Miranda, seen here in Quebec on March 18, 2020, has a goal to retire at age 65 with $80,000 in after tax spending.Christinne Muschi/The Globe and Mail
Miranda is approaching age 60, a “self-employed contractor with no clue as to how much I need to retire,” she writes in an e-mail. She has two grown children.
Over the past two decades, Miranda has been earning good money working as a consultant, but her government contract recently expired.
“I put in a proposal for longer-term work and if unsuccessful I’ll look at other opportunities,” Miranda writes. “I feel that my line of consulting will likely be in demand though I could experience a few months of downtime,” she adds. “I understand my situation currently to be more hopeful than proven.”
She’s been teleworking from her house in Quebec – her former recreational property – and is wondering if it would make sense to move to Ontario to make finding work easier. Her most pressing question, assuming all goes well, is whether to incorporate her business or stay as a sole proprietor. She also wonders how best to invest her substantial cash holdings as well as funds in her registered retirement savings plan.
Although her investments have been volatile over the past couple of months, she has no plans to sell. In addition to her savings, Miranda has a defined benefit pension from a previous employer that will pay $19,175 a year starting at age 65. Her goal is to retire at age 65 with $80,000 in after tax spending, far more than the $55,680 a year she is spending now.
We asked Matthew Sears, a certified financial planner and associate portfolio manager at T.E. Wealth in Toronto, to look at Miranda’s situation. Mr. Sears holds the chartered financial analyst (CFA) designation.
What the expert says
“With Miranda’s plan to continue to work for a few more years, she should be able to ride out the short-term volatility in the market,” Mr. Sears says. “More concerning, a lot of Miranda’s retirement plan is centred on her ability to earn a significant income through work contracts,” he adds. She’s been bringing in about $160,000 a year.
“If a recession were to last for a significant amount of time, would this still be a reasonable assumption in planning for retirement?” In that case, taking refuge in a mortgage-free home in a beautiful part of the country might make good sense for awhile.
Regardless of what she decides, she’ll have to sell her house at some point to meet her lifestyle spending goal of $80,000 a year. If she wants to keep the house, she’d have to cut her spending plans or work longer.
If she decided it was more important to keep the Quebec property than to be able to spend $80,000 a year, “moving to Ontario would give her a much better retirement outcome in terms of sustainable spending,” Mr. Sears says.
In Ontario, she would benefit from lower personal and corporate taxes, allowing her to save more funds toward retirement personally or inside the corporation, depending on what option she chooses.
If Miranda does move to Ontario, there’s virtually no difference whether she incorporates or stays as a sole proprietor, Mr. Sears says. “I would recommend the sole proprietorship unless she feels she needs the limited liability. If she doesn’t, it isn’t worth the hassle to incorporate.” The advantage of limited liability is that shareholders are generally not personally responsible for their corporation’s debts.
His view would change if Miranda was able to make significantly more than $160,000 a year. In that case, it would make sense to incorporate because the tax-deferral advantage would help her more, he adds.
Incorporating comes with an initial cost, the planner notes. “In addition, there are annual costs for filing tax returns, bookkeeping and possibly legal costs,” he says. “Initial costs can be between $1,000 and $3,000, while accounting and bookkeeping fees could be between $1,500 and $2,500, or more.”
If Miranda incorporates, she will have to decide whether to take dividends or a salary. Taking a salary would allow her to earn RRSP contribution room and make contributions to the Canada Pension Plan. It would also mean less planning at tax time because income tax would be withheld at source through payroll. Dividends, alternatively, come with lower costs and are simpler because she would not have to set up a payroll and make deductions.
If Miranda continues as a sole proprietor earning $160,000 a year, she could contribute the maximum of $27,830 a year to her RRSP and $6,000 a year to her tax-free savings account, the planner says. After taxes, the remaining surplus cash flow – $29,800 a year – would go to her non-registered investment account, the planner says.
Regardless of where she lives, to meet her $80,000 a year spending goal she would have to sell her house and invest the proceeds or work longer.
To illustrate, let’s look at what happens if she doesn’t sell the house.
If Miranda stays in Quebec and continues as a sole proprietor, she would be able to sustain retirement spending of $66,152 a year in 2020 dollars, Mr. Sears says. If she sold the house at age 84 and added $764,000 to her portfolio, she could sustain spending of $79,316 a year.
If she moves to Ontario and keeps her Quebec residence, she would be able to sustain spending of $71,113 a year, the planner says. If, in contrast, she sold the property when she moved to Ontario and added $385,000 to her retirement portfolio ($500,000 less 5 per cent selling costs and $90,000 set aside for rent), she would be able to spend $87,331 a year in current dollars, surpassing her target, he says.
As for investing her cash, Miranda could first of all maximize her contributions to a tax-free savings account, Mr. Sears says. Miranda’s risk-tolerance questionnaire shows she is a balanced investor, so a portfolio of 60 per cent stocks and 40 per cent fixed income would be suitable. Her current portfolio is 20 per cent Canadian equity, 25 per cent U.S. and 33 per cent international, with only 22 per cent fixed income. Both now, while she is in between contracts, and later, when she retires, Miranda must ensure she has enough liquidity – that is, investments that can be readily cashed in – to meet her cash flow needs, Mr. Sears says.
Client situation
The person: Miranda, age 59
The problem: Should she move to Ontario and incorporate her business?
The plan: Move to Ontario if and when it makes sense to do so, but don’t bother incorporating unless she wants the limited liability.
The payoff: A handle on what she’ll be able to spend when she retires from work.
Monthly net income: $8,500, variable
Assets: Cash in bank $30,000; cash awaiting investment $88,000; RRSP $423,160; estimated present value of defined benefit pension $230,795; residence $500,000. Total: $1.27-million
Monthly outlays: Property tax $350; home insurance $200; utilities $350; maintenance $315, garden $45; transportation $635; groceries $400; clothing $200; gifts, charity $100; vacation, travel $500; other discretionary $300; dining, drinks, entertainment $600; personal care $100; club membership $80; pet $40; sports, hobbies $50; subscriptions, other personal $60; doctors, health care $115; phones, TV, internet $200. Total: $4,640
Liabilities: None
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