Leonard and Gwen hope to retire in about three years with a spending goal of $144,000 a year after tax, plus $15,000 a year for travel for the first 15 years.Tijana Martin/The Globe and Mail
As high-income earners with no children, Leonard and Gwen are well-fixed financially for the next phase of their lives.
Leonard is 53 years old and earns $275,000 a year in an executive position. Gwen is 56 and makes $90,000 a year in health care.
Gwen has a defined benefit pension plan that will pay $2,190 a month to age 65 and $2,005 a month thereafter. It has a 60-per-cent survivor benefit and a 10-year guarantee.
Their goal is to retire in about three years and maybe live abroad for a while, although they haven’t decided where.
Fattening their balance sheet substantially is the company stock Leonard was granted by a previous employer. “About half of my RRSP value is held in software stock,” Leonard writes in an e-mail. “It doesn’t pay a large dividend, but their formula for delivering outsized shareholder returns for years on end is very rare.”
They’ve recently paid off the mortgage on their Vancouver residence and ask if it is realistic for them to retire early and maintain their current lifestyle. “What is the best strategy to remove the money from our RRSPs and minimize taxes?” Leonard asks. When should they start drawing government benefits?
Their retirement spending goal is $144,000 a year after tax, plus $15,000 a year for travel for the first 15 years. “Anything left over will likely be donated to charities we support.”
We asked Trevor Fennessy, a certified financial planner and portfolio manager with CWB Wealth Partners in Calgary, to look at Leonard and Gwen’s situation. Mr. Fennessy also holds the chartered financial analyst (CFA) designation.
What the expert says
Diligent saving and Leonard’s company stock have put the couple in position to enjoy an early retirement at the end of 2026, Mr. Fennessy says.
Assuming a life expectancy of age 95, a 5-per-cent rate of return on their portfolio, 1-per-cent price growth on real estate, and inflation of 2.1 per cent, Leonard and Gwen’s desired spending level is achievable, the planner says. At age 95, this would leave about $3.55-million within their estate.
“The single largest risk within Leonard and Gwen’s retirement plan is concentration risk,” Mr. Fennessy says. “With more than half of their portfolio invested in a single company, an adverse impact on their retirement could easily surface.”
“For example, a 20-per-cent unrecoverable drop in Leonard’s stock would be enough of a catalyst to significantly derail their retirement,” the planner says. “Measures such as working longer, downsizing real estate, liquidating personal belongings, or forgoing travel in retirement would be required to keep their lifestyle afloat.”
Diversifying away from this concentrated position will require a plan and rational thinking to overcome the behavioural biases that have led Leonard and Gwen to remain “heavily attached” to the company, the planner says.
“Given that the stock is held within a registered account, there will be no immediate tax consequences to reduce or sell out of the position,” he says. They should set price targets and a defined schedule for reducing the company weighting. “This could be coupled with an options trading strategy to provide downside protection on the position.”
When looking to redeploy the capital, they should diversify into different sectors and geographical regions that are not directly correlated to their existing large stock position.
Given Leonard and Gwen’s healthy, active lifestyle, longevity must be addressed in their retirement plan. He advises them to delay Canada Pension Plan and Old Age Security benefits to age 70. This will increase the inflation-adjusted benefit amounts they receive.
Currently, Leonard and Gwen’s portfolio provides a seven-year buffer for increased life expectancy; that is, they could live to age 102 at their desired spending level without needing to liquidate real estate, Mr. Fennessy says.
However, given that their final decade of life is likely to come with increased health costs, Leonard and Gwen should plan accordingly. With no children, they could consider using a portion of Leonard’s registered assets to purchase a life annuity to provide additional protection against increased longevity.
Registered withdrawals cannot be split for income tax purposes until after the age of 65. So the first several years of their retirement will be “highly punitive” from a tax perspective. That’s because the bulk of the registered assets have been accumulated in Leonard’s hands. Leonard should look to convert his RRSP to a registered retirement income fund (RRIF) upon retirement. This will provide some flexibility in managing the withholding taxes on his registered withdrawals because the minimum amount can be withdrawn without any withholding tax. Also, this will ensure that any withdrawals after age 65 are eligible for pension splitting and the pension income amount.
Any of Leonard’s further registered contributions should be directed to a spousal RRSP, Mr. Fennessy says. This will allow the couple to shift some of the income before age 65 to Gwen, who will be in a much lower tax bracket.
When taking withdrawals, Leonard and Gwen will need to be mindful of the three-year attribution period, during which the withdrawals would be attributable back to Leonard for income tax purposes. During the attribution period, the couple could look at converting the account to a spousal RRIF, in which minimum withdrawals are not attributable back to the contributing spouse.
From age 65 onwards, Leonard and Gwen will benefit greatly by splitting a portion of Leonard’s registered withdrawals with Gwen. “The sharing amount will need to be optimized annually and will likely change over time as other government benefits are received in Gwen’s hands,” the planner says. “At age 65, the couple will see their family tax bill decrease by more than 16 per cent.”
Pension-income splitting will also help to keep their incomes within a more manageable tax bracket, mitigating some of the impact of the OAS clawback, Mr. Fennessy says. When the first of Leonard or Gwen dies, the surviving spouse will be taxed quite heavily and will likely be subject to a full OAS clawback.
Given the size of their potential estate, Leonard and Gwen should reflect on how to be strategic and effective with their charitable giving. They should look beyond their investment portfolio for funding their charitable giving. For example, they have term life insurance that is set to renew in the next few years. With the premiums skyrocketing, it may make little sense for the couple to renew it. Instead, they could convert the policy to a whole life insurance policy and donate it to charity.
Once the charity becomes the owner of the policy, any future insurance premium payments they make will provide a charitable donation tax receipt, providing tax relief to the couple on a continuing basis. Because they are planning to leave funds to charity within their estate, it would be best to do so by naming the charity as a beneficiary of one of their registered accounts. This will allow the funds to pass directly to the charity, bypassing probate fees.
Client situation
The people: Leonard, 53, and Gwen, 56.
The problem: How to draw down their savings in a tax-efficient manner.
The plan: Use income-splitting strategies to reduce taxes. Sell some of the oversized stock position to lower risk.
The payoff: A secure retirement with more than enough money.
Monthly net income: $21,165.
Assets: Bank accounts $90,000; his RRSP $3.4-million; her RRSP $40,000; his TFSA $92,000; her TFSA $8,000; residence $1,250,000. Total: $4.8-million.
Monthly outlays: Condo fees $535; property tax $195; home insurance $140; electricity $110; maintenance $100; transportation $730; groceries $1,000; clothing $150; gifts, charity $100; vacation, travel $1,250; dining, drinks, entertainment $1,350; sports, hobbies $1,250; subscriptions $165; other personal $100; drugstore $50; life insurance $190; cellphones $180; TV, internet $180; RRSPs $735; TFSAs $585. Total: $9,095.
Liabilities: None.
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