Joan has done well working as an independent contractor, but her husband, Jeremy, “is burned out and disenchanted with the corporate world,” Joan writes in an e-mail.
Jeremy earns about $200,000 a year. Joan takes a salary of $120,000 from her consulting corporation. He is 51, she is 49. They have two children, one of whom is still living at home, and a $2-million, mortgage-free home in a Toronto bedroom community.
“My husband works as a full-time employee, which provides benefits for our family,” Joan writes. However, his industry has gone through some turmoil that has left him unemployed twice in the past few years. "The last time, it took him almost two years to find another job,” she adds.
“Can we afford for Jeremy to retire now?” Joan asks. “Do we have enough to live on for 40 years?”
Their goals include paying for their children’s higher education. Longer term, they plan to downsize to a smaller home and buy a condo in Florida.
“Now that we are entering our 50s, we'd like to know if we are on track to retiring comfortably in the next five years,” Joan writes. They also ask about strategies to keep income taxes payable to a minimum. Their retirement spending goal is $100,000 a year after tax.
We asked Ross McShane, vice-president, financial planning, at Doherty & Associates of Ottawa, to look at Joan and Jeremy’s situation.
What the expert says
Mr. McShane looks at what would happen if Jeremy retires fully at the end of the year and Joan at the end of 2025. The planner assumes Joan continues to draw $120,000 of salary and retains $20,000 a year for the next six years in her corporate investment account. Their average annual rate of return on their investments, net of fees, is assumed to be 4.5 per cent and the inflation rate 2 per cent.
“Joan and Jeremy are on a very strong financial footing,” the planner says. He recommends they pay off the car loan now using existing cash resources.
If they decide to sell their house when Joan retires and use the proceeds to buy two condos – one in Ontario and the other in Florida – there are some things they will need to consider, Mr. McShane says. With the Canada-U.S. exchange rate at $1.33 to one U.S. dollar, spending winters in Florida will be expensive. They also have to factor in carrying costs for the U.S. property.
On the plus side, Jeremy would no longer need disability insurance after he quits working. But he would lose his employee benefits, so they would have to pay out of pocket for health and dental care. Also, people tend to spend more early in retirement when they are more active, the planner says. Their spending tends to fall as they get older, although it could rise again late in life if they needed assisted living.
Investing a portion of the house-sale proceeds rather than spending it all on real estate would provide a cushion to cover potentially higher living costs, the planner says. “Or they can always sell the Florida property late in retirement to replenish their investment accounts.”
Next, Mr. McShane looks at where the money will come from.
If Jeremy retires at year end, they will need to draw funds from their investment portfolio to supplement Joan’s income. They could draw on the cash in their personal bank account, or from Jeremy’s registered retirement savings plan.
They have a significant amount in their RRSPs that will be taxed in a high tax bracket in retirement even after splitting income, the planner says. “Plus, they will run the risk of the RRSP/RRIF [registered retirement income fund] withdrawals pushing their incomes above the Old Age Security claw-back threshold when they are required to begin drawing more from their RRSPs,” he adds.
“An argument can therefore be made to have Jeremy withdraw $43,000 from his RRSP in early retirement to generate the additional required cash flow and to use up his 20-per-cent tax bracket,” Mr. McShane says. Income earned up to $43,000 is taxed at the lowest rate of 20 per cent. Although Jeremy would be giving up tax deferral, they would potentially save more tax later in retirement, the planner says. Jeremy’s withdrawal would cover the gap and provide funds that can be used to contribute to their tax-free savings accounts or reinvested in Jeremy’s non-registered account.
If feasible, an alternative might be for Jeremy to work for Joan’s business and draw a salary. This would lower their combined tax payable. She could pay him $30,000 or so in salary if he works for the business, reducing her income to $90,000. This would shift income from her 43-per-cent tax bracket to his, of 20 per cent. Even so, he would still need to draw from their investments to cover their cash-flow needs.
When Joan retires at the end of 2025, they will be fully dependent on their investments for cash flow, the planner says. By then, he projects they will have more than $2.7-million in their RRSPs, TFSAs, non-registered accounts and Joan’s corporate account.
They should withdraw enough funds from their RRSPs to cover their living costs and income taxes, Mr. McShane says. RRSP withdrawals of between $60,000 and $70,000 each would cover their needs.
Joan could also elect to pay herself a dividend out of her corporate retained earnings instead of drawing on her RRSP, the planner says. “Her accountant might prefer this over the RRSP withdrawal for corporate tax planning reasons,” he says. “As well, an argument could be made for draining the corporation sooner rather than later in order to reduce annual compliance costs and to simplify their affairs.”
If they withdraw a combined $135,000 a year from their investment portfolio, this would translate into a withdrawal rate of 5 per cent of the $2.7-million portfolio. With an estimated dividend yield of 3.5 per cent, a portion of the withdrawal would come from capital gains earned, Mr. McShane says. To avoid having to sell stocks in a down market, “it would be prudent to maintain three years’ of cash flow requirements (over and above the dividend income they will earn) in short-term cash equivalents.”
Finally, their sizable registered education savings plan will cover the cost of their children’s education, the planner says. They should invest the funds with a focus on liquidity and capital preservation.
The people: Joan, 49, Jeremy, 51, and their two children, 17 and 19
The problem: Can Jeremy pack in his stressful job at year end and retire?
The plan: Downsize the house as planned in 2026 but consider investing some of the proceeds. Jeremy retires at year end and draws up to $43,000 a year from his RRSP. Joan retires at the end of 2025 and begins drawing on her registered savings. Keep a cash reserve of three years.
The payoff: Financial security even with an early retirement.
Monthly net income: $18,965
Assets: His TFSA $92,110; her TFSA $90,155; cash in bank $65,000; his RRSP $1,153,110; her RRSP $746,560; residence $2-million; cash in her corporation $60,000; RESP $179,000. Total: $4.4-million
Monthly outlays: Property tax $875; home insurance $180; utilities, water $465; maintenance, garden $640; groceries $1,000; car insurance $355; fuel $450; parking $250; clothing $200; phones, TV, internet $370; entertainment, dining, drinks $250; hobbies, activities $100; life, disability insurance $330; gifts, donations $435; travel $1,665; RRSPs $2,900; car loan $835; TFSAs $1,000. Total: $12,300. (Surplus of $6,665 goes to saving.)
Liabilities: Car loan $34,255
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