In addition to their $120,000-a-year of income, Sal and Carla have substantial savings and investments.Michael Bell/The Globe and Mail
Sal and Carla have run a successful consulting business over the years, saved well and used tax-planning strategies such as their individual pension plan (IPP) to ensure their financial security. An IPP is a form of defined-benefit pension plan.
Sal is age 69, Carla is 65. They have three adult children in their 30s.
In addition to their $120,000-a-year of income, the couple have substantial savings and investments. They have decided that some of their wealth will be used to fund a donor-advised fund at a local community foundation. They want to maintain their current lifestyle spending of $180,000 a year after tax when they retire in the next year or so. They are also concerned about keeping taxes and estate fees to a minimum.
Their questions: How to draw down their registered savings funds (RRSPs) to meet their $180,000 after-tax spending goal; how to maximize what they leave to their three children by reducing probate and estate taxes; and how to ensure they will have $500,000 for a family foundation, Sal writes in an e-mail.
We asked Brinsley Saleken, a fee-only financial planner and portfolio manager at Macdonald Shymko & Co. Ltd. in Vancouver, to look at Sal and Carla’s situation. Mr. Saleken holds the certified financial planner and advanced registered financial planner designations.
What the Expert says
The first task was to affirm that the $180,000 after-tax in today’s dollars that they wish to spend is sustainable, the planner says. They want something left over for their three adult children as well as funding the foundation to their long-term goal of $500,000.
Assuming a 6.1-per-cent annual rate of return, consistent with what they have been earning with their portfolio manager, and a funding period of 20 years for the foundation, the assets seem to sustain themselves “but run dry right at the end,” Mr. Saleken says. That doesn’t include their real estate or their $600,000 airplane, which they plan to sell in the next year or so.
If a more conservative assumption of a 5.1-per-cent return is used, the funds would run out sooner unless they sell the airplane.
In preparing his forecast, the planner assumes a life expectancy of 91 for Sal and 93 for Carla and that they defer Canada Pension Plan and Old Age security benefits to age 70.
Their investment portfolio has about 70-per-cent equities, including non-conventional assets and 30-per-cent fixed income. The assumed 6.1-per-cent return is based on fixed-income returns of 4 per cent and equities of 7 per cent.
In the assumptions, Inflation averages 2.5 per cent, the mid-point of the Bank of Canada target range.
“Realistically, they likely will have a significant surplus given we have indexed their spending requirement each year by 2.5 per cent and made no assumptions for reduced expenditures in the latter part of their retirement,” the planner says. The first 15 years includes a significant travel budget that would likely fall at some point given health changes or just the normal aging curve, he notes.
“Of course, this travel budget could be replaced by enhanced health care costs at some point should they need access to in-house or external assisted living,” Mr. Saleken said.
He assumes they both start Canada Pension Plan and Old Age Security benefits at age 70 to take advantage of the enhanced payouts. They had thought that OAS would be fully clawed back but this does not seem to be the case given it will be deferred, which means the OAS clawback ceiling will be higher, the planner says.
They plan to take the commuted value of their IPP rather than drawing a monthly pension from the plans. “Based on the actuarial reports, Carla can roll all of hers into a locked income fund, whereas part of Sal’s becomes taxable,” Mr. Saleken says. They should time this conversion no later than Sal’s age 71 so it doesn’t come in the year when he is required to begin drawing from the rest of his retirement plans. “This should save some tax in the long-run.”
Next, Mr. Saleken also looked at the couple’s estate planning and potential for reducing probate fees.
Sal and Carla are interested in how to maximize the after-tax estate for the children, he notes. They live in a province where probate fees are $7 for each $1,000 of assets.
“From a tax perspective, there may be limited options given that almost all of their financial assets are within registered plans,” Mr. Saleken says. One strategy might be to pull additional funds from the registered plans annually to be taxed at a lower rate than they would be in their estate, which will likely be taxed at the highest marginal tax rate. That may not make much difference.
“The default is to take the minimum amounts from each of their plans and base this on the younger spouse’s age,” he says. “Given how significant the minimum withdrawals already are, there does not seem to be an advantage in pulling more out than necessary because they are already in a relatively high tax bracket.”
There is a family cottage that, if passed on to the next generation, could be a point of planning in terms of when this occurs so as to spread the gain out before it forms part of the parents’ estate. “As an aside, family cottages are often a great source of family discord. If it is to be retained, the suggestion is to convene a family meeting at some point and put agreements and operating procedures in place to ensure everyone’s expectations are in place,” Mr. Saleken said.
Probate fees are often something that people try to avoid, but in doing so “end up with unintended consequences from planning that goes awry,” Mr. Saleken says. Assuming all assets are held jointly between Sal and Carla, and beneficiary designations have been made, a probate filing will occur when the last spouse dies. “Based on current asset values, if Sal and Carla were to pass away today, there would be probate fees of about $40,000,” the planner says. “Any planning done to avoid this fee should keep this figure in mind and ensure that the cost-benefit is met.”
If investment management, market risk and/or longevity risk are areas of concern, they may want to consider annuities for part of their registered plans so as to secure some base level of predictable cash flow beyond just their government benefits. “For some, this is a peace of mind exercise but also risk management for longevity concerns.”
Client Situation
The People: Sal, 69, Carla, 65, and their three children, 35, 34 and 31.
The Problem: Can they maintain their lifestyle, leave something for their children and provide $500,000 to fund a family foundation? Is there an effective way to minimize probate fees?
The Plan: They will have enough to fund the foundation for 20 years if they sell their airplane. They may want to draw on their registered retirement income funds (RRSPs) early so their income – and taxes – aren’t as high as they would be when they begin collecting government benefits at age 70 and making mandatory minimum withdrawals from their registered retirement income funds (RRIFs) at age 72.
The Payoff: The comfort of knowing they can achieve their financial goals and that the probate fees they face may not be worth the complicated tax planning that would be required to lower them.
Monthly net income: $15,000 or as needed.
Assets: Residence $1-million; cottage $500,000; his RRSP $574,480; her RRSP $450,025; his locked-in retirement account $156,260; her spousal RRSP $262,105; his IPP $1,032,200; her IPP $955,600; taxable portion of his IPP $98,800; airplane $600,000. Total: $5.6-million.
Monthly outlays: Property tax $625; water, sewer, garbage $170; home insurance $505; electricity $190; heating $155; home maintenance $1,300; car insurance $400; fuel $600; maintenance $100; groceries $800; clothing $500; gifts $100; charity $1,000; vacation, travel $5,000; other discretionary (gifts to family) $2,000; dining, drinks, entertainment $460; personal care $300; pets $200; health care (health insurance a benefit of their corporation); phones, TV, internet $390; registered education savings plan for grandchild $200. Total: $15,000.
Liabilities: None.
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