One of the key challenges people face in retirement is how to determine the right amount of money to take out of their investment accounts each year. The amount has to provide the appropriate cash flow, incur minimal tax and ensure the portfolio will last through retirement.
Michael* and Stacey* are trying to create a retirement withdrawal strategy that meets each of these objectives while already in retirement.
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Michael is 63 and has been semi-retired for 10 years. After working as an electrical engineer, he became a teacher and taught for 20 years in Northern Ontario, where he and his wife Stacey raised their two children before moving to Ottawa in 2013. In addition to his defined-benefit pension, which brings in about $30,000 a year before tax, he earns about $10,000 a year from a part-time job and started taking Canada Pension Plan (CPP) payments at age 60 (net $700 per month). He plans to fully retire later this year.
Stacey retired last year having worked in the non-profit and government sectors. She has a government pension of about $10,000 a year before tax. Each of their pensions is indexed to inflation. Unlike Michael, she has not yet started drawing CPP and would like to know when she should start.
The couple purchased their home in 2012 and it is currently valued at $700,00. They have two mortgages with a combined value of a little less than $300,000 ($135,000 at 2.54 per cent maturing in 2025 and $141,000 at 3.19 per cent maturing in 2027). It’s their only debt and their total mortgage payments are $660 biweekly.
“We used to be aggressive about paying off our mortgages,” Michael said. “But when we renewed it a couple of years ago and took out the second mortgage to help fund a $150,000 renovation we’re planning, we decided we wanted less expensive payments to be able to enjoy ourselves more.”
The couple spends about $12,000 a year on travel and they each have hobbies.
“We’re frugal but don’t mind spending money on what we like to do,” Michael said.
The couple has about $700,000 in registered retirement savings plans (RRSPs), $175,000 in tax-free savings accounts (TFSAs), $43,000 in non-registered accounts and $117,000 in a high-interest savings account earning five per cent.
Michael manages the family’s portfolio, which is largely invested in Canadian (90 per cent) and U.S. (10 per cent) stocks and exchange-traded funds (ETFs). He also has about $10,000 to $15,000 invested in high-risk tech stocks.
“I look for four-per-cent dividend returns,” he said. “Our RRSPs and TFSAs spin off about $30,000 a year in dividends which is currently being reinvested.”
With their money largely invested for growth, he wonders if they should be directing funds to guaranteed investment certificates and bonds to minimize risk.
What the expert says
The following is a Q&A with Ed Rempel, a fee-for-service financial planner, tax accountant and blogger.
FP: Can Michael and Stacey afford to retire and maintain their lifestyle?
Rempel: It’s important for people about to retire to be clear about their expenses — all expenses, including miscellaneous and discretionary spending. In this case, the provided list of expenses omitted what Michael and Stacey call “slush spending” and other miscellaneous items that totalled $27,000 a year. I see this often.
Based on the information provided, they need $100,000 a year after tax ($124,000 per year before tax) to maintain their lifestyle, which means they need about $925,000 in investments. They have $915,000. Technically, they are one per cent behind their goal, but this is OK. They are on track and have just enough investment income to provide for their desired lifestyle — including travel expenses — to age 100. It is advisable to be 10 to 20 per cent ahead of your goal to give you a margin of safety, but this is OK.
FP: What is the most tax-efficient manner to draw down their RRSPs, TFSAs and non-registered investments?
Rempel: The most tax-efficient strategy in this case is for both of them to try to stay in the lowest 20-per-cent tax bracket, which is taxable income of $53,000 per year each. To achieve this, they should convert their RRSPs to registered retirement income funds (RRIFs) and only take the minimum withdrawal. Never take lump sums from the RRIFs.
The minimum RRIF withdrawals plus your pensions equal $109,000 per year. They should be able to split this evenly on their tax returns, so virtually all their income will be taxed at only 20 per cent. To make up the additional $15,000 a year they need, they should draw from their savings and non-registered investments as these are not tax-sheltered. Transfer $6,500 a year from non-registered investments to their TFSAs to keep them maximized and use these funds last since growth is not taxed.
FP: When should Stacey start her CPP and when should they both start their Old Age Security (OAS) benefits?
Rempel: Stacey should start her CPP now and both should start OAS when they turn 65. I estimate their equity-focused investments should average a higher long-term return of about seven per cent versus the implied return of about five per cent from deferring CPP and OAS.
FP: Should they adjust their asset mix (currently almost exclusively equities) to reduce risk and/or improve returns?
Rempel: No. Their life expectancy is more than 30 years. With a long time horizon, you need an income that rises with inflation, not fixed income. The stock markets tend to go up and down in the short and medium term, but are far more reliable long term than most people realize. Your returns after inflation are more predictable than bonds or even GICs for periods of 20 years or longer. This is because bonds and GICs often make less than inflation.
Investing globally or in the United States should give them higher returns over time than their current investments, which are 90 per cent in Canada. Their focus on dividend stocks earning four per cent or more is not the most effective way to invest. It’s more effective to invest based on fundamentals such as return, risk and growth potential. Whether or not a company pays a high dividend is an indication of a mature, slower-growing company, which is likely to grow less than companies chosen for the highest reliable long-term growth.
* Names have been changed to protect privacy
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