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Mike and Miriam want to arrange their finances to leave their daughter as much as possible without diminishing their own retirement plans.Tijana Martin/The Globe and Mail

After years of working, saving and investing, Mike and Miriam are approaching their “de-accumulation” years. He is 63, she is 61. Mike plans to continue working part time for awhile longer but Miriam already has retired. From now on, their focus will shift from saving to gradually drawing down their savings, hoping their money will last a lifetime and more.

They needn’t be concerned. They have $2.5-million in their various saving and investment accounts, plus they own their $750,000 Toronto-area house outright. Because neither has a guaranteed work pension, their investment portfolio will serve as their pension plan. Their retirement plans include travelling extensively, renovating their house and helping their daughter to buy a home of her own some day.

They wonder how to structure their retirement income in a tax-efficient way, when to take Canada Pension Plan and Old Age Security benefits, and when to convert their registered retirement savings plans (RRSPs) to registered retirement income funds (RRIFs). They are concerned that their OAS benefits will be clawed back.

We asked Warren MacKenzie, head of financial planning at Optimize Wealth Management in Toronto, to look at Mike and Miriam’s situation.

What the expert says

First, Mr. MacKenzie looks at the couple’s investments. Mike is a do-it-yourself investor, he says. “It’s a hobby he enjoys, and he has been successful in building a $2.5-million portfolio of registered and non-registered investments.”

Mike and Miriam are financially secure. Mr. MacKenzie’s analysis shows that even if they live to be 100 and average only a 2-per-cent rate of return on their investments, they’ll still be able to leave their daughter more than $2-million. That includes a reserve of $500,000 for possible nursing home costs later in life.

“The most serious flaw in their investment strategy is that they are taking far more risk than is necessary to achieve their lifestyle goals,” the planner says. Their current asset mix is 75-per-cent common stocks, 10-per-cent preferred shares and 15-per-cent cash and fixed income.

“Given that they do not need a high return to maintain their lifestyle – they are spending about $80,000 a year, including planned vacations, after tax – this aggressive asset mix only makes sense if one could be certain that markets will not experience a serious drop any time in the near future,” Mr. MacKenzie says. “Many experienced investors are concerned that the end result of COVID-19 will be a serious stock market crash.”

If this happened when Mike and Miriam were beginning to make monthly withdrawals (from their RRSPs/RRIFs) to maintain their lifestyle, “they may experience sequence risk; that is, they would effectively lock in losses by having to sell stocks to fund their lifestyle when prices are low,” he says.

Typically, people’s tolerance for risk is lower after they retire and are relying almost entirely on investment income to cover their lifestyle needs, the planner says. This aversion to risk could cause Mike and Miriam to make poor investment decisions during a significant market downturn.

To better diversify their investment portfolio, they may want to hire an investment counsellor that can provide them with securities offered to institutional investors and high-net-worth individuals, the planner says. This might include private debt and equity funds that do not trade on public markets.

“These assets classes are not as liquid as common stocks (not as easily bought and sold), but historically they have had the effect of increasing the average rate of return while minimizing portfolio volatility,” the planner says.

As to their government benefits, there are two reasons why it makes sense to delay the start date until the age of 70 in order to receive the higher monthly payout, the planner says. First, they don’t need the money now. Second, they’re in good health and based on family history, it’s reasonable to expect they will live well into their 80s. The higher annual payout will increase the size of the estate. If Mike starts CPP at 70, the monthly payments would be 42 per cent higher than if he started at the age of 65.

At 65, Mike should convert $300,000 of his RRSP to a RRIF, Mr. MacKenzie says. Miriam should convert an equal amount (all of her RRSP and $163,000 from her locked-in retirement account) to a RRIF and life income fund (LIF). “By so doing, they will each get the $2,000 federal pension tax credit, and they will each have enough income to take full advantage of the low average tax rate of 14.4 per cent on the first $44,740 of taxable income.” The marginal tax rate on the next $1,000 of income rises to 20 per cent.

In future this will reduce the probability of their OAS benefits being clawed back because the early RRIF withdrawals will reduce the size of their RRIFs. This means the mandatory minimum RRIF withdrawals will be lower.

Finally, estate planning for their 17-year-old daughter. “Something they should do immediately is ensure that their wills are up to date, and that they have confidence in the ability of their executor to administer the estate,” the planner says. They could provide in their wills for a testamentary trust and appoint a trustee to manage their estate on behalf of their daughter until she reaches the age at which they are comfortable she will be ready to inherit a large estate, he says.

Instead of planning to leave a large estate when they die, they might want to consider giving their daughter advances on her inheritance, Mr. MacKenzie says. They intend to help her buy a house, but they may want to go further. They would get to enjoy seeing the good they can do, they will be left with less investment income and so will pay less in income tax, and their daughter could get some experience in managing money.

Part of the reason they are seeking higher returns is that they want to leave as much as possible to their child, Mr. MacKenzie says. “If this is their goal, there is a better, more income-tax-efficient, and more certain way to achieve it,” he says. The better way would be to use tax-exempt permanent life insurance.

With whole life insurance, they would pay less income tax. That’s because their surplus capital will be in a tax-exempt insurance policy rather than a taxable investment account. With lower investment income, they would be less likely to have their Old Age Security benefits clawed back, and the child’s inheritance would be guaranteed. As well, the inheritance could be significantly larger, Mr. MacKenzie says.

Client situation

The people: Mike, 63, Miriam, 61, and their daughter, 17

The problem: How to arrange their financial affairs in a tax-efficient way so as to leave as much as possible to their only child without diminishing their own retirement lifestyle.

The plan: Better diversify their portfolio to lower investment risk. Put off collecting government benefits to the age of 70. Consider advancing their daughter part of her inheritance while they are still alive.

The payoff: Achieving their most important goals and a stronger financial foundation.

Monthly net income: $7,085

Assets: Bank accounts $128,000; GICs $205,000; stocks $903,000; his TFSA $85,000; her TFSA $85,000; his RRSP $500,000; her RRSP $137,000; child’s registered education savings plan $103,000; residence $750,000; her locked-in retirement account (from work) $479,000. Total: $3.38-million

Monthly outlays: Property tax $350; home insurance $100; utilities $360; home maintenance $265; car insurance $300; fuel $460; vehicle maintenance $300; groceries $1,000; clothing $85; charity $200; entertainment $250; sports, hobbies $625; doctors, dentists $125; health and dental insurance $475; life insurance $50; communications $310; TFSA contributions $1,000. Total: $6,255. (Spending does not include gifts and travel.) Surplus $830

Liabilities: None

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