Creative financial moves and putting a cash mountain to work will pay off
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Sep 18, 2020 • • 5 minute read
A couple we’ll call Nancy, 52, and Bill, 53, make their home in Ontario. Their children are grown and gone. Bill is unemployed, downsized out of a management job in the construction industry. Nancy works for a large company in document management. They fear that having only one income will imperil their financial future but, as we’ll see, there are ways to mitigate the lost wages through some creative financial moves.
The couple’s income consists of Nancy’s salary, $8,600 per month before tax and $5,640 after tax. They want to design a retirement that starts now for Bill, but allows Nancy to work several more years to take advantage of her salary and the solid defined-benefit pension her employer provides. They have $959,200 in financial assets including $354,300 in cash. They have no debts. At 65, Nancy expects company pension income of $3,143 per month.
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Family Finance asked Owen Winkelmolen, head of PlanEasy.ca, an advice-only financial planning service in London, Ont., to work with the couple. “They can look forward to a generous retirement,” he explains, but notes they have to do something about their “mountain of cash” that is earning them little. His advice — use Bill’s present lack of income and Nancy’s dependable job pension to develop retirement income.
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Too much cash
We need to understand how the cash mountain came to be. Nancy and Bill sold a former home and put the proceeds into a series of GICs and what are referred to as premium savings accounts which, in truth, barely cover inflation before tax and lag it after tax. The $354,300 from the home sale makes up 36 per cent of their financial assets. If they leave it in cash earning at most two per cent per year in GICs, they will lose purchasing power and erode their way of life. The cash has to be invested in non-volatile assets that fit with Nancy and Bill’s emotional preferences as investors, but also have the ability to pace inflation and grow the portfolio.
For our analysis, we assume that Nancy and Bill transfer this sum to a balanced portfolio of 60 per cent stocks, 40 per cent fixed-income that provides a return of three per cent per year after three per cent inflation. Asset prices will wobble, but over ten, twenty and thirty year periods, returns should match our model.
They want to make gifts and large purchases totalling $90,000 in the next four years. That leaves a nominal $264,300 in cash. This sum, invested to grow at three per cent after inflation for the 13 years to Nancy’s age 65 would become $388,149. Then, annuitized for the following 30 years to her age 95 with the same assumptions, it would generate $19,225 per year before tax.
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Heading into retirement
For the next seven years, Nancy and Bill can live on her $5,640 monthly after-tax salary. That’s also the sum of allocations, but if we recognize $920 per month as TFSA savings, they are taking home more than they are spending.
The couple can use Bill’s unemployed status to make withdrawals from his RRSP. Nancy can contribute a similar amount to her own, smaller RRSP and get a tax savings. Nancy saves 31.5 per cent tax for money added to a spousal RRSP. With Nancy’s existing RRSP contribution room and her future contribution room assuming that she works to 65, the couple could have $23,000 of additional tax savings by the time Nancy is 65 and retires. With no further contributions to their $465,000 of RRSPs but growth at three per cent per year after inflation for the 18 years to Bill’s age 71, the account would have a balance of about $800,000. That capital, still growing at three per cent per year, would then support payouts of about $45,000 for the following 25 years to Nancy’s age 95.
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The couple can use tax savings from RRSP shifts to build TFSA balances at $12,000 per year growing at three per cent after inflation to $398,500 by the time Nancy retires at age 65. That capital would produce a non-taxable cash flow of $19,740 for the 30 years to her age 95.
When Bill reaches 60 in seven years, his Canada Pension Plan benefits will start at a rate reduced by 36 per cent from his age 65 entitlement to $7,764 per year with no tax. Added to Nancy’s $103,200 salary, $72,100 after benefits and 30 per cent tax, they will have $79,864 to spend. That’s $6,655 per month. That would cover present allocations.
When Bill reaches 65, his Old Age Security can start at $7,362 per year. Added to his annual CPP benefit, $7,764, he will have pension income of $15,126 per year. Combined with Nancy’s $103,200 annual salary less 30 per cent tax and benefits, they will have $7,300 spendable cash per month. That would be surplus to expected cost of living and allow discretionary spending or more TFSA saving. Based on their present budget, they would have about $1,000 per month to spare.
When Nancy reaches 65, her job income will end but her pensions from her company, $37,716 per year before tax, an estimated $15,479 from the enhanced CPP, $7,362 from OAS and $19,740 income from their invested cash will total $80,297 before tax. She will pay average tax of 18 per cent and have $65,840 on top of Bill’s $15,126 with negligible tax for total, after-tax income of $80,970. They could add TFSA cash flow of $19,740 for total income after tax of $100,700 per year or about $8,400 per month.
When Bill reaches 72 and Nancy 71 — we’ll clump the ages that are just a few months apart — they can start RRSP withdrawals. Their RRSPs by this time will generate $45,100 as previously estimated and push combined annual taxable income to $126,397. With splits of eligible income, they would pay tax at an average rate of 19 per cent, leaving $102,382. With TFSA cash flow, $19,740, added, their annual spending would rise to $122,100 or $10,175 per month. “There is a good deal of planning required, but it will pay handsomely. Prudence will have been its own reward,” Winkelmolen concludes.
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