Neetu’s goal is to leave her house, her TFSA and any remaining money to her daughter, but a financial planner says she may want to reconsider her goal of leaving such a large inheritance.EDUARDO LIMA/The Globe and Mail
Neetu is 61 years old and earns $80,000 a year, and a bonus of about $8,000, as an assistant manager. She has a mortgage-free house in Toronto that she shares with her daughter, who is 28.
In addition to her salary, Neetu is receiving the survivor benefit of her late husband’s work pension ($7,656 a year) and the Canada Pension Plan ($9,084), for a total annual income of nearly $105,000. Neetu contributes to a defined contribution pension plan at work and her employer matches her contributions.
Her goal is to retire before 65 with a spending target of $65,000 to $70,000 a year after tax. Short term, she plans to spend $30,000 on house renovations and hopes to purchase a new used car. She would also like to spend $10,000 on a trip each year until she is 80.
“Do I have the funds to retire before age 65 but not claim CPP until age 70?” Neetu asks in an e-mail. “Which accounts should I draw from first in the most tax-efficient way?” Her goal is to leave her house, her tax-free savings account and any remaining money to her daughter as her inheritance.
We asked Warren MacKenzie, an independent Nova Scotia financial planner, to look at Neetu’s situation. Mr. MacKenzie holds the chartered professional accountant designation.
What the expert says
Neetu has a net worth of more than $2.8-million, including her $1.4-million house, Mr. MacKenzie says. In addition to her salary, she gets $16,740 a year of indexed income from her late husband’s pensions.
“Given her moderate lifestyle expenses, Neetu is in better financial shape than she realizes,” the planner says.
Assuming a 5 per cent average rate of return with 2 per cent inflation, Neetu could retire tomorrow and still be on track to achieve her spending goals. “She’d leave a legacy with a value greater than her home and the current value of her TFSA.”
Neetu is spending about $50,000 a year. In his projections, Mr. MacKenzie increased Neetu’s future lifestyle spending to $75,000 a year.
“If she lives to be 100, even with the higher spending, Neetu is on track to leave an estate valued at more than $2-million in dollars with today’s purchasing power,” he says. If she lives to 90, the inheritance will be about $2.5-million in today’s purchasing power.
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Neetu may want to reconsider her goal of leaving such a large inheritance. Instead, she should start spending a bit more on her own lifestyle and travel, Mr. MacKenzie says. “She is considering buying a used car some time in the next few years. If she sees a new car that she likes, she should not hesitate to indulge herself.”
If at some point, she needs a nursing home and expensive health care – in her early 80s, for example – this cost could be funded by selling her home. If the proceeds from the sale are invested to earn 5 per cent, “it is unlikely that this would make a material difference in the size of the inheritance her daughter will receive,” the planner says.
Long-term financial projections are never going to be totally accurate, so they should be updated every few years or when major economic changes happen, Mr. MacKenzie says.
If a person is financially secure, but feels they need to save even more, “this is an unfortunate waste of the hard work and the sacrifice that was required to create existing wealth.”
Neetu is planning to defer her CPP benefit to the age of 70 in order to increase the amount she would receive by 42 per cent. She is in good health and expects to live into her 90s. But she is already collecting a CPP survivor pension, and there is a limit to how much CPP a person can collect.
If she defers her own CPP to 70, the larger benefit, in addition to how much she collects from her husband’s survivor pension, would exceed the maximum amount allowed. The survivor benefit would be reduced because the total cannot be more than the maximum CPP benefits any one individual is entitled to receive.
“Assuming CPP benefits increase by 2 per cent a year, in line with inflation, in January, 2035, when Neetu is 70, the maximum pension amount for someone who has delayed CPP until age 70 is estimated to be about $28,000 a year,” the planner says.
In 2028, which could be Neetu’s first full year of retirement, her cash outflow is projected to be $95,000, consisting of lifestyle spending of $78,000, $9,500 in income tax and $7,500 for her annual TFSA contribution.
Cash inflow is projected to be about $9,500 from the CPP survivor benefit, $8,000 from her late husband’s defined benefit pension, a $30,000 withdrawal from her registered retirement savings plan or registered retirement income fund, and $47,500 from her savings account and non-registered investment portfolio.
