Retirement is a time of great excitement and the beginning of a new stage of life. As with any big life change, there is also an element of concern, as people become overwhelmed with the decisions they must make.
- How will they spend their time?
- How much will that cost?
- What sources of income are available to them?
- When is the best time to begin accessing that income?
These questions can be daunting, and to prepare for this new stage of life, it’s important to understand the various options, and make informed choices. Let’s look at an example.
Meet Jim and Sue Smith
Jim and Sue Smith are a married couple with three adult children. Jim is 65, and retired last year. Sue is 59, and retired last month. They are both Canadian citizens and qualify for full OAS benefits of $578.53 (since Sue is only 59, she cannot begin to collect OAS prior to age 65). Jim will receive maximum CPP retirement pension of $1,114.17 per month, and Sue will receive about 70% of the maximum benefit, when she decides to begin receiving payments.
Sue has a defined benefit pension plan through her employer and a spousal RRSP worth $225,000. Jim has a locked-in RRSP worth about $750,000 and a personal RRSP, valued at about $350,000. Jim also has a $500,000 non-registered account in his name only, resulting in additional investment income allocated to Jim. They have maximized their TFSAs, and own a home worth $600,000. They have about $2,000,000 in total assets and spend about $70,000 per year. Being somewhat conservative investors, they estimate returns of 4% net of fees.
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What are Jim and Sue’s Concerns?
Jim and Sue are concerned with tax efficiency and the risk of outliving their money. They both have family histories of longevity. Jim and Sue would also like to have some funds available for their grandchildren upon their passing. In a year, they are moving to another province to be closer to their children and grandchildren. They are considering whether to buy another home of equal value or rent an apartment. They would like to compare the financial outcomes of these two options.
Making Informed Decisions
Upon reviewing their situation, Jim will convert his RRSP and locked-in RRSP into a RRIF and an LRIF, with payments beginning in the New Year. By converting these accounts now, as opposed to at age 71, he should avoid OAS clawback now and throughout the rest of his life, and will benefit from the $2,000 pension income amount tax credit. He is splitting his income from his RRIF and his LRIF with Sue.
Sue’s only source of income is her employer pension with annual payments of $16,000 (non-indexed), so allocating some of his income to her to reduce the family tax bill makes good sense.
To maximize tax efficiency, Sue will convert her RRSP to a RRIF at age 65. She will not split her pension or RRIF income with Jim. Keep in mind that he has the additional investment income from the non-registered account in his name. She will also remain under the OAS income threshold.
OAS benefits begin to be clawed back when net annual income before adjustments reaches $74,789. Income in excess of this amount results in a 15 cent per dollar reduction in OAS benefits. For example, if Jim earned $100,000 of net income while receiving OAS, he would be subject to a clawback of $3,781.65. This is calculated as follows: ($100,000-$74,789) x 15%. This amount would be deducted from the maximum benefit of $6,942.36. His total OAS benefit would be $3,160.71. Not everyone qualifies for the maximum OAS benefit. There is a residency requirement in place.
Deferring CPP or OAS pension start dates beyond the standard age of 65 may have merits for Jim and Sue. The couple will consider deferring these pensions in particular for Sue, as she gets closer to age 65.
Income sources (CPP, OAS, employer pensions, and minimum RRIF withdrawals) will be sufficient to fund their lifestyle without reducing investment capital for the remainder of their lives.
Jim and Sue will benefit from the tax advantages of a TFSA by maximizing deposits for life. There is sufficient cash flow and non-registered assets to accomplish this.
We agreed that Jim will add Sue’s name to his non-registered investment account with rights of survivorship. Due to attribution rules, Jim will still be responsible for the taxes payable on the account, but this action will assist with ease of access to the funds should he become disabled or die. Probate fees on the account would be avoided on Jim’s death.
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Sell the Home and Rent, or Buy Another Home?
As previously mentioned, Jim and Sue will be moving to another province next year. If they decide to sell their home and rent, they assume that annual expenses would rise by about $30,000 annually. Proceeds of the home will be deposited into a joint non-registered account, since both contributed equally to the home.
Upon comparing the two scenarios, if Jim and Sue rent, their net worth will be about 55% of what it would be if they continued to own, should they live into their mid-90’s. This is a result of losing the principal residence tax exemption, higher annual expenses, and a larger non-registered portfolio generating taxable investment income. There are instances where selling a home and renting makes good financial sense. It depends on the specifics of each situation, so it is important to compare the financial outcome in all cases.
To reduce the negative impact on their estate value, consideration may be given to renting later in life, perhaps in their late 70’s or early 80’s, when it becomes more difficult to maintain the upkeep of the home. Depending on health, they may opt for a retirement home over a rental condo – and assets seem sufficient to fund an increase in expenses from long-term care costs.
Jim and Sue are well-positioned for retirement. They made sound financial choices in their earning years. Even if returns were only 2%, they would be able to maintain their current lifestyle. With returns projected at 4%, if they chose to deplete their liquid assets, spending could be increased by over $42,000 annually.
The decision to begin renting immediately would have the most significant impact on their estate value if their estimated budget for a rental is, in fact, accurate. Jim and Sue will need to determine if letting go of the responsibilities of home ownership in the short term is more important to them than the preservation of their estate.