Rory and Ruth have a solid financial situation, but want to generate a tax-friendly income stream for when they retire.Kevin Van Paassen/The Globe and Mail
Rory and Ruth are 59 and 62, respectively. Rory is an executive earning $200,000 a year, plus bonus, but he will be out of work in mid-2017 when his contract expires. Ruth brings in $50,000 a year from her small business. Neither has a company pension, although Rory is expecting a one-time severance payment of $100,000.
With their children grown and retirement in view, Ruth and Rory are wondering how to generate a "tax-friendly income stream." Rory plans on picking up another job for a few years but at a fraction of his current salary. He would like to retire completely at 65.
"We will likely both continue to work in some capacity in the future, but in my case I would like to scale back to something less stressful," Rory writes in an e-mail.
They are in a solid financial position in that their surplus cash flow exceeds their expenses by almost $7,400 a month. They have investments and a big pile of cash they had been saving up to put down on an income-producing property. With real estate prices so high, they have since changed their minds and are wondering what to do with the money.
"Our conundrum: What to do with the $340,000 sitting in a savings account earning 1-per-cent interest," Rory writes. Their desired after-tax retirement income is $60,000 a year.
We asked Marc Henein, an investment adviser at ScotiaMcLeod in Mississauga, to look at Ruth and Rory's situation.
What the expert says
Given the pending job change for Rory and the uncertainty in the second half of 2017, their first step should be to open a savings account with $50,000, Mr. Henein says. This will more than cover their expenses for at least six months. In Rory's next job, by way of income, all he needs to look for is a role paying enough to cover their lifestyle expenses of $5,000 a month, which roughly equates to $100,000 pre-tax.
The next step is for Ruth to open a tax-free savings account and deposit $41,000 (the maximum contribution room to 2015). The third step is to take advantage of Rory's $74,000 in unused RRSP contribution room while his income is still relatively high. If he contributes the full amount, he will receive a tax refund of 46.1 per cent or $34,000, the adviser says. Once these three steps are completed, Rory and Ruth will have about $175,000 in cash remaining.
With this $175,000 and the $34,000 from the RRSP refund, they should consider investing in a portfolio of corporate class mutual funds, Mr. Henein says. "Given that Rory is in the top tax bracket, he needs to defer any tax this portfolio will generate until he is in a lower tax bracket," he adds. The best way to do this is through a corporate class mutual fund. Such funds allow income and growth to be deferred until the time the fund is sold. If they have a $210,000 medium-risk portfolio that grows at 4 per cent net of fees for five years, that amount will be worth $255,000. The $100,000 severance payment growing at the same rate from June 2017 until Rory reaches age 65 in June in 2021 will be worth about $116,000. This adds up to $371,000 in non-registered funds that can be used to provide retirement income.
Upon retirement, Mr. Henein suggests they switch to either a dividend-paying stock portfolio or a corporate class mutual fund structure that pays income by way of return of capital in order to continue to defer taxes. Assuming a 4-per-cent income payout, that will equate to $14,800 a year.
They are looking to spend $60,000 a year in retirement after tax. Canada Pension Plan and Old Age Security benefits for a couple will generate about $32,000 a year pre-tax. So they will be looking to the investment portfolio to generate another $50,000 (roughly) to cover the tax and remaining lifestyle expenses. With the non-registered portfolio generating $14,800, they need to take $35,000 a year from their registered retirement savings plans. With a 4-per-cent growth rate and assuming no contributions beyond July, 2017, their RRSPs will be worth about $760,000. If they withdraw $35,000 a year, they will draw down the RRSPs by 4.6 per cent a year. Assuming the portfolio grows by 4 per cent a year net of fees, they will deplete the accounts by 0.6 per cent a year, "which is a comfortable figure," Mr. Henein says.
He suggests they not draw down the TFSAs until future years, but rather draw down the RRSPs first in order to lower their estate taxes once the second of them dies. The investments in the non-registered account, TFSAs and RRSPs should be conservatively managed, the adviser says. They do not need to take a material amount of risk to meet their retirement objectives, so a portfolio designed to return 4 per cent "is all they should want and expect," Mr. Henein says.
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CLIENT SITUATION
The people: Rory, 59, and Ruth, 62.
The problem: How to invest their cash and savings to generate a tax-efficient income stream that will last a lifetime.
The plan: Take advantage of unused TFSA and RRSP room. Set up an emergency fund. Invest the balance in tax-efficient corporate-class mutual funds to defer taxes.
The payoff: Retirement income goal met without having to take too much risk.
Monthly net income: $12,374
Assets: Cash $340,000; his stocks $26,000; his TFSA $45,000; his RRSP $484,000; her RRSP $46,000; residence $800,000. Total: $1.74-million
Monthly disbursements: Property tax $365; utilities $245; home insurance $50; security $120; maintenance $100; transportation $435; groceries $500; clothing $20; miscellaneous $200; gifts, charitable $150; vacation, travel $800; dining, drinks, entertainment $1,200; grooming $200; clubs $85; sports, hobbies $50; subscriptions $65; life insurance $170; telecom, TV, Internet $230; RRSPs $2,100; Total: $7,085
Liabilities: None
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