Justine Beaulieu-Poudrier/The Globe and Mail
Herman is 60 years old, single and recently retired.
“I immigrated to Canada in 1986 and live in Vancouver,” he writes in an e-mail. “I read The Wealthy Barber when I moved here and followed his advice,” Herman writes, referring to the personal finance book by David Chilton. “I know I have enough to retire on.”
He is looking for advice on how to draw down his registered retirement savings plan to “maximize spending and minimize taxes.”
As well, he is in the process of rebalancing his investments and would like help with that. “I use the Couch Potato system.”
He does not specify a retirement spending target. “I would like to know how much I can withdraw yearly to maximize income, minimize tax and reduce the clawback of Old Age Security at age 70.” He plans to defer government benefits until then. “I don’t plan to leave much in my estate,” Herman adds.
“Is my plan of simplifying my investments to all-in-one exchange-traded funds over the next 10 years realistic?”
We asked Ian Calvert, head of wealth planning at HighView Investment Group in Oakville, Ont., to look at Herman’s situation.
What the expert says
Herman has accumulated a sizeable asset base but leaving a large estate is not a top priority, Mr. Calvert says.
Herman’s net worth is $3,036,000, which consists of his house, valued at $500,000 with no mortgage, $454,000 in non-registered stocks and some cash, $297,000 in his tax-free savings account and $1,785,000 combined in his RRSP and a registered retirement income fund, or RRIF.
His RRSP and RRIF represent 70 per cent of his investable assets, “so they certainly require some careful planning.”
“Herman has done an excellent job building up his RRSP, investing in a tax-deferred structure with meaningful tax deductions along the way,” the planner says. Now that he has retired and is in a lower tax bracket, he requires an exit strategy because all the withdrawals from his RRSP and RRIF accounts will be taxable income.
“Dividing the assets between his RRSP and RRIF is a wise strategy given the size of the portfolio and his age,” Mr. Calvert says. For now, Herman can manage both accounts concurrently and does not need to change his investment strategy.
“Having assets divided between an RRSP and a RRIF gives Herman the flexibility to control the annual minimum withdrawals from the RRIF because he is still many years away from having to take mandatory minimums.”
Both accounts offer the same tax-deferred structure; however, the RRIF account has advantages for meeting recurring withdrawals, the planner says. “It’s the optimal account to use for the outflows to him personally.”
If Herman moved his entire RRSP to the RRIF, he would have to take a much larger annual minimum withdrawal. As well, there could be years where he wants to take less or even nothing from the RRIF.
“Moving smaller amounts from the RRSP to the RRIF will allow him to manage his withdrawals strategically. The balance of the RRIF and his age as of January 1 each year will dictate the minimum withdrawals for the year.”
This strategy of keeping most of his assets in his RRSP and moving smaller amounts to the RRIF each year will work well until age 71, the planner says. At that time, all assets will be forced into the RRIF, and Herman will be required to take the annual minimum withdrawal the following year.
Should Reba, 63, tweak her portfolio to bolster her retirement goals?
For the first phase of Herman’s retirement plan, a RRIF withdrawal of $75,000 a year would be an optimal place to start, Mr. Calvert says. The full $75,000 will be taxable income.
On top of this, Herman will have to report all the interest, dividends and capital gains generated by his non-registered holdings. “With an estimated $17,000 of other investment income, his total taxable income is estimated to be $92,000 a year,” the planner says.
“This is a favourable target because keeping his income below $100,000 a year will keep his marginal tax rate at 28.2 per cent and his average tax rate at 15.5 per cent, combined B.C. and federal tax brackets. This also leaves a small buffer if he sells any positions and realizes capital gains year to year,” the planner says.
At this rate of withdrawal, if Herman can average an annualized rate of return of 5 per cent, the value of his RRIF should be maintained until age 72 when his full minimums start. At that time, the account would slowly start to deplete based on the larger minimum withdrawals.
The early withdrawals from his RRSP/RRIF throughout his 60s will provide income taxed at a favourable rate and prevent the accounts from creating a compounding tax problem for later years, the planner says.
His after-tax income on the $75,000 would be about $60,500 a year, which should satisfy his lifestyle expenses of $5,000 a month after tax. He should also continue to transfer $7,000 from his non-registered assets to his TFSA each year.
Given his strong financial position, Herman could increase his spending, Mr. Calvert says. He could comfortably spend about $20,000 a year more generated from the income in his non-registered portfolio. “Whether he spends this or not, this income will appear on his tax return each year.”
Herman’s withdrawal plan will work well until 2038, when he turns 70. That assumes he delays both of his Canada Pension Plan and Old Age Security benefits.
Because his RRIF can easily bridge the income gap between 65 and 70, and still maintain its value during this period, Herman is in a position to delay all government benefits without having an unsustainable withdrawal rate from his portfolio.
When his RRIF minimum withdrawals start in 2038, they will increase his total withdrawals to about $100,000 per year, based on his age and the estimated value at that date, Mr. Calvert says.
At age 72, when Herman is withdrawing his full RRIF minimum, plus his enhanced CPP and OAS benefits, he will have gross income of about $145,000 a year. This will increase his marginal tax rate to 38.29 per cent and will likely result in one-third of his OAS being clawed back.
Based on his current spending and the size of his portfolio, Herman’s net worth is expected to increase over the years. “If his goal is to leave only a small estate, he could consider spending more without concern, gifting to family members now, or reflecting on the purpose of his wealth and what legacy he wants to leave.”
Client situation
The person: Herman, 60.
The problem: How much can he afford to spend now that he is no longer working? Should he rebalance his investments?
The plan: Continue transferring RRSP holdings to his RRIF and drawing on it for the bulk of his income. At 70 start collecting government benefits. Consider spending more or making plans to give some of his money away.
The payoff: The satisfaction that comes from knowing you have more than you need.
(Income, expenses, assets and liabilities provided by the applicant.)
Monthly after-tax income: $5,000 or as needed.
Assets: Bank accounts $180,000; non-registered mutual funds $274,000; TFSA $297,000; RRSP $1,531,000; cash in RRIF $254,000; residence $500,000. Total: $3,036,000.
Monthly outlays: Condo fee $395; property tax $175; home insurance $120; electricity $30; garden $25; transportation $100; groceries $400; clothing $100; vacation, travel $2,500; dining, drinks, entertainment $250; personal care $50; club memberships $150; health care $310; communications $170. Total: $4,775. Spending may be understated.
Liabilities: None.
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Some details may be changed to protect the privacy of the people profiled.