Clearing the path toward early retirement
With modest goals, Herb and Hattie may not have to draw on investment income right away
Herb has a union job in the oil patch that takes him away from home more than he would like. At the age of 63, his goal is both reasonable and modest: to retire from his $120,000 a year job next year and spend time gardening, cycling and travelling south each winter with his wife, Hattie, who is 11 years younger.
Hattie, who is self-employed and earns about $30,000 a year, would retire at the age of 55 “so we can do things together before I’m too old,” Herb writes in an email. They have two children, ages 21 and 31.
Herb has a work pension that will pay him $2,300 a month, not indexed to inflation, starting at the age of 65. They also have savings and investments.
Herb’s main concern is how to structure their retirement cash flow. Their spending goal is $60,000 a year after tax. “My question is, what should I draw down first and what should I leave for later, always keeping in mind tax efficiency,” Herb writes. He also wonders about their portfolio. “Am I properly invested?”
We asked Ross McShane, vicepresident of financial planning at Doherty & Associates in Ottawa, an investment counselling firm, to look at Herb and Hattie’s situation. Herb and Hattie will have sufficient assets to cover their income needs without having to worry about outliving their capital, Mr. McShane says.
In preparing his forecast, the planner makes a number of assumptions, among them a 4.5per-cent average rate of return, after fees, on their investments and an inflation rate of 2 per cent a year. Herb begins collecting full Canada Pension Plan (CPP) benefits at the age of 65, and Hattie partial benefits, also at 65. They both begin taking Old Age Security (OAS) benefits at 65.
Mr. McShane “bumps up” their retirement spending goal to $70,000 a year after tax to allow for vehicle depreciation and to provide a buffer against unexpected expenses. They are currently spending about $42,000 a year.
If they keep their spending as is next year, they may not have to draw from their investment income after Herb retires mid-year, the planner says. His pension starts in 2020. In 2022 – the first complete year in which they are both fully retired – they are forecast to have $1.5-million of in-
Given that there is not expected to be a significant increase in tax brackets later on in retirement, my suggestion for now is to delay withdrawing from the RRSP. ROSS MCSHANE VICE-PRESIDENT OF FINANCIAL PLANNING AT DOHERTY & ASSOCIATES IN OTTAWA
vestments, spread among registered retirement savings plans (RRSPs), tax-free savings accounts (TFSAs) and non-registered, or taxable, accounts.
Their income sources will be Herb’s pension, CPP and OAS benefits totalling slightly less than $50,000 gross. Hattie will have no income source (other than investments) until she turns 65 and begins getting OAS and CPP. They will need to withdraw $35,000 from their investments that year to cover the gap, a withdrawal rate of 2.5 per cent.
“The good news is that they will only be dependent on the income [interest and dividends] from their portfolio and should not have to draw on their principal,” Mr. McShane says.
Herb can split his pension income with Hattie, lowering their tax bill. This also will allow Hattie to claim the federal pension income credit.
“An argument could be made that Hattie should consider an RRSP withdrawal in 2022 to take advantage of her low tax bracket,” Mr. McShane says. But after going over the numbers, he does not foresee their tax brackets surpassing 30 per cent in the future. “Given that there is not expected to be a significant increase in tax brackets later on in retirement, my suggestion for now is to delay withdrawing from the RRSP,” he says. They should review this annually.
As for their investments, they have a “smorgasbord” of guaranteed investment certificates, mutual funds, stocks and exchangetraded funds (ETFs), Mr. McShane notes. Their asset mix is 30-per-cent cash and fixed income and 70-per-cent equities. He wonders whether they have an overall strategy. “Are all of these accounts working together as one?” he asks.
As well, the portfolio is not as tax-efficient as it could be, the planner says. The TFSAs are heavily weighted with U.S. dividend-paying ETFs “that give rise to a withholding tax [on the dividends] that is not recoverable,” he says.
“It is generally better to hold the U.S. dividend payers in the RRSPs with the Canadian dividend payers inside the TFSAs.” This could be taken a step further by replacing the U.S. dividend payers that are held in the nonregistered account with Canadian dividend payers, he adds. A dividend from a Canadian company is taxed at a lower rate than a dividend from a non-Canadian company.
“Better to hold the foreign dividend payers in the RRSP.” The overall mix does not have to change, only the location of where the investments are held, he says. Some details may be changed to protect the privacy of the persons profiled.