Hey there, time traveller!
This article was published 2/8/2013 (1225 days ago), so information in it may no longer be current.
Julie and Rubin are savouring love a second time around.
"Both of our spouses passed away a couple of years ago, and we met at a support group," says Rubin, age 71. "We went for a cup of coffee and now we've been living in sin for the last six years."
Although the couple has plenty of savings, they still worry about their finances quite a bit.
"We want to sleep at night not worrying about losing money," he says.
To that end, their retirement savings, about $1.5 million, sits in high-interest savings accounts at a credit union.
Earning less than two per cent on their money, they're more concerned about their savings lasting as long as they do than leaving behind a legacy.
Although Julie, in her mid-70s, has no children, Rubin has one adult child.
"I always tell my kid that we're spending his inheritance, but he's doing very well," Rubin says. "They have more stuff than we ever had, but if there's anything left, they can have it."
Figuring out if their money will last is a less pressing concern than coming up with a plan for Rubin to unwind his considerable registered retirement assets. Having turned 71 this year, Rubin will soon have to convert his RRSP to a RRIF and start withdrawing much more than the $8,000 annual lump sum he's been taking from his registered retirement account.
He says he is worried that between taxes and inflation, their savings might not go as far as they think, so they're looking for a little advice from an expert to provide peace of mind.
"Do I leave the money where it is at 1.75 per cent?" Rubin says. "Will it be enough to live on?"
Retirement planning expert Doug Nelson says to address their concerns, Rubin and Julie should take a three-step approach. First, they need to determine their retirement-income needs. Second, they have to figure out how their retirement income will be taxed. Then they can search for ways to reduce their taxable income.
"This is an 'income first and capital second' approach to retirement income planning," says the certified financial planner and author of Master Your Retirement.
The couple's monthly expenses are about $3,000. That's well below their current monthly after-tax income of about $5,500. This means their biggest concern is the taxes they are paying on retirement savings withdrawals and earnings that exceed their income needs.
At present, both Julia and Rubin's top tax rate is 27.75 per cent because they are splitting RRSP and RRIF income. This is a good tax situation, but it won't last for long.
Once Rubin converts to a RRIF, he will have to withdraw at least 7.38 per cent of $570,000 in registered money.
"This means he will have to draw approximately $42,180 from his RRIF in the first year, which is considerably higher than the $8,000 he is drawing now," says the adviser with Nelson Financial Consultants in Winnipeg. "While this income can be shared equally between Julia and Rubin, it will push both of them up into the next tax bracket at 34.75 per cent."
As a result, their net annual combined income will increase from about $66,000 to about $88,426, so they will be paying more taxes on more income -- tens of thousands of dollars -- they don't need.
Nelson says Rubin and Julie can't do much about Rubin's RRIF tax bill at this point, but they can try to reduce their taxable income from other sources.
"The first goal to improve the tax picture is to eliminate the interest income," he says, referring to their non-registered savings, almost $900,000 combined.
One option would be investing in a short-term income-class money market fund. This will eliminate their interest-income tax liability while keeping their money in low-risk assets. Money market funds earn about one per cent per year, less than what Julie and Rubin are earning now in a high-interest savings account, but the interest would be reinvested to purchase more fund units, instead of being paid out as income. Because it's reinvested inside the fund structure, the interest earnings aren't considered taxable income.
While the money market fund rate of return is lower than what they are presently earning, the potential tax savings will likely result in greater overall wealth preservation when other sources of taxable income are considered, he says.
Another option is to invest in dividend stocks or mutual funds that hold dividend stocks.
"The problem with this approach is that while it creates more tax-efficient income that would be taxed at 16 per cent, instead of 34.75 per cent, there will be some volatility in their investments that they would likely not be comfortable with and they would be taking risks that they don't need to take."
Long story short: the first option is a better fit because it will save them about $16,000 in taxes a year without taking on more risk.
"To increase the after-tax return even more, they should make sure they are investing with a 'fee only' adviser so they can access a lower fee structure on this type of fund," Nelson says. "The lower fee structure is called F-class, which eliminates the imbedded commission paid to the advisor and dealer each year."
Nelson says another tax strategy for RRSP and RRIF withdrawals involves investing in flow-through shares.
Normally, if Rubin withdrew $100,000 from his RRSP or RRIF, for example, the money would be added to his other income sources and taxed at a very-high marginal rate, Nelson says. "However, if this same dollar amount were invested into a flow-through share product, then this same amount would create a tax deduction, thus offsetting the taxes to be paid."
The end result is the RRSP/RRIF withdrawal would essentially be tax-free.
"It sounds like a good plan except it is the equivalent of moving money from one extreme -- the safest investment -- to another -- the most risky and speculative investment, such as an oil, gas or mineral exploration firm," he says. "I am personally not a fan of this strategy and I do not recommend Rubin and Julia consider such an approach."
One step the couple can and should do right away is maximize their TFSAs. At the moment, neither one has any money set aside in this tax-free account, so they're missing an opportunity to shelter interest earnings on as much as $51,000 of their non-registered savings from taxes.
In addition, they should also structure their RRSP and RRIFs into five-year GIC ladders. Nelson says this will increase the return on their RRSP investments with no additional risk while ensuring a sum of money is available every year for withdrawal.
Any money from an expired GIC that doesn't get withdrawn from the RRSP can be reinvested for a five-year term.
"This laddered approach will result in 20 per cent of their money maturing each year and helps to take the guess work out of changing interest rate values."
While none of these options is a silver-bullet solution to easing their tax costs, Nelson says at least Rubin and Julie can take comfort they have more than enough savings to fund the rest of their retirement.
Sure, they can take on more risk in search of greater tax savings, but it's not necessary or recommended, Nelson says.
"Why take the risk if you don't have to?"