for a comfortable retirement?
We asked Andrea Thompson, a financial planner at Raymond James in Toronto, to look at Nicole and Justin’s situation.
What the expert says
With a $1.25-million mortgage, Justin and Nicole will be taking on a significant payment each month, Ms. Thompson says. They have both already used the federal Home Buyers’ Plan, so this option is not available.
Justin is making monthly RRSP contributions through his group plan at work of $168. His employer makes “matching” contributions of three times what Justin contributes, in this case $504 a month. “It is advisable for Justin to keep maximizing these contributions to get his employer match,” Ms. Thompson says. Justin has been topping up his RRSP with an additional $200 a month, plus he contributes $400 a month to his TFSA. Because Justin is at the 30 per cent marginal tax bracket, he should redirect the $200 a month that he has been making to his RRSP to his TFSA instead, the planner says.
“The couple will need financial flexibility over the coming years, requiring potential withdrawals from their accounts during maternity leaves, to handle unexpected expenses that often come with purchasing a new home, and to support their parents financially if and when required,” Ms. Thompson says. Any withdrawals made from TFSAs are tax-free, and Justin can contribute the amount withdrawn in any subsequent tax year when cash flow allows, she adds.
Justin is paying an average management expense ratio (MER) of 2.32 per cent in his RRSP and 2.25 per cent in his TFSA. His investment adviser has invested his accounts in mainly low-load mutual funds that carry penalties to redeem within the first three years.
“Justin would greatly benefit from a lower-cost portfolio,” Ms. Thompson says. “Simply reducing his average MER by one percentage point could result in an increase of $209,000 in his portfolio by age 65, assuming a 5 per cent rate of return,” she says. “He could consider working with an adviser who charges a lower management fee and uses more cost-effective products or investment options.” Or he could take advantage of a robo-adviser service that would use passive exchange-traded funds to drive a lower cost. “Nicole uses a robo-adviser and is happy with the service,” the planner notes.
Because her income is variable, Nicole has been contributing ad hoc to her TFSA and RRSP. She has been earning $100,000 a year net of expenses on average. She has been drawing a salary of $4,500 a month for lifestyle expenses, leaving the surplus earnings ($3,835 a month) inside the corporation, the planner says.
Should Nicole continue to save within her corporation or should she draw out all of her earnings as salary and contribute to her TFSA and RRSP?
“Using her corporation for investment savings in lieu of drawing extra money out to make personal TFSA and RRSP contributions will accomplish the following,” the planner says. First, the comparatively low 12.5 per cent combined Ontario/federal corporate tax rate would apply on any earnings that aren’t paid out as salary. On Nicole’s surplus earnings of $3,835 a month, she would be paying $480 a month in corporate tax, leaving $3,355 for investment. “This would have been the main purpose of incorporation for Nicole.”
Second, assuming Nicole is able to retain $3,355 a month inside the corporation, she will have built up a nice nest egg so she can continue withdrawing $4,500 a month during her maternity leave(s), the planner says.
Using a 5 per cent average rate of return, Nicole’s total corporate assets would accrue to $2.6-million by the time she plans to retire at the age of 60. Including her personal investments, she would have about $2.97-million.
If Nicole wasn’t incorporated or was drawing all of the income of $100,000 a year from the corporation, she would be able to make annual RRSP contributions of $18,000 a year. She would pay personal taxes of about $17,500, leaving her with net income of $64,500, Ms. Thompson says. Assuming she would require $45,000 for lifestyle purposes, this would leave her with $19,500 to save between her TFSA account (she has unused contribution room) and her non-registered account. At retirement, her total investment assets would have accrued to about $2.63-million, assuming a 5-per-cent rate of return and that no withdrawals have been made.
“Comparing the two scenarios, this represents an enhancement of almost $340,000 in savings using her corporation,” Ms. Thompson says.
Given that Nicole’s income could well be higher in future, the benefits of saving inside her corporation would be enhanced as her income potential grows, the planner notes. She would be able to enjoy the low 12.5 per cent corporate tax rate on earnings up to $500,000.
At the age of 65 Justin and Nicole could be entitled to maximum Canada Pension Plan benefits of $1,204 a month each in 2021 dollars, or a total of $2,408 a month, the planner says. Old Age Security benefits will provide another $615 a month each, although some of their OAS may be clawed back depending on their income level. Because retirement is a long way off for this couple, these estimates are by way of illustration only, she adds.
Justin and Nicole could consider purchasing a life annuity at retirement (or later) with a portion of their investments to create their own pension-like income stream, the planner says.
The people: Justin and Nicole, both 33
The problem: How to map out their financial future to cover current and future costs, and set aside enough savings in Nicole’s corporation to serve as a pension plan.
The plan: Begin a regular savings plan for Nicole using her corporation. Justin should continue to take advantage of his employer’s RRSP contributions, contribute to his TFSA and take steps to reduce his investment fees.
The payoff: A flexible game plan focusing on properly prioritizing their goals.
Monthly net income: $9,165 plus future rental income.
Assets: House $1.6-million; her RRSP $60,090; his RRSP $135,390; her TFSA $20,535; his TFSA $81,930; corporate account $70,000; corporate reserve for taxes $40,000; her stocks $22,890; his stocks $13,700; her cash $35,000; his cash $16,000. Total: $2.1-million
Monthly expenses: Mortgage $4,430; property tax $630; home insurance $75; utilities $140; maintenance $400; auto lease $350; other transportation $630; groceries $600; phone, internet, cable $190; vacations $800; entertainment, dining out, drinks $800; sports, hobbies $350; subscriptions $25; doctors, dentists $230; RRSP contributions $500; TFSAs $400. Total: $10,550
Liabilities: Mortgage $1.25-million
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