William and Belle live in a part of the country – small-town Alberta – where a person with a good job and a stay-at-home spouse can raise a child, pay off the family home and amass investment assets of more than $1-million by the age of 55.
William earns $99,205 a year. Their investments bring in another $28,000 a year in dividends, which they reinvest. As well, they have $9,600 a year in net income from a rental condo. The condo is financed by a $114,000 line of credit that William aims to pay off before he retires.
His goal is to retire in five years with an after-tax income of $60,000 a year – without ever having to touch their capital. He is concerned about leaving an estate for their son, who is in his early 30s, and their grandchildren. Although Belle is 67, she has postponed applying for government benefits in order to qualify for a higher payout later.
William manages the couple’s investments, which are almost entirely dividend-paying blue-chip stocks, diversified internationally, that he buys through a discount broker.
“Are we on track?” William asks in an e-mail. “Will we have enough cash flow without touching the principal?” He wonders whether he might be able to retire even earlier.
We asked Ron Graham, an independent financial planner and chartered professional accountant based in Edmonton, to look at Belle and William’s situation.
What the expert says
William and Belle have about $998,000 saved for retirement in their various investment accounts, Mr. Graham says. All of their extra income goes toward paying down the line of credit they took to buy the rental condo. As well, he contributes to a spousal RRSP for Belle, and to both of their tax-free savings accounts.
When William turns 60, he will be entitled to a defined benefit pension of $713 a month, assuming he chooses a 100-per-cent survivor benefit, the planner says. He will get $689 from the Canada Pension Plan, and when he turns 65 in five years, $614 a month in Old Age Security. If Belle defers her government benefits three more years to the age of 70, as she plans to, she will get $494 from CPP and $833 from OAS.
When William retires at the age of 60, they could convert their RRSPs (including Belle’s spousal RRSP) to registered retirement income funds. William could convert his locked-in retirement account from a previous employer to a life income fund. Minimum withdrawals from the RRIFs and the LIF would give them about $2,500 a month. William will qualify for the $2,000 federal pension tax credit because it is monthly income from an employer-sponsored defined benefit plan. As well, because Belle is over the age of 65, she will be entitled to the $2,000 pension income tax credit on her RRIF withdrawals.
Once William starts his pension, he can share up to 50 per cent of pension with Belle. This would allow her to use all or part of her personal exemption and her age exemption. Any unused portion of Belle’s pension income-tax credit, personal exemption and age exemption could be transferred to William.
Another advantage to Belle converting her spousal RRSP to a RRIF has to do with income attribution. Because William is still contributing to the spousal RRSP, any withdrawals by Belle will be taxed in William’s tax return up to the amount contributed for the past three years. By transferring her spousal RRSP to a spousal RRIF, Belle can avoid this income attribution.
Three years after William has stopped contributing to the spousal RRSP for Belle, she should consider drawing more than the minimum from the spousal RRIF, the planner says. “This will allow the income to be taxed at her lower 25-per-cent tax rate.” If Belle were to predecease William, the opportunity for income-splitting would end. William’s income would surpass the OAS clawback threshold of $77,580 a year and he would be in the 40.9-per-cent tax bracket.
“So it would be better for Belle to withdraw as much as possible from her RRIF at her lower tax rate,” Mr. Graham says.
Belle’s extra income could be used to pay down the line of credit more quickly or to invest in her non-registered account in Canadian dividend-paying stocks. The dividends would have an effective tax rate of zero because the dividend tax credit would offset all of the tax on the grossed-up dividend, Mr. Graham says. (In most provinces, the dividend tax credit will offset all of the tax on eligible dividends of up to $35,000 assuming there is no other income.)
“Another benefit of withdrawing more from RRIFs early in retirement is that it will reduce the amount of tax on the estate,” Mr. Graham says. If this money is not needed for lifestyle spending, they could gift it to their son and grandchildren while William and Belle are still alive, the planner says.
William anticipates earning $800 a month after expenses from his rental property once the line of credit is paid off. As well, their non-registered stock portfolio may provide about $300 a month in dividends.
When William retires at 60, their monthly income will be about $6,300, or $76,000 a year before tax, Mr. Graham says (his pension $713, his CPP $689, her CPP $494, her OAS $833, RRIF $2,500, rent $800, dividends $300 – total $6,329). Income taxes for the couple will be about $10,000, so they will have enough to meet their $60,000 a year after-tax spending target with money to spare. Once William’s OAS starts, they will be able to contribute the maximum to their TFSAs.
Could William retire earlier?
Yes, Mr. Graham says. William could take money from his non-registered account to pay off the line of credit. He would get a reduced work pension. His CPP benefit would be lower if he stopped working now. Belle’s government benefits would be lower if she began taking them now as well. With their lower pension income, they would have to withdraw more than the minimum from their registered holdings. Even so, they would still achieve their goals, the planner says. They could spend $60,000 a year, indexed for inflation, to age 90 and still leave an estate of $2-million in future dollars.
Mr. Graham’s forecast assumes a life expectancy of 90, a rate of return on investments of 6 per cent, and an inflation rate of 2 per cent. This is based on their existing portfolio of 90-per-cent stocks and 10-per-cent cash, and assumes a 3-per-cent dividend and 3-per-cent capital appreciation.
Mind you, with such a large stock holding, William is taking more risk than he needs to, Mr. Graham says. If, for example, William added some fixed income, lowering their return estimate to 4.5 per cent a year, they would still meet their spending target, Mr. Graham says. Their estate at the age of 90 would have grown to $2.5-million in future dollars. This assumes the sale of the investment condo, but does not include the value of their principal residence.
The people: William, 55, and Belle, 67
The problem: How soon can William retire without jeopardizing their retirement-spending target and running down their capital, thus eating into their son’s inheritance?
The plan: William retires at the age of 60 and they both convert their RRSPs to RRIFs and begin making withdrawals. William takes CPP at 60. They consider gifting to their son while they are still alive. They add some fixed income to their portfolio.
The payoff: A financially secure retirement and a larger estate than they might have thought possible.
Monthly net income: $7,025
Assets: His RRSP $516,100; his TFSA $64,940; his LIRA $124,155; his non-registered account $144,000; rental property $210,000; her TFSA $54,860; her spousal RRSP $86,600; her non-registered account $7,200; residence $325,000; estimated present value of his pension $150,000. Total: $1.68-million
Monthly outlays: Property tax $520; utilities $310; maintenance $100; transportation $560; grocery store $400; line of credit $300; car loan $195; vacation, travel $200; other discretionary $500; personal care $30; club membership $30; dining out $200; phones, TV, internet $325; pension-plan contributions $380. Total: $4,050. Surplus goes to paying down mortgage on rental property.
Liabilities: Line of credit $114,000; car loan $3,500. Total: $117,500
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