Hey there, time traveller!
This article was published 27/4/2012 (2763 days ago), so information in it may no longer be current.
Hey there, time traveller! This article was published 27/4/2012 (2763 days ago), so information in it may no longer be current.
Mark and Tori are model savers who are seemingly perfectly poised for retirement in a couple of years.
They earn a combined gross annual income of more than $150,000. They have no debt. They have defined benefit work pensions, and they only spend about $2,300 a month while earning about $7,800.
Their children are grown up and independent. And Tori and Mark have managed to accumulate more than $600,000 in investments.
Now in their mid-50s, they are ready to retire. Yet not everything is hunky-dory in this financial Camelot.
"How do we bridge this together?" Mark asks.
Here's their problem: They own a number of investments, including a substantial amount of money in GICs and mutual funds outside of their RRSPs and TFSAs, both of which have been maximized.
But they have little idea of how to use their investments to help generate retirement income.
Obviously, they could benefit from expert advice, but finding comprehensive advice is problematic, too, because their investments are spread out at three different financial institutions.
"We diversified ourselves not only the way we invest but also who we invest with," he says. By their own design, no adviser at one financial institution knows about the investments held at the other places. Now they are questioning this strategy.
"Should we bring things together under one financial institution?"
Retirement income planning specialist Daryl Diamond says Tori and Mark are indeed in the driver's seat heading into retirement.
No debt, good pensions and excellent saving habits have put them there. And these factors will have them on cruise control throughout retirement, as well. Even before they become eligible for CPP at age 60, Mark and Tori will earn enough from their pensions to cover their living expenses.
"Their monthly income target is modest and part of what permits this is that they are not servicing any debt," says the author of Your Retirement Income Blueprint.
Once they retire, it's likely they won't spend much more than they do now, since their current budget already includes about $4,000 a year for vacations. It's safe to say their pension incomes should cover about $2,500 in monthly costs.
Tori will earn $1,840 a month from her pension and Mark will receive $2,170 a month before taxes.
"That alone will create after-tax cash flow of $3,500 monthly, so the base pensions, which are guaranteed and which they can never outlive, actually will provide them with $1,000 monthly more than they have set as their income target."
As they age, those government benefits will kick in — OAS and CPP — and they will have even more guaranteed income.
Prior to age 60, if they need additional cash, they should consider withdrawing from the RRSPs before other sources.
"The reason I suggest this is that they have an opportunity to use the fully taxable withdrawals that the RRSPs would create and bring that money into taxation at low rates, keeping under the first federal tax bracket of $42,709," says the certified financial planner with Diamond Retirement Planning in Winnipeg.
They should make these withdrawals even if they don't need the money. It can be re-invested in their TFSA or other non-registered investments.
Because Tori and Mark already have a guaranteed income stream in retirement to suit their needs, tax efficiency is their main concern. That's why it's important they withdraw from their RRSPs in a controlled manner before they turn 71. Once they reach that age milestone, their RRSPs are converted to RIFs (retirement income funds) and annual, taxable withdrawals are mandatory. This can lead to them paying higher taxes than anticipated and a clawback on OAS and the age credit.
"To complement this strategy, there are extremely efficient and meaningful ways to defer taxes on their non-registered holdings, which they should investigate."
Incidentally, their current preference to invest a substantial amount in GICs would not be part of a tax-efficient plan.
"Having nearly $140,000 of non-registered holdings in GICs is great for the taxman, but not so good for them."
GICs generate interest income, which is fully taxable. Besides, GIC rates barely keep ahead of inflation. Combine those two headwinds and GICs are arguably a losing investment.
That doesn't mean they need to steer clear of them, but a better place may be in their TFSAs, where the interest won't be taxable.
Diamond says one tax-efficient strategy for non-registered money — aside from investing in their TFSAs — is to invest in corporate-class mutual funds. Normally, a mutual fund is considered a trust, and income generated is paid out to investors. That income is taxable in the hands of the investor. But a corporate-class mutual fund is a corporation, which provides a couple of tax efficiencies. For one, a corporate-class fund is an umbrella structure for a group of mutual funds. So you can invest in a Canadian equity corporate-class fund and then switch within this class to a Canadian income fund without triggering taxes. But corporate-class funds also would offer Mark and Tori another advantage.
"A corporate-class structure commonly produces fewer taxable distributions than a unit trust fund," Diamond says. "This is accomplished by having what would otherwise be taxable income being used to offset fees and expenses, and gains offset by losses."
Diamond says Mark and Tori certainly can execute a tax-efficient retirement income strategy on their own, but a good adviser will likely make this process easier and less costly in the long run.
Having three different advisers oversee separate parts of their portfolio, however, probably won't achieve this goal.
"It is like going to three different doctors and not giving them all of the information on your health," he says.
Ideally, Mark and Tori should seek the help of a financial planner who can build them a comprehensive retirement plan. This advice isn't free. They can choose to pay a planner a flat fee, which can run a few thousand dollars for a complete plan, or they can make the planner the adviser of record on their invested funds so he or she is compensated by the fund companies through trailer fees. They're already paying three financial institutions fees on their investments for no planning help, so they might as well consolidate and pay fees to one planner for comprehensive advice.
"Overall, retirement-income planning can be complicated stuff, and it is not a case of people not being able to do it on their own," he says. "It is a case of people not being able to do it as efficiently as it could be done and paying far more in taxes than they ever would have paid in fees."
Tori's and Mark's finances
Tori: $76,027 ($4,018 a month net)
Mark: $76,810 ($3,781 a month net)
Monthly: $2,299 (excludes contributions to registered savings)
Home: valued at $275,000
Mark's defined benefit pension: $2,170 before age 60
Mark's defined contribution pension: $21,570 total value
Tori's defined contribution pension: $1,840 at age 55
Mark's RRSP: $114,974
Tori's RRSP: $24,394
Spousal RRSP in Tori's name: $43,479
Mark's TFSA: $20,854
Tori's TFSA: $20,854
Non-registered investments: $419,058
$940,183 (excludes value of defined benefit pensions)