Rafal Gerszak/Globe and Mail
Together, Erik and Tracey have raised five children, paid for their Vancouver-area house and amassed substantial savings and investments. Now that they have retired from the work force, they are wondering how best to draw down their savings to ensure they last a lifetime. He is 66, she is 59.
Erik has an overseas pension that pays him $20,332 a year and an annuity that will pay $20,180 a year, starting in 2020. Neither is indexed to inflation. They are not yet drawing government benefits. In the meantime, they must take their cash-flow shortfall from their savings. Their spending goal is $100,000 a year after tax.
“How can we best draw down our savings to minimize taxes and maximize investment gain?” Erik asks in an e-mail. They take out money to contribute to their tax-free savings accounts each year and are looking for ways to split their income.
We asked Ian Calvert, a financial planner and portfolio manager at HighView Financial Group in Toronto, to look at Erik and Tracey’s situation. HighView is an investment counsellor/portfolio management firm.
What the expert says
If their goal is to reduce their income taxes today, they could withdraw from their savings and non-registered portfolio, and leave their registered retirement savings plans intact for the time being, Mr. Calvert says. They would have to convert the RRSPs to registered retirement income funds (RRIFs) at the age of 71 and begin withdrawing funds at the age of 72.
This strategy will result in large mandatory minimum withdrawals at the age of 72 – perhaps larger than they desire, he notes – making it difficult to have control of their taxable income after that age. As well, on the death of the second spouse, all funds remaining in the RRSP/RRIF are taxed at once on the final tax return. This typically means all funds left in the account are taxed as income at the highest tax bracket, which can reduce the inheritance for their children or beneficiaries, Mr. Calvert says.
“To put this in perspective, if Erik and Tracey wait until age 72, only taking the minimums and earning an annualized rate of 5 per cent, they would have a combined total of about $700,000 remaining in their RRIF accounts when Erik is 90," he says.
Because both Erik and Tracey now find themselves in a relatively low tax bracket, they may want to consider an early withdrawal plan from their RRSPs, he says. If both Erik and Tracey converted their RRSPs to RRIFs, based on their ages, the minimum withdrawal would be 4.17 per cent of the account balance as of Jan. 1, 2019, for Erik and 3.23 per cent for Tracey. The combined withdrawal would be about $25,600 a year. The withdrawal percentage will rise each and every year.
Adding the RRIF income would bring Erik and Tracey’s taxable income to about $67,000 and $55,000, respectively ($122,000 before tax), assuming Erik takes his Canada Pension Plan and Old Age Security in 2019.
“This is a very good place to be for several reasons,” the planner says. “Firstly, they would still find themselves in a fairly favourable tax bracket at 29.65 per cent. Secondly, they would be very far from having their OAS clawed back.” For every dollar above the 2018 threshold of $75,910 each, the amount of OAS pension is reduced by 15 cents. “Keeping their income below this threshold should be a top priority.”
If, instead, Erik and Tracey wanted to speed up the RRSP/RRIF withdrawals, they could choose to delay their CPP and OAS until the age of 70, Mr. Calvert says. This would allow them a window to take some additional funds from their RRIFs and not be pushed above the OAS claw-back number. Also, by delaying CPP and OAS to the age of 70, they would get 42 per cent more than if they took the benefits at 65. “This strategy works well if you don’t need the funds for your retirement cash-flow and you are confident you will live beyond the age of 81,” Mr. Calvert says.
Erik and Tracey also want to know how to split their income. The first step is to understand which income can be split and at what age. To split up to 50 per cent of eligible pension income, it must be considered income that is eligible for the pension income tax credit. For someone 65 or older, this includes income from a registered pension plan, payments from a RRIF, locked-in retirement income fund (LRIF) or life income fund (LIF), and annuity payments from an RRSP or deferred profit sharing plan (DPSP). “However if you are under the age of 65, eligible pension income is typically limited to payments from a registered pension plan, such as a defined-benefit pension from your employer.”
If Erik and Tracey do start to withdraw funds from the RRSPs, they should convert them to RRIFs so they can take advantage of both the ability to split income and the pension tax credit, the planner says. As well, Erik and Tracey should ensure they keep enough money in readily saleable non-registered investments to cover the $50,000 or so they will need to withdraw each year to cover their costs until they start to collect government benefits.
Their portfolio is 75 per cent equities and 25 per cent laddered guaranteed investment certificates. If they can earn a net return of 5 per cent on their equities and 2.5 per cent on their GICs, they will be in terrific shape financially, the planner says. With expenses of $100,000 a year indexed to 2 per cent inflation, they should expect to have investable assets of about $2.3-million in addition to their real estate when he is 90 and she is 83.
Client situation
The people: Erik, 66, and Tracey, 59
The problem: How to withdraw from their savings in a tax-effective way.
The plan: Consider converting RRSPs to RRIFs and withdrawing money now so they won’t find themselves in a much higher tax bracket at the age of 72 when they must begin making mandatory minimum withdrawals. Consider postponing government benefits to the age of 70.
The payoff: Financial security
Monthly net income: $9,070 (largely from savings)
Assets: GICs $616,220; stocks $501,130; mutual funds $123,670; annuity $290,715 his TFSA $81,980; her TFSA $74,185; his RRSP $443,475; her RRSP $212,705; residence $1.4-million. Total: $3.74-million
Monthly outlays: Property tax $315; home insurance $235; heat, hydro, water $325; maintenance, garden $250; car insurance $415; fuel $520; auto maintenance $800; oil $65; parking or transit $85; grocery store $1,000; clothing $200; gifts, charity $290; vacation, travel $835; dining, drinks, entertainment $625; personal care $180; sports, hobbies $85; doctors, dentists $835; drugstore $85; health, dental insurance $380; life insurance $240; cellphones $220; TV, internet $170; TFSAs $915. Total: $9,070
Liabilities: None
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