Situation: Couple in their late 50s with poor investments fears a financial squeeze in retirement
Solution: Raise returns by selling real estate and improve their investment plans
In British Columbia, a couple we’ll call Henry, who is 56, and Julia, who is 58, have complicated financial lives. Henry runs his own consulting company. It makes a $30,000 annual profit and he takes out $1,200 monthly before tax. Julia is a civil servant earning $9,900 per month before tax and benefit deductions. After tax, they have $6,694 per month to spend. They have ample resources, yet they fear a squeeze in retirement. Pessimism and lagging investments dog them.
Julia plans to retire in May 2019. Her take-home pay will drop from her present net of about $5,500 per month to about $5,200 per month until she is 65. At that point, she will lose the bridge in her pension worth about $1,365 per month but gain a similar amount in Canada Pension Plan and Old Age Security benefits.
The couple’s finances are complex. They have a $1.5 million home and an $800,000 condo in the U.S. that is owned by Henry’s company, which is also holding $250,000 in profits. While he and Julia have $361,000 in their RRSPs, their TFSAs have combined assets of just $800, the low balance reflecting a fear of investing in anything but property and cash. Their investments, apart from real estate are heavily in cash and GICs which, after inflation and tax, generate negative returns. Their goal is to have $5,500 per month after tax in retirement.
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Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Henry and Julia. “The good part of this case is that these folks have substantial savings and no debt. They have rather low expectations of retirement income as well. The bad news is that their financial assets are almost completely invested in cash and GICs. The small age difference of two years complicates calculations, but we’ll assume that they retire together and draw benefits together. It makes no difference in their standard of living,” Moran notes.
They could sell the U.S. property. They bought it when the Canadian dollar was close to par with the U.S. dollar. They can capture a 30 per cent gain on currency and a $190,000 estimated capital gain. The rent they get is just two per cent of their current equity.
After capital gains tax, they would walk away with an estimated $700,000. They also have $250,000 in Henry’s company account. The total $950,000 could be taken out of the company as taxable dividends over a nine-year period. Each year, they would have $105,555 available from this plan. Subject to tax advice, and apportionment into non-taxed capital dividends, the balance of dividends would be taxed at a rate of about 20 per cent, Moran advises.
To keep things simple, we’ll assume that the $950,000 grows at three per cent a year after inflation and is spent over the following 34 years to Henry’s age 90. That would generate $45,000 a year in indexed pre-tax cash flow, Moran estimates. For now, all their retirement savings are in cash and GICs. They can do much better with index funds, low fee mutual funds or well-chosen individual stocks.
They should build up their Tax-Free Savings Accounts. At present, they have just $400 in each account, $800 total. We’ll assume that they do build up each account by $57,100 each this year and $6,000 each for following years — the TFSA limit is expected to rise in January. But we’ll not include the payouts in income. The cash to pay contributions and returns from that money is in the company account detailed above and already counted.
Each will have a defined-benefit pension, Henry’s for prior work for another company, Julia’s for her present job. Henry’s would be $4,308 per year plus a $1,044 bridge, and Julia’s $53,124 plus a $9,420 annual bridge. The bridges end at age 65 for each.
Their RRSPs have a present balance of $361,000. There is scant contribution room. If the accounts grow at 3 per cent a year after inflation, they will become $485,150 in ten years in 2018 dollars when they are 66 and 68, respectively, and the company has been wound down. If they start paying out the money then, it would pay a taxable income in 2018 dollars for a total of $27,812 per year for 24 years to Henry’s ago 90. We’ll assume that RRSP benefits are paid through RRIFs and evenly split.
They can expect Canada Pension Plan benefits — $9,384 for Henry and $13,128 for Julia at age 65. Each would receive Old Age Security benefits of $7,212 per year. OAS could be clawed back if the sum of their individual gross income exceeds about $74,000.
With these numbers, the couple could have $50,352 for Henry and $62,544 for Julia each to age 65 or more if they want to accelerate company withdrawals. At 65, their bridges disappear but their regular pensions plus OAS and CPP begin.
At 65, their incomes would be, for Henry, $4,308 pension, $45,000 of investment income, RRSP income of $13,906, OAS of $7,212 and CPP of $9,384, total $79,810 before tax. Some of Henry’s income would be return of capital and he would probably be able to avoid the OAS clawback.
Julia’s post-65 income would be $53,124 pension, $13,906 RRSP benefits, $7,212, OAS and $13,128 CPP, total $87,370. Her clawback would cost her 15 per cent of income over the threshold, a cost of about $2,000 per year. Her net taxable income would be $85,370.
With incomes totalled and eligible pension income divided, they would pay average tax of about 20 per cent for Henry and 21 per cent for Julia, leaving them with $11,000 per month to spend.
They could postpone drawing down RRSP income to age 72, thus lengthening the time for growth and reducing the payout period. They would have additional money later in life, but even with age 65 starts to taking RRSP payouts, they will have more money than they are accustomed to spending. With no children, the couple could endow good causes when they pass on. If they improve their records, they will understand how good their fortune is.