Max hopes to retire in the spring with a budget of $9,000 a month, so he wants to know how he should he draw down his investments to meet his goals.Liam Richards/The Globe and Mail
Fifty-eight and on his own again, Max returned to his native Saskatchewan a few months ago to be closer to family. He got a job and a house and now he’s preparing for the next stage of his life – moving to the country and retiring from the work force. He recently bought a recreational property that will be his principal residence.
Max hopes to quit his $88,000-a-year education job this spring when he turns 59. He’ll spend his time pursuing the outdoor activities he enjoys and, longer term, he plans to spend his winters “somewhere hot.” In addition to his salary, Max is collecting a survivor’s pension and some smaller pensions from previous employers totalling about $45,200.
Short-term, he plans to spend about $125,000 on a new truck and some toys – an ATV, a snowmobile and ice-fishing equipment, Max writes in an e-mail. He’s also thinking of buying a place in a nearby city for about $250,000 “to get some city life and because my grandkids live there.”
Max has three investment properties – two houses and one condo – that generate a positive cash flow. He has yet to decide whether to sell or rent the house he is leaving. If he keeps it, he plans to add a basement unit, which will cost about $50,000. Max plans to leave any rental properties he might have to his two children.
His retirement spending goal is $9,000 a month, or $108,000 a year. His main question is how to draw down his savings in a tax-efficient way.
We asked Jeffrey Ryall, a certified financial planner (CFP) and investment counsellor at Cardinal Capital Management in Winnipeg, to look at Max’s situation. Mr. Ryall also holds the chartered financial analyst (CFA) designation.
What the Expert Says
Max faces two challenges to his retirement goals: the significant amount he plans to spend at the onset of retirement, which will reduce the investment income otherwise generated on his savings; and achieving tax efficiency given his high desired spending target with no income-splitting opportunities, the planner says.
In preparing his forecast, Mr. Ryall assumes an inflation rate of 2.1 per cent and a rate of return on investments of 4.45 per cent. The plan is based on a balanced portfolio of 60 per cent stocks or stock funds and 40 per cent fixed income and cash equivalents.
About 62 per cent of Max’s income from various pensions, including the Canada Pension Plan survivor benefit, is indexed to inflation. The forecast assumes he starts collecting CPP at the age of 65 and defers Old Age Security to the age of 70. It also assumes net rental income – now about $10,000 a year − increases over time.
Based on the above assumptions, Max can meet his desired after-tax spending target of $108,000 a year, Mr. Ryall says.
The trade-off Max faces is balancing his desire to retire now and spend $108,000 a year with his intention to leave a larger inheritance for his children, the planner says.
Max asks about the most tax-efficient way to draw down his savings.
“Max has done a great job accumulating assets in different savings vehicles,” Mr. Ryall says. These have different tax consequences upon receipt or withdrawal.
“Co-ordinating the sources of his withdrawals can help alleviate the tax drag initially,” the planner says. “However, when he begins drawing funds from his retirement accounts, the tax efficiency declines, causing his Old Age Security benefit to be clawed back,” he adds.
“My suggestion would be for Max to augment his pension and rental income initially with $60,000 from his non-registered savings,” Mr. Ryall says. When the non-registered savings and tax-free savings account run out, when Max is about 68, he should unlock half of his Alberta locked-in retirement account (LIRA) of $181,000, convert his RRSP to a registered retirement income fund (RRIF) and transfer 50 per cent of the LIRA to the RRIF. The other half will go to a life income fund, or LIF. Taking $85,000 out of his RRIF and LIF will achieve his desired annual income target.
“As registered assets are drawn, his taxable income increases to a level where his OAS is clawed back,” the planner says. As his RRIF is depleted, his taxable income level in turn decreases and his OAS resumes at the age of 78. “This coincides with my estimated full debt repayment of his rental mortgages.” Starting at Max’s age 78, his retirement income will be reliant on his private pensions, government benefits and rental income.
Alternatively, to help improve tax efficiency from the age of 68 to 77, Max could choose to access the built-up equity in his real estate. “While there would be capital gains, accessing these funds would likely be more tax-efficient than increasing RRIF/LIF withdrawals,” Mr. Ryall says. Max may want to talk to a tax professional about deducting capital cost allowance on his properties, which has positive as well as negative consequences.
“Depending on his comfort with debt, Max could look to extend the amortization on his rental property mortgages now or at some point in the future to increase his net rental cash flow and likely defer the need to tap into his real estate equity later on,” the planner says.
Max has no mortgage on his principal residence and he should keep it that way. “Personal mortgage interest is not tax deductible but borrowing for investment is,” he says.
“Estate planning and succession of properties upon death is an additional obstacle Max will need to be vigilant of,” Mr. Ryall says. Instead of acquiring additional rental properties, as he is thinking of doing, Max could consider directing any surplus cash flow to his children to help them with their investments – “giving with a warm hand instead of upon death.”
This should be reviewed and monitored to ensure his plan can be achieved.
Client Situation
The People: Max, age 58, and his two children, 31 and 33, and grandchildren.
The Problem: Can he afford to retire in the spring with a budget of $9,000 a month? How should he draw down his investments?
The Plan: Draw on his non-registered investments first, then his TFSA. Then tap his RRSP/RRIF or perhaps the equity in his rental property. Consider gifting any surplus cash flow to his children as an advance inheritance.
The Payoff: A wealth of alternatives to finance his remaining years.
Monthly net income: $9,000, variable.
Assets: Cash and short-term $475,000; pending inheritance $250,000; LIRA from previous employer $181,000; TFSA $136,700; RRSP $617,600; residence $700,000; investment properties $1,090,000. Total $3.45-million.
Monthly outlays: Property tax $300; home insurance $200; utilities $250; maintenance $500; car insurance $350; fuel $500; oil changes, maintenance $200; groceries $600; clothing $50; gifts, charity $300; vacation, travel $1,000; other discretionary $400; dining, drinks, entertainment $1,100; personal care $20; club membership $300; golf $50; sports, hobbies, sporting equipment $500; subscriptions $20; phones, TV, internet $420. Total: $7,060.
Liabilities: Mortgages on rentals $664,000.
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