Retirement planning challenge for dual citizens

SITUATION Middle-aged couple need to boost savings for retirement at 60 STRATEGY Maintain savings, track tax obligations, target sustainable income SOLUTION Sufficient funds for retirement, children’s education

The resumé of a U. S.born, Toronto- based electrical engineer we’ll call Matt is a monument to his success. With a distinguished academic background and a string of successful jobs within his company, he has a salary of $168,000 a year plus bonuses that can be high as $26,000 a year. His wife, Jennifer, as we’ll call her, has a part-time job as an office manager with a $24,000 annual salary. Their combined gross income, as high as $218,000 a year, pays for a comfortable way of life. Question is – can he sustain it in retirement?

Matt’s problem and that of his wife, Jennifer, also a U.S. citizen with permanent residence in Canada, is that the laws governing RRSPs and their equivalent U.S. retirement plans don’t mesh very well. Matt, 48, and Jennifer, 46, intend to stay in Canada and, in any event, they have been here almost all their adult lives. The focus of their planning therefore has to be to build up their RRSPs, taking account of U.S. rules that do not allow contributions to the plans to be deducted from their taxable worldwide incomes, while making use of the US$92,000 exemption of foreign — that is, Canadian — income for the income they report on their US. basic 1040 tax return.

With careful accounting to ensure they comply with the tax laws of both countries, they can build their RRSPs and avoid tax on the sums Canada allows to be deducted from the worldwide income they report to the Internal Revenue Service. The reason — they will get a Canadian federal foreign tax credit as well as an Ontario credit for sums over the federal credit. In the end, they come out with their RRSPs working as intended and no U.S. tax penalty.

Family Finance asked Graeme Egan, a financial planner and portfolio manager at KCM Wealth Management Inc. in Vancouver, to work with the couple to focus their financial plans, enhance returns from their investments, and plan retirement.

Investment goals

The couple has two investment targets — one, to add money to their three children’s education funds, and two, to fund their own retirements. Their family RESP has a $115,000 balance. It is being used to pay for one child, age 20, in a professional curriculum in university and another child, 17, who has just started first-year university. The two older students cannot receive the Canada Education Savings Grant of the lesser of $500 or 20% of annual contributions, for the CESG ends at age 17. But the couple can contribute $2,500 a year to get the maximum $500

Careful observance of rules of both countries will keep his tax bill to no more than what it would be in Canada without

exposure to American taxes

CESG for their 14-year-old for the next three years.

Matt puts $22,000 a year into his RRSP. If he maintains this rate of accumulation for 12 years to age 60 and grows the account, now $258,000, at 3% a year after inflation, he would have $689,400 in the account. While the United States does not recognize RRSP contributions as deductions from taxable income., a U. S. taxpayer can elect to defer tax on this income until it is actually paid out. In other words, on payout, the U.S. tax treatment will be the same as Canada’s.

Their non-RRSP assets, which total $ 170,000, would grow to $242,400 at 3% per after inflation to year at Matt’s age 60, with no further contributions. Add an expected inheritance of $150,000 and the sum of non-registered capital would be $392,400.

RetIRement plannIng

If Matt and Jennifer downsize their $ 1- million house at retirement at Matt’s age 60 to $500,000 and invest what could be a $600,000 balance — allowing for $100,000 growth in value in the next 12 years — then combine the $600,000 with their future non-registered capital, they would have about $1-million. They should observe the U.S. tax rule that only the first $500,000 of any capital gain on the house will be tax-exempt.

Assuming financial assets grow at 3% before inflation adjustments and they exhaust all capital by Matt’s age 95, $1-million of non-registered assets would provide $61,000 a year, and their $689,400 of registered assets would support a draw of $45,000 a year, for total investment income of $106,000 before tax.

If Matt starts his Canada Pension Plan benefits at his age 65, he would receive the maximum $12,150 in 2013 dollars. They can take benefits at age 60, but the loss of 0.6% a month for each month that benefits are taken before age 65, or 36% for five years, would be costly. There is no need for early application for benefits, Mr. Egan says. It should be noted that having left the U.S. in 1990 when they were in their early twenties, they would have negligible entitlements to Social Security benefits. If Matt takes his CPP at 65, he would receive $12,150 a year in 2013 dollars. CPP benefits for Jennifer, based on her interrupted work history, cannot be calculated, Mr. Egan says.

When each is 67, both will be entitled to full OAS benefits, currently $6,553 a year. If pensions are split, each will have annual income of $65,628 in 2013 dollars before tax. They will avoid the OAS clawback that begins at $70,954 in 2013. After 30% average tax, they should have combined disposable income of $7,657 a month. Their present expenses of $6,000 a month net of retirement and other savings, childcare costs and debt-service costs would be covered.

“The cost of being an American in Canada is not higher total tax, for careful observance of reporting rules usually means that one gets credit for what are usually lower American income taxes, but in the time and cost of compliance,” Mr. Egan says. “Most of Matt’s income will be exempt and that will be key to his tax costs in the U.S. In the end, careful observance of rules of both countries will keep his tax bill to no more than what it would be in Canada without exposure to American taxes.” Need help getting out of a financial fix? Email andrewallentuck@mts.net

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