Situation: Couple with adequate income and growing assets wants to ensure long-term security
Solution: Pensions and savings are sufficient, but bolstering their TFSA reserves will set them up for decades
A retired couple we’ll call Harry, 61, and Linda, 59, live in northern Ontario. With discipline and persistence, they have built up financial assets that total $235,000. They have also recently received $100,000 cash from an inheritance. Their goal is to turn those assets, and their other streams of retirement income, into $80,000 in after-tax cash — with a rock-solid guarantee that they will never bring in less than that.
Family Finance asked Eliott Einarson, a financial planner in the Winnipeg office of Ottawa-based Exponent Investment Management Inc., to work with Harry and Linda. “The problem in this case is not about whether they will attain the post-65 spending goal,” Einarson says. “Rather, it is how to get the most benefit out of an inheritance and preserve financial flexibility.”
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Harry and Linda live simple — and frugal — lives. Their children are in their 30s, educated and gone. They have no debts and, though they are light on financial assets, they have Harry’s indexed job pension as a base for their financial future.
Savings and income
Harry’s Tax-Free Savings Account with a $30,000 balance is underfunded. Linda has no TFSA. The total lifetime contribution limit at present is $63,500 per person, so the couple has $97,000 TFSA space. The TFSA is a good place to park the $100,000 inheritance. We’ll leave out $10,000 to leave them with a cash cushion. That will give the couple a combined TFSA balance of $120,000. Assuming they generate three per cent after inflation every year, the TFSA accounts will produce $5,336 per year for the 36 years to Linda’s age 95.
For now, their income consists of Harry’s work pension, $6,586 per month or $79,032 per year including a $12,000 annual bridge to 65 and $8,904 in annual pre-tax income from his Canada Pension Plan benefits started at age 60. His RRSP, with a $116,600 balance, can generate $5,158 annual income before tax for the 36 years to Linda’s age 95 after which all income and returns would be expended. Adding the TFSA funds brings their total income $98,430 per year. After splits of eligible income, no tax on TFSA cash flow and 15 per cent average tax, they have $84,466 per year to spend. That’s over their target, thanks to the inheritance.
Linda can expect CPP benefits of $5,760 per year starting in a few months when she turns 60. She can add income from her $89,000 RRSP paid over 35 years at $4,020 per year. Their annual family income will be $108,100 before tax. After 16 per cent average tax and no tax on TFSA cash flow. They would have $91,750 to spend yearly until each person receives Old Age Security.
At 65, Harry’s income would rise by $7,290 OAS. He would lose $12,000 per year from his pension bridge, reducing his pre-tax income to $103,500. After splits of eligible income, no tax on TFSA cash flow and 16 per cent average tax, they would have $87,794 per year to spend, more than their $80,000 after-tax target.
When Linda reaches 65, she can get $7,290 annually from OAS. That will boost family income to $110,780 per year or $93,917 with no tax on TFSA cash flow and a 16 per cent tax on the balance.
Money they have and will have is beyond anticipated needs, so Harry and Linda can either travel more, which is their goal, and use money they do not need for estate planning or to endow good causes, preferably those that issue receipts for deductible contributions.
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Timing withdrawals from RRSPs is problematic. If they leave money in the RRSPs for untaxed growth for ten years for Harry’s account and twelve for Linda’s, then each $100 invested at 3 per cent after inflation with compounding would grow by 46 per cent in 10 years and 57 per cent in 12 years before being paid out and taxed. They have sufficient cash flow to pay current bills. Above all, they should preserve CPP benefits, avoiding penalties of 7.2 per cent per year for each year withdrawals start before 65 and preserving bonuses of 8.4 per cent per year for each year after 65 to the upper limit of 70. Harry and Linda will be able to afford to wait. The range of benefits from 60 to 70 is 78 per cent plus a big lift in the base for subsequent indexation. It pays to be patient.
There is no reason to rush RRSP payouts until federal rules require payments to start in each partner’s 72nd year. At that time the payouts from Registered Retirement Income Funds start at 5.4 per cent of account balances. Minimum payout rates rise to six per cent at age 77 but stay below seven per cent until the early 80s. Then they rise to nine per cent at 87 and 11 per cent at 90. Withdrawal rates peak at 20 per cent of remaining balances at age 95 and older. These are steep payout ratios. Each decade’s rate can be seen as a discount on the future payout rates and taxes on those payouts. The irony is that in the last decades of life, with no more shelters, taxation can be a grim reaper.
Harry’s job pension plus the OAS and CPP life incomes provide a solid base for the couple’s retirement. It is tempting fate to call their retirement finances bulletproof, but with diverse sources of government guaranteed CPP and OAS pensions, a solid work pension, and ample savings, it is hard to imagine what could go wrong.
They could buy long-term care insurance to protect against the possibility of illness. However, that’s not necessary, Einarson says. Purchased in one’s 60s, long-term care insurance is costly. Moreover, with travel currently budgeted at $1,500 per month, serious illness that keeps them at home would automatically liberate those funds for care. If they need more care, they could sell their $575,000 house and use its capital for accommodation and care not easily available at home.
“Their retirement is secure,” Einarson concludes. “Capital in excess of their estimated needs gives them many choices and a cushion for unexpected expenses.”
Retirement stars: 5 ***** out of 5
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