At age 64, Hayley is on her own again, starting a new consulting business from scratch and drawing on her lump-sum settlement, the result of a separation agreement with her former spouse and business partner.
“With the separation, my income from the company ended,” Hayley writes in an e-mail. With the success of her new venture uncertain, she wants a solid plan in place “on how to live solely off my investments.”
She is drawing $6,000 a month, or $72,000 a year, from savings – roughly 4 per cent of her portfolio – and hopes to continue doing so without running down her $2-million or so in capital. Her short term goals are to minimize investment losses owing to fees and market slumps, Hayley writes, and to not sacrifice her lifestyle because of poor money management. She lives in British Columbia and rents rather than owns her home.
Hayley is also concerned about drawing down her savings in the most tax-efficient manner possible.
“Given that I am waiting until age 70 to access Canada Pension Plan and Old Age Security, should I be converting some of my RRSP and locked-in retirement account (LIRA) to a registered retirement income fund now to decrease lifetime taxes paid?” Hayley asks. She asks, too, whether she should use $150,000 she has in a high-interest savings account to reinvest in the stock market or buy more guaranteed investment certificates.
We asked Andrew Dobson, a certified financial planner at Objective Financial Partners Inc. of Markham, Ont., to look at Hayley’s situation.
What the expert says
Before drawing on her registered accounts, Hayley should try to estimate two variables, Mr. Dobson says: the taxable income from her non-registered accounts, and the potential income from her business.
“Then she can start working on where to take the next dollar,” the planner says. If her self-employment income is modest, and her non-registered capital gains are minimal in a given year, taking RRSP withdrawals may allow Hayley to make use of low tax brackets between now and age 72, the latest she can defer her withdrawals, Mr. Dobson says.
He estimates Hayley’s marginal tax bracket is 20 per cent now. If she delays her RRSP/RRIF withdrawals to age 72, that rate would jump to 38 per cent. Her income would also exceed the OAS clawback limit, pushing up her effective tax rate to 53 per cent, the planner says. “So, taking some strategic RRSP withdrawals now seems advisable.” She would not need to convert her RRSP to a RRIF yet.
“If she converts her RRSP to a RRIF, she will be forced to take withdrawals each year based on the government minimum percentages that rise with age,” Mr. Dobson says. Because she has the potential for self-employment income, as well as a large taxable non-registered portfolio that could have capital gains from year to year, it may make sense to defer converting her RRSP to a RRIF until age 72. “She can take RRSP withdrawals as needed to try to plan her income each year, ideally toward year-end when her income is easier to estimate.”
The benefit of melting down her RRSP before age 72 would be to pay some tax now and less later by virtue of having smaller balances subject to full tax in the future. Because Hayley’s marginal tax rate in her 70s is estimated to be at least 46 per cent and possibly as high as 53 per cent, she may want to consider taking her income as high as $100,000 before age 72, the planner says. If she defers her OAS, her marginal tax rate at $100,000 a year in B.C. would be 31 per cent, the planner says.
For Hayley, deferring CPP and OAS to age 70 is probably a good idea. A 64-year-old woman has a 50-per-cent chance of living to age 91. If she lives into her mid-80s, she will receive more lifetime CPP and OAS by deferring to age 70 compared with starting these pensions at 65. By deferring CPP to age 70, Hayley will receive a 42-per-cent benefit premium, he notes. A larger CPP benefit will give her more guaranteed income, making her income less dependent on investment performance.
“By deferring her CPP and OAS to age 70, Hayley could have around $3,000 per month coming from government-guaranteed, inflation-protected sources,” Mr. Dobson says. Her current $6,000 monthly expenses may be closer to $7,000 by then (with inflation), and there is tax to pay on her income, but the required withdrawals from her investments will be fairly modest relative to her assets, he says. “In fact, in 10 years, she is projected to have about $77,000 per year of withdrawals from her investments to supplement her CPP and OAS income, which is only about 3.5 per cent of her projected investments at that time.”
Hayley seems to have concerns about stock market volatility, the planner notes. Even if her investments earned a more conservative, 3-per-cent return over the rest of her life, her projected investments at age 95 are nearly $1.2-million, or about $600,000 in today’s dollars, he says.
She wonders, too, about how much income tax she will be paying. The average return on her GICs is 4.66 per cent, which represents about $20,000 (on $428,000 in GICs). He assumes a dividend yield on her non-registered stock portfolio of 3 per cent, or $12,800 a year. “If you add these two up, you get about $40,000 in passive portfolio income without triggering capital gains or withdrawing from her RRSP/RRIF,” Mr. Dobson says. “This is a relatively low income with not much tax payable.”
Hayley asks how to invest the $150,000 she has in a high-interest savings account. That represents about 7.5 per cent of her investable assets, the planner says. “Given that another $428,000 or so is invested in GICs, close to 30 per cent of Hayley’s overall wealth is invested in cash or equivalent investments.” Hayley should work with her investment adviser to figure out an appropriate overall asset allocation, he says. “Based on my projections, she does not need to earn a high rate of return to fund her lifestyle,” Mr. Dobson says. “So, she should balance her desire to sleep well at night with the potential to provide a larger inheritance for her children.” She may want to keep the $150,000, or part of it, readily available for emergencies or major purchases.
The people: Hayley, 64, and her two adult children
The problem: Can she continue to spend $72,000 a year for the remainder of her life without drawing much, if any, on her capital? Should she melt down her RRSP now?
The plan: Consider drawing from her RRSP now (without converting it to a RRIF) and defer CPP and OAS to age 70. This way, she’ll pay a little more tax now but less later when she begins making mandatory withdrawals from her RRIF.
The payoff: A secure and comfortable lifestyle
Monthly net income: $6,000
Assets: GICs and bank accounts $578,000; stocks $427,000; TFSA $108,840 (all stocks); RRSP and LIRA $969,875 (44 per cent stocks). Total: $2.1-million
Monthly outlays: Rent $2,500; home insurance $25; electricity $20; laundry, maintenance $70; transportation $600; groceries $500; clothing $100; gifts, charity $140; vacation, travel $500; dining, drinks, entertainment $120; personal care $60; club memberships $40; books $25; education $125; accountant $40; sports, hobbies $50; subscriptions $60; doctors, dentists $150; drugstore $20; health insurance $40; communications $210; registered education savings plan for grandchildren $105; TFSA $500. Total: $6,000
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