National Post Article: B.C. couple, both 49, wonder if retiring at 60 is possible

The National Post asked me to review the finances of a B.C. couple who are both 49-years old, wondering if they can retire at 60.

George has a full-time position in the public sector, a private business and takes on consulting projects. His wife Elyse is a stay-at-home mom to their two teenage children. One of the couple’s children has persistent mental-health challenges and will likely require financial support throughout life.

George earns $225,000 before tax from his full-time job, between $45,000 to $90,000 in dividends from his business, and between $45,000 and $60,000 from consulting.

They have paid off the mortgage on their $1.8 million British Columbia home this year and are now debt-free. They have $245,000 in investments and are investing $2,500/month now that their mortgage is paid off.

In the article you’ll learn:

• Why Ed estimates they will need an annual income of $200,000/year before tax in addition to George’s pension plan to live the lifestyle they want.
• Why they need $3.3 million, but are only on track for $1.1 million at the age of 60.
• How much of the extra cash flow now that their mortgage is paid off should they invest?
• How can George save $33,000/year in tax with effective corporate tax planning?
• Why it’s important to invest money into George’s corporation and use it like an RRSP.
• Why a Registered Disability Savings Plan (RDSP) is better for their child than an RESP.

CLICK THE LINK BELOW TO READ THE ARTICLE BY MARY TERESA BITTI:

B.C. couple, both 49, wonder if retiring at 60 is possible

Financial Snapshot:

They are living a very comfortable life with high income, but have saved very little for retirement. 

This is often a mistake by government employees, who think that their pension should provide a comfortable retirement. 

In general, a maximum government pension + CPP provides about half of your salary. That can be okay for a frugal retirement, but most people (including George & Elyse) want a more comfortable retirement.

George has also been earning $90-150,000/year on the side, so half of his salary does not replace all this income that they have become used to spending.

Their retirement goal is to retire on $200,000/year in today’s dollars at age 60 or 65. 

Their expenses today are $11,600/month ($16,600-$5,000 tax included in that figure = $11,600). 

Add about $15,000/year for 2-3 more trips/year in retirement is $154,000/year after tax, or $200,000/year before tax.

To retire at age 60, they would need $3.3 million in addition to George’s pension plan. 

They are on track for $1.1 million. They need to invest $11,000/month more. This is out of reach.

To retire at age 65, they would need $2.8 million in addition to George’s pension plan. 

They are on track for $1.75 million. They need to invest $2,900/month more.

Now that they paid off their mortgage, they have $4,700/month extra cash flow. 

They have already allocated $1,500/month for retirement, $600/month for future expenses for their disabled child, and $2,600/month for future renovations. 

If they invest that $2,600/month for retirement (in addition to the $1,500/month), then they are essentially on track to retire at age 65.

This assumes that they are comfortable with a high equity portfolio that averages 8%/year long term. 

They have been investing in medium to high risk mutual funds, which should be a high equity allocation. 

They should maintain this allocation through their retirement, in order to provide the cash flow they want for life.

However, if George stops taking a dividend entirely from his corporation and invests all of it inside his corporation (uses his corporation like an RRSP), then they would be ahead of their retirement goal at age 65 without contributing to TFSA for retirement at all. This is their best strategy.

Incidentally, this story shows why paying off their mortgage early was not their best strategy. 

Without a mortgage payment, they have much more cash flow and are using most of it for lifestyle. 

If instead they had paid off their mortgage more slowly by the time they retire, they would have been able to invest far more, which could mean they could retire years earlier.

Financial Planning Notes, Questions, and Ed’s Insights:

“Our main question is how to save effectively for retirement given that my wife has not worked since 2005 and will not have any kind of pension or significant savings or RRSPs.”

The easiest way is to invest the $2,600/month for future renovations for their retirement. They could either defer the renovations, find a less expensive option, or finance them with a low rate mortgage. 

This is likely much easier than reducing their lifestyle expenses by $2,600-2,800/month. 

Using his corporation like an RRSP is their best strategy and explained below. 

The general rule of thumb when paying off your mortgage is to invest all or almost all for your retirement. This is necessary for George & Elyse.

Upon his death, Elyse would receive 100 per cent of George’s pension for five years and then 60 per cent. He also has a $400,000 life insurance policy through his employer. 

If Elyse outlives George, she would lose $73,000 in pension income ($50,000/year for 40% of his pension + $13,000/year for his OAS + $10,000/year for 40% of his CPP). That is about half their total after-tax retirement income. She would likely spend somewhat less by herself than they spend together. A term-to-100 life insurance policy of $1 million could cover about 80% of this lost income, if she had to cover it from early in their retirement. There is also a price break at $1 million.

It is somewhat unlikely that she would need this. Typically, women live only about 5 years longer than men, so a $500,000 policy is most likely to be enough. Having $1 million protection can provide the peace of mind that she would be okay in all scenarios.

Elyse’s other option is to sell their home if George passes away. It is worth $1.8 million and she likely would not need that large a home. If she is okay selling the house at that time and either renting & investing the proceeds or buying a new home (maybe a condo) for half the value, then she would not need the life insurance.

