Steve and Heather have a house in Toronto and a rental condo that is just breaking even. Both have mortgages.Duane Cole/The Globe and Mail
Steve and Heather are both information technology professionals. Heather took early retirement during the COVID-19 pandemic and Steve, who is earning $270,000 a year at a big consulting firm, would like to join her next fall. They are both 61 years old and have two adult children, 26 and 29.
“We have saved consistently but aren’t sure if it’s enough for the lifestyle we want, helping our kids get started with their homes and managing debt and taxes,” Steve writes in an e-mail.
They have a house in Toronto and a rental condo that is just breaking even. Both have mortgages.
Heather has a defined-benefit (DB) pension indexed to inflation that will pay $30,500 a year plus two other DB pensions not indexed totalling $9,500 a year. All start when she is 65.
Their retirement spending target is $150,000 a year after tax plus another $20,000 a year for travel until they are 85 and an extra $60,000 a year for potential medical needs from 85 to 95. “Is our target income achievable?” Steve asks. They also ask about the most tax-efficient way to withdraw their savings.
We asked Amit Goel, a portfolio manager and financial planner at Hillsdale Investment Management Inc. in Toronto, to look at Steve and Heather’s situation. Mr. Goel holds the certified financial planner (CFP) and chartered financial analyst (CFA) designations.
What the Expert Says
As well as their house value and high salaries, an important contributor to the family’s wealth has been Steve’s management of their investments, Mr. Goel says. Steve has invested mainly in technology stocks over the past 15 years. “As a result, their portfolio has grown significantly and is currently valued at more than $3-million,” Mr. Goel says.
Because Heather is already retired and has no income yet, she has converted her locked-in retirement account (LIRA) to a life income fund (LIF) to start generating income while she’s in the lower tax bracket. “They have optimized her withdrawals to generate a taxable income of $125,000 per year and have been using it to pay down the mortgage on their primary residence,” the planner says.
They hope to pay off the balance of their residence mortgage entirely next year by increasing the mortgage on their rental property to $350,000 when it comes up for renewal early next year. They plan to sell the condo once the market improves.
While they hope to be debt-free in retirement, they will still have a mortgage on the rental property when Steve retires. Drawing from registered accounts to pay off the condo mortgage would be inefficient from a tax perspective, the planner says. “Instead, they are better off selling the condo after Steve’s retirement late next year.”
The sale of their rental property should generate about $40,000 net of fees and after the mortgage is repaid, which could go toward their plan to gift $200,000 to their son for the purchase of his first home. They have already helped their daughter. Their son is contributing $8,000 annually to his First Home Savings Account (FHSA), allowing him to benefit from further tax credits.
To further support their son’s condo purchase, the couple could choose to act as a guarantor on his mortgage. Or they could borrow against their home. “It would be more efficient for the couple to utilize a home equity line of credit against their primary residence and loan the funds to their son, rather than withdrawing from their investment accounts,” Mr. Goel says. The HELOC can be paid off when they downsize their house.
From retirement until age 71, the couple can focus on generating tax-efficient income by withdrawing from their registered retirement accounts. “Converting their RRSPs to RRIFs will classify these withdrawals as pension income, allowing them to split nearly all their taxable income equally after age 65,” Mr. Goel says. Heather’s DB pensions kick in at 65. This strategy will also enable them to defer Canada Pension Plan (CPP) and Old Age Security (OAS) benefits until age 70, resulting in increased payouts – 42 per cent higher for CPP and 36 per cent higher for OAS.
“According to this early withdrawal strategy, the couple will need to withdraw 8 per cent to 10 per cent annually during the first few years of retirement,” Mr. Goel says. “This withdrawal rate will ease in later years as they begin receiving CPP and OAS benefits and downsize to a smaller home.”
Because their portfolio is heavily invested in technology stocks, Steve should consider gradually reducing their equity allocation, the planner says. They can split their portfolio into three distinct buckets, each with different goals, to balance risk and provide more stability in their retirement years.
For liquidity and cash flow, the couple should maintain at least three years’ worth of their withdrawal needs – about 25 per cent to 30 per cent of their portfolio – in cash, guaranteed investment certificates (GICs), and other cash-equivalents, Mr. Goel says.
To combat inflation, they could allocate a second bucket to stable growth securities. This would include a mix of low-volatility, dividend-paying investments with the potential to outpace inflation over the long term. This second bucket could make up 25 per cent to 30 per cent of their portfolio.
For their legacy or long-term holdings – the portion of their portfolio they likely won’t need to access for at least 10 years – they can continue to invest more aggressively. This will help them outpace inflation and grow their portfolio further, with this third bucket comprising 40 per cent to 60 per cent of their total investments.
To increase their flexibility in withdrawals, the couple should invest any surplus funds into tax-free savings accounts. This strategy will also help reduce the future taxes that their estate will owe before their children receive the inheritance.
When they downsize their home, the couple expect to generate funds surplus to their needs. They would like to explore strategies to gift some of this surplus to their children. The planner’s forecast includes a total gift to the children of $500,000, to be distributed evenly over 10 years. “To promote responsible use of the gifts, they might consider lending money to the children with the option of forgiving the loan later,” the planner says. Or they could tie their giving to specific purposes, such as supporting new business ventures or their grandchildren’s education.
Mr. Goel stress-tested the plan using a Monte Carlo simulation, which introduces randomness into various factors, including returns. The result show Steve and Heather have a more than 80 per cent chance of success. “In the event of poor investment returns, they can adjust their gifting goals in later years to ensure they can sustain their own retirement needs,” the planner says.
Client Situation
The People: Steve and Heather, 61, and their children, 25 and 29.
The Problem: Can they afford for Steve to retire next year, meet their financial spending goals and help their children financially?
The Plan: Draw on their LIRAs and/or RRSPs as soon as they retire. Defer government benefits to age 70. Consider selling the rental condo. Gift $500,000 to children over 10 years.
The Payoff: All their goals achieved.
Monthly net income: $14,200.
Assets: Cash $20,000; her RRSP $347,000; his RRSP $1,850,000; her LIF $179,000; his LIRA $658,000; market value of his defined contribution pension $110,000; residence $3,500,000; rental condo $425,000. Total: $7.1-million.
Estimated present value of Heather’s DB pensions: $660,000. That is what someone with no pension would have to save to generate the same income.
Monthly outlays: Mortgage $2,000; property tax $1,200; water, sewer, garbage $250; property insurance $270; electricity $300; heating $150; maintenance $500; transportation $450; groceries $1,200; clothing $100; gifts, charity $350; vacation, travel $500; dining, drinks, entertainment $600; pets $240; sports, hobbies $200; other personal $700; health care $300; phones, TV, internet $305; his pension plan contributions $1,065. Total: $10,680.
Liabilities: Residence mortgage $225,000 at 1.47 per cent; rental condo mortgage $279,000 at 5 per cent. Total: $504,000.