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In 2035, when Neetu is 70, the cash outflow is projected to be $116,000, consisting of lifestyle spending of $90,500, $16,500 for income tax and $9,000 for her TFSA contribution.
After inflation adjustments, the cash inflow is projected to be about $116,000 a year, made up of $28,000 in CPP benefits, $9,000 from the defined benefit survivor pension, $10,700 from Old Age Security, a $42,000 withdrawal from her RRSP/RRIF, and a $26,300 withdrawal from her non-registered investment portfolio.
During most of her years in retirement, Neetu will be paying about 29.65 per cent on taxable income above $58,000 a year, Mr. MacKenzie says.
“There would be several benefits if she decided to start giving some of her non-registered capital to her daughter,” he says. First, her daughter would have an opportunity to learn about investing. Second, her daughter would be in a lower income tax bracket, so overall, the family would be paying less tax on the investment income earned. This would reduce the amount that is eventually paid by the estate in probate fees.
“This would also give her daughter money to invest in her own TFSA,” the planner says.
Neetu has nearly $184,000 of unused RRSP room. “While she is still working, she should make sufficient RRSP contributions to at least bring her taxable income down to $58,000 a year,” Mr. MacKenzie says.
His financial projections show that when the money is eventually withdrawn from her RRIF, she will be in a lower income tax bracket. “Based on reasonable assumptions, she will not be hit with a clawback of her Old Age Security benefits at any point in the future.”
“A sensible way to give her daughter some investing experience and also save income tax would be to draw sufficient capital from her non-registered account to enable her daughter to maximize her own TFSA contribution,” he says. “If her daughter has not already contributed to a TFSA, Neetu could give her $109,000 from her taxable account. The daughter could then invest this in her TFSA.
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Next, the planner looks at Neetu’s investments. The asset mix in Neetu’s investment portfolio is almost 100 per cent stocks and stock funds. Over the past four years, her net return was 12.9 per cent.
“Neetu has expressed a desire to have some protection against a major stock market crash,” Mr. MacKenzie says. “Given that stock markets are near an all-time high, and she can achieve her financial goals with a low-risk portfolio, she should reduce her exposure to equities,” he says.
Neetu has almost $500,000 in non-registered investments, and she should continue to maximize her contributions to her TFSA.
Neetu’s daughter is named as the executor of Neetu’s estate. Her daughter does not have experience managing large sums of money. “To avoid a potential problem, if Neetu were to die in an accident, for example, Neetu should consider revising her will to appoint a corporate trustee to manage the estate. “She should set up a trust fund to manage the financial affairs until such time as her daughter has demonstrated that she can manage money wisely,” Mr. MacKenzie says.
Neetu expects to receive a $500,000 inheritance some time in the next five to 10 years, money she does not need to achieve her spending goals.
“If she does, in order to give her daughter investing experience, Neetu should consider transferring $100,000 a year to her daughter,” the planner says. “By transferring the money in stages, Neetu can revise her will if she sees that the money is being unwisely used.”
Client situation
(Income, expenses, assets and liabilities provided by the applicant.)
The people: Neetu, 61, and her daughter, 28.
The problem: Can Neetu afford to retire before she is 65 and still leave a large inheritance for her daughter?
The plan: Retire as soon as she wants and spend a little more on herself. Consider giving her child an advance inheritance. Simplify her investments and reduce her exposure to the stock market.
The payoff: Peace of mind.
Monthly after-tax income: $5,580.
Assets: Bank account $26,000; non-registered stock portfolio $448,955; locked-in retirement account $153,550; TFSA $156,905; RRSP $515,210; market value of DC pension plan $113,200; residence $1,400,000. Total: $2.8-million.
Estimated present value of DB pension survivor benefit: $200,000.
Monthly outlays: Property tax $705; water, sewer, garbage $145; home insurance $145; electricity $140; heating $140; security $50; maintenance $345; garden $50; transportation $285; groceries $500; clothing $70; gifts, charity $340; vacation, travel $210; other discretionary $50; dining, drinks, entertainment $340; personal care $150; sports, hobbies $35; subscriptions $50; other personal $35; health care $165; communications $180; pension plan contributions $495. Total: $4,625.
Liabilities: None.
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