The only reason they might need life insurance after they retire is because George has a pension that does not provide 100% survivor benefit. Most people with no pension don’t need life insurance after they retire, since the survivor keeps 100% of their investments.

He directs $1,000 a month from his business earnings into this investment account. “Is this a good idea? Are there other options I should be looking at? Or should I take more dividends and put those funds into Tax Free Savings Accounts,” he wonders. “In some ways I see the company savings as my wife’s pension. Once we retire, I believe I can distribute the earnings as dividends to her because she’s a shareholder in the corporation.” 

Yes, it is a good idea, but he should save far more in his corporation. George should use his corporation as his RRSP-equivalent. He could buy the same investments in his corporation that they buy in their RRSP. It would be far more tax-efficient for George to stop his dividends from his corporation entirely and invest the entire amount inside his corporation. He could then withdraw it and pay far less tax after they retire. This would give him $5,625/month more to invest inside his corporation.

He pays himself on average $67,500 in dividends and pays $33,000 in income tax on it, since it is on top of his salary and consulting incomes. If he stopped taking dividends entirely, he would have about $35,000/year ($3,000/month) less cash flow. He could then contribute $3,000/month less to his TFSA, which leaves him $1,100/month that they could still save for their future renovations.

If he invests the full $67,500 plus the $1,00/month he is doing inside his corporation, they can stop TFSA contributions for retirement entirely and still retire one year earlier at age 64.

It is not tax-efficient for business owners to take dividends and pay tax on them to contribute a smaller amount to a TFSA.

It is worthwhile to take a dividend from a corporation to contribute to RRSP, but George only has $4,200 RRSP room. This is small, but worthwhile. (It used to be better to invest inside a corporation than RRSP, but with the higher capital gains tax announced this year for corporations, taking a dividend to contribute to RRSP is not usually better.

Seeing his corporation investments as his wife’s savings is somewhat correct. The TOSI rules (tax on split income) for paying dividends to a non-active spouse are complex and he would need advice from his accountant. However, he should be able to pay her larger dividends after they retire if their corporation is inactive and purely an investment corporation.

However, he can split his pension with Elyse after they retire for tax purposes, so their taxable income should already be close to equal after they retire.

The couple stopped contributing to the RESP about two years ago, when it became clear only one of their children would likely be going to university or college in the near future. 

It is worthwhile for them to save enough in their RESP to pay for the education costs that they want to pay for. They have $30,000 in their RESP now, which is likely not enough for one child. If the child does not need it, George & Elyse could still invest in the RESP and get the grant, invest both so they have the money available, but then withdraw it all for their retirement.

It might be worthwhile contributing for their child with the disability that won’t go to university, if they have not contributed the maximum for the other child. In that case, the one that does go to university could use the grant and investments for the other child.

George sold his RRSP holdings to buy back 16 pension years when his employer transitioned from a defined contribution pension plan to a defined benefits pension plan), George would like to know if it makes more sense to maximize non-taxable investments such as TFSAs rather than RRSPs, which will be taxed later on?” 

It was likely not worthwhile for George to buy back the pension. Given that they invest in higher growth investments, the investments in his RRSP would probably have provided a higher retirement income than the extra pension from the top-up. This is because the pension formula generally assumes investment returns about 5% a year, but George & Elyse are likely to get higher returns over time.

No, George is better off maximizing taxable investments, like RRSP. He is in a high tax bracket today at 53.5% and should be in a lower tax bracket about 31% after they retire. This means he can get a larger refund than the tax he would pay withdrawing the same amounts after they retire. He does not have much RRSP room and only gets $750/year new room, but it is still worthwhile contributing.

He should invest inside his corporation before contributing to TFSA and not contribute anything to TFSA for retirement from any dividends from his corporation. In other words, he should stop his dividends totally and only contribute to TFSA if there is still cash flow available (other than short-term savings).

He would also like advice about when he and Elyse should apply for Canada Pension Plan and Old Age Security benefits.

Ideally, they should start both at age 65 for both of them. Deferring CPP from age 60 to 65 gives them an implied return of 10.4%/year. This is likely more than their investments would make in that period. Deferring to age 70 gives them an implied return of 6.8%/year, which is likely a bit lower than their investment returns.

They likely won’t be able to retire at the lifestyle they want until age 65 or close. George should not start CPP or OAS before he retires to avoid paying a very high tax rate on them.

The couple’s vision for retirement is to maintain their current lifestyle and to travel more, likely two or three times a year.  “Is retiring at 60 possible and what would it take to make that happen? Is there a better way to save to be able to afford to support our child into the future?”

To retire at age 60, they would need $3.3 million in addition to George’s pension plan. They are on track for $1.1 million. They need to invest $11,000/month more. This is out of reach.

Their child with mental health issues might qualify for a disability tax credit. If so, then they can save for this child in an RDSP, which provides a much larger grant than RESP and can be continued to age 50 for the child. Contributing $1,500/year would give them a $1,000/year grant. After the child is 18, contributing $1,500/year should give them a $3,500/year grant. The contribution and grant can all be invested for this child’s future.

The most effective way for them to save for their retirement is inside George’s corporation. Investments there could also provide for their child in the future in a more efficient way than TFSA or RRSP.

Ed