Couple kept their finances separate and they are set for a secure retirement

$3,800

In Montreal, a couple we’ll call Freddi, 58, and Nate, 59, are transitioning into retirement. Freddi has retired from her management job in high-tech. Nate is a publishing manager. Their present combined income, $3,800 per month after tax, supports a $700,000 mortgage-free house, $1,146,000 in non-registered investments, $1 million in RRSPS, $103,000 in TFSAS, $27,000 cash and a 19-year-old car with what Freddi and Nate estimate is a $500 market value. Their expenses are quite modest and each will receive QPP and OAS. At age 60, Nate will receive a $3,376 monthly pension including an $858 bridge that disappears at 65, leaving $2,518 per month before tax.

Family Finance asked Caroline Nalbantoglu, head of Cnal Financial Planning Inc. in Montreal, to work with Freddi and Nate.

ESTIMATING RETIREMENT

INCOMES

The couple’s situation is unusual in that Freddi and Nate keep their finances separate. They share some costs, such as food, but spousal RRSP contributions and even spousal loans consistent with Canada Revenue Agency rules are off the table, Nalbantoglu explains. Their method is complicated for it adds to record keeping. However, it also makes for more transparency in avoiding the OAS clawback.

For simplicity, we’ll combine living costs but treat asset management and taxes individually. Moreover, we will leave cash flow from their Tax-free Savings Accounts out of income calculations. They may use TFSA funds to buy a cottage.

Nate wants to cover his share of living expenses. He estimates it would cost him $30,000 a year. That should work because his work pension is integrated with the Quebec Pension Plan. His work pension will therefore provide him with $40,512 per year including a $10,296 bridge if he retires immediately declining to $30,216 per year at age 65. That is above his target.

At age 65, when his integrated pension is reduced, he will have annual benefits as follows: QPP $12,252, OAS $7,623 and work pension $30,216. That adds up to $50,091 before tax.

Nate’s RRSP balance growing at three per cent per year after inflation to 71 will be $164,500. Annuitized to pay out all income and assets for 24 years to his age 95, it will provide him $9,430 per year. His taxable income will climb to $59,521 per year. His income will be subject to average tax at about 20 per cent with pension and age credits included. His after-tax income will be $47,620.

Freddi has no defined-benefit pension, but she does have a substantial investment portfolio. She has retired. She uses her non-registered portfolio to pay her share of monthly expenses. The cottage she has in mind will cost her an estimated $833 per month. At present, though her non-registered portfolio generates income, dividends and capital gains, Quebec tax credits allow her to pay no income tax.

At age 65, Freddi will be eligible for QPP at $9,288 per year and OAS at present rates of $7,623 per year. She can take $20,000 per year for seven years from her RRSP portfolio. On top of her RRSP and taxable withdrawals, she will have total gross income of $36,911 and net income of $31,000 after pension and age credits and a 16 per cent average tax rate. That’s more than her lifestyle requires. She can save the difference or buy a new or newer car with Nate or donate to good causes.

At age 72, she will have to receive her first RRIF payment. The RRSP will have been reduced by $140,000 with growth at three per cent about equal to withdrawals for seven years to $748,000. An age 72 withdrawal at the regulatory minimum, 5.4 per cent would be $40,392. Her income would then be $57,303 before tax. After 22 per cent average tax, she would have $44,700 per year to spend. Given that Freddi and Nate are only months apart in age, we’ll combine their incomes. On this basis, they would have his $47,620 plus her $44,700 to spend, total $92,320 per year. Assuming that their $45,600 present annual allocations do not change, they would have an annual surplus of $46,720. They would have money for extensive travel and perhaps gifts to good causes.

Given that all RRSP payouts are taxed at the same rate regardless of source such as dividends, interest income or capital gains, the couple should use RRSPS for fixed-income investments, Nalbantoglu advises. TFSAS can hold growth assets, preferably Canadian shares. Tax withholding on dividends from foreign shares held in TFSAS is not refunded. In her non-registered portfolio, she can have an allocation of 20 per cent Canadian shares with the balance in U.S. and foreign shares, Nalbantoglu suggests.

COST OF A COTTAGE

The asset drawdown to buy a cottage for, say, $400,000, would be readily affordable by using their TFSAS with a present value of $103,000 as a down payment and borrowing $300,000. The cottage price gain, if any, would be taxable if and when sold, for it would not be a principal residence. Freddi and Nate should clarify ownership — who owns what — with their solicitor before purchase.

“The calculations for this couple are complex given their preference for keeping their accounts separate, but it is clear that they can well afford to live in retirement as they do now and have a $400,000 cottage,” the planner explains. “They have wealth surplus to their needs. Their retirement would be secure.”

THE VIRTUE OF SEPARATE

ACCOUNTS

Keeping separate accounts adds to the work required to assemble their retirement finances, but it does not affect their after-tax incomes. Most retirement income components can be split for tax purposes in Quebec. The effect is to average certain income and, very importantly, to reduce the risk of hitting the trigger for the OAS clawback. That currently starts when taxable income (excluding TFSA cash flow), hits $79,845 per tax filer. The clawback takes 15 per cent of income over that hurdle and takes back all OAS when individual income, subject to some adjustments such as exclusion of TFSA cash flow, reaches $129,075 at present rates.

“This couple has done everything right,” Nalbantoglu explains. “Their bookkeeping process of separate finances gives them a good focus on their finances.”