Tom and Pat are wondering how much they will need to save to generate an income of $200,000 a year after tax in eight years or so. Will they have to work longer to reach their goal?Shannon VanRaes/The Globe and Mail
Tom is 42 years old and operates a successful consulting business, drawing a salary of more than $200,000 a year and investing the surplus through his holding company. His spouse, Pat, is 43 and earns about $100,000 a year as a realtor. They have two children, ages four and six, and a house with a mortgage in the Prairies.
Ideally, they’d like to retire together by the time they are 50 or so.
With the lion’s share of his retirement savings in his holding company, Tom is wondering about the tax implications of withdrawing it once he retires.
“Given that most of my retirement savings are in my holding company, I’m curious how much more I need to save to retire with my desired income,” Tom writes in an e-mail.
“I’d like to retire with enough income so that I don’t significantly deplete my savings. I want to be and feel financially independent.”
Can Luke, 56, afford to retire soon while paying for his kids’ education?
Tom and Pat are wondering how much they will need to save to generate an income of $200,000 a year after tax in eight years or so. Will they have to work longer to reach their goal?
We asked Jon Knutson, a certified financial planner at RGF Integrated Wealth Management in Vancouver, to look at Tom and Pat’s situation.
What the expert says
Tom has about $2.86-million of investments in his holding company, 65 per cent of which is in stocks and the rest in fixed income, Mr. Knutson says. Tom and Pat hold about $460,000 in RRSPs, $105,000 in a TFSA and $30,000 in a non-registered account. These accounts are invested 60 per cent in stocks and 40 per cent in bonds.
Tom and Pat are contributing $2,250 a month to their registered retirement savings plans (RRSPs) and $900 a month to their tax-free savings accounts (TFSAs).
Tom is receiving $26,700 per year in rental income. Both expect to receive the full Canada Pension Plan and Old Age Security benefits, although their CPP benefits will depend on how long they work, the planner says. Old Age Security could be clawed back if their taxable income is too high; the clawback threshold is currently $93,454 each.
In preparing his forecast, Mr. Knutson assumed a life expectancy of age 95, an inflation rate of 3 per cent and an average rate of return on investments of 6.5 per cent.
Based on their current savings, Tom and Pat fall a bit short, the planner says.
They’d be able to generate a net spendable income after tax of about $180,000 a year until age 95 if they retire eight years from now, he says.
Can Diego, 71, and Monique, 68, spend $130,000 a year in retirement and still give to charity?
To generate their target of $200,000 a year after tax, they would need to save an additional $100,000 a year in Tom’s holding company until retirement, which would result in a surplus of $2,000,000 in savings left at age 95, Mr. Knutson says.
Alternatively, “if they chose to defer retirement by five years, their $200,000 per year after-tax retirement goal should be achievable based on their current savings,” he says.
“The equity in their personal assets – home and rental property – has not been included in these calculations, as we assume these assets will not be used as a source of their retirement income.”
Tom asks about the most effective way to draw income from his holding company.
Tom’s decision to leave his surplus earnings in his holding company makes sense because it allows him to defer paying personal income tax on the surplus funds, leaving him with more money to invest, the planner notes.
Now with $4-million, what’s the best way for Mike and Miriam to deal with their capital gains?
The corporate tax rate on investment income exceeds 50 per cent in many provinces. “However, you have more funds to invest than if you simply paid yourself personally,” Mr. Knutson says.
“You also have control as to when you would like to pay yourself. Hopefully you can do so when your marginal tax rate is lower; for example, in retirement.” In Tom’s case, he will be able to spread his taxable income over decades.
Because of the higher tax rate, money invested in a corporation, regardless of its source, should be invested as tax efficiently as possible, Mr. Knutson says. Capital gains are tax-preferred over interest income, whether the corporation leaves the income invested or pays it out to a shareholder through a dividend.
Capital gains are more tax-efficient because only half is taxable. The non-taxable half of the capital gain is added to the capital dividend account and can be withdrawn tax-free.
“Understanding the taxation of investment income within a corporation can have a significant impact on the corporation’s and the business owner’s bottom line,” the planner says.
How can Seth, 53, and Maeve, 54, reach their goal of spending $120,000 a year in retirement?
If Tom has a capital dividend account balance or a shareholder loan, where the company owes him funds, he’d be able to withdraw those balances tax-free, Mr. Knutson says. That would change how much would need to be saved.
Tom’s holding company has about 35 per cent in bonds, which will pay interest income at the highest tax rate. “Tom should consider reducing his bond exposure and increasing exposure to investments that are capital-gains oriented within his holding company,” Mr. Knutson says. “He could buy back the fixed income in his personal RRSP.”
Tom and Pat could also consider moving their life insurance to the corporation, the planner says. “That way, premiums could be paid with less-costly corporate tax dollars rather than after-tax personal dollars,” he says. Transferring the life insurance would also have the ancillary benefit of creating a mechanism to extract any money trapped in the holding company at Tom’s death in a tax-efficient manner.
“Careful consideration will need to be given to the corporate ownership structure, the type of life insurance coverage and adjusted cost basis of the policies because the change of ownership would be considered a deemed disposition for tax purposes,” Mr. Knutson says.
In summary, with no additional savings, Tom and Pat are on track to retire comfortably with their desired retirement income goal when they are around 55, the planner says. “In order to retire earlier, they will need to save more.”
Client situation
The People: Tom, 42, Pat, 43, and their two children.
The Problem: How to withdraw Tom’s retirement savings from his holding company in a tax-effective way. Can they afford to retire young and still meet their spending goal?
The Plan: Shift more of the corporate investments from bonds to stocks to take advantage of lower-taxed capital gains. Consider working another five years or so.
The Payoff: Plenty of time to arrange the corporate investments in the most advantageous manner, which will help them reach their goal sooner.
Monthly net income: $18,500
Assets: Bank accounts $80,000; company’s stock holding $1,839,000; Pat’s stocks $30,000; company’s bond holdings $1,018,425; Tom’s TFSA $104,742; Tom’s RRSP $397,783; Pat’s RRSP $60,000; registered education savings plan $44,852; residence $825,000; rental real estate $187,500. Total: $4.58-million.
Monthly outlays: Mortgage $1,655; property tax $475; water, sewer, garbage $350; home insurance $305; electricity $100; heating $195; security $50; maintenance $150; garden $50; transportation $100; groceries $800; child care $1,000; clothing $100; gifts $50; vacation, travel $1,665; personal care $40; dining, drinks, entertainment $550; club memberships $100; pets $50; subscriptions $150; life insurance $100; cellphones, TV, internet $430; RRSPs $2,250; registered education savings plan $415; TFSAs $900. Total: $12,030.
Liabilities: Residence mortgage $293,000 at 1.75 per cent; mortgage rental $19,500 at 4.49 per cent. Total: $312,500.
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