National Post Article: Now retired, how do we withdraw funds without running out of money?

The National Post asked me to review the finances of Walter and Joanne, a retired couple in their late 60s, who have been struggling for years with the same question:

How do we draw income from our investments in the most tax-efficient way—so we can maintain our lifestyle without running out of money?

They’ve built a strong financial foundation, with over $2 million in investments, a mortgage-free home, and a solid travel budget. But despite working with a stock broker and tax accountant, they still don’t have a clear drawdown strategy. 

They’re unsure how to structure withdrawals, when to start OAS, and whether to start passing wealth to their children now.

Their biggest questions:

• How should they draw down their investments in the most tax-efficient way to ensure their savings last?
• Can they afford to increase their RIF withdrawals to $8,000 per month without worrying about running out of money?
• Should they keep their term life insurance or redirect those funds elsewhere?
• Is it smarter to start passing wealth to their children now rather than waiting? If so, what’s the best way to do it?
• Why are their stockbroker or accountant not able to plan a tax-efficient income for life for them?
• How do they balance investment growth, tax efficiency, and estate planning to secure their financial future?

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

Now retired, how do we withdraw funds without running out of money?

Financial Plan

Walter & Joanne are spending $8,600/month, or $103,000/year after tax – $126,000/year before tax. To provide this income for life with a 7%/year return they would need about $1.8 million in investments. They have just over $2 million. They are 15% ahead of their goal, which is a reasonable margin of safety.

Good news! They have enough to support their lifestyle plus inflation for life.

They should both start their OAS now. Deferring it to age 70 gives them an implied return of 6.8%/year, which is likely a bit lower than their investment returns.

Q & A

A/ “Now that we’re retired, how should we be drawing income from our investments in the most tax effective way that will ensure we can maintain the lifestyle we want throughout retirement?” “We cannot get a clear understanding of which accounts we should be drawing down from and in what order from our financial advisors,” said Walter.

A/ They are paying about $23,000/year in income tax now. This will rise to about $30,000/year once they start their OAS.

There are 2 main issues for them to focus on to minimize tax in their situation – income splitting and trying to stay in the lowest tax bracket.

For income splitting, they should be able to split all their RRIF & LRIF income on their tax returns. They can’t split their CPP that easily, but they could call Income Security and request splitting their CPP.

Splitting their taxable income should allow them to avoid having one of them have taxable income high enough to have their OAS clawed back (once they start it).

Their income up to $57,000/year is taxed at 28% (Alberta tax including clawback of Age credit) and the amount over $57,000 is taxed at 34%. The high effective tax bracket (including government clawbacks) that they should avoid starts at $91,000/year with an effective tax rate of 44%, including clawbacks of their OAS and Age credit.

In their case, the best strategy is to try to keep their taxable incomes below $57,000/year each. They can save about $10,000/year in income tax if they can do this. This would mean they only pay 28% tax or less on all their income.

Their strategy should be to take enough from their RRIFs or LRIF to bring their taxable incomes to $57,000, including their OAS & CPP. Then take the rest of what they need for their lifestyle from their non-registered investments or TFSAs.

Their lifestyle goal is $126,000/year, which would be $123,000/year with this tax strategy. They can have OAS, CPP & RRIFs of $57,000/year each, or $114,000/year total. That means they need about $10,000/year from their non-registered investments with a minimum of tax.

Their non-registered investments should be invested more tax-efficiently than a REIT, so they can take more from their RRIFs and keep their taxable income below the target $57,000/year. They should withdraw the $10,000/year for their lifestyle from their non-registered investments, plus use them to contribute $14,000/year to keep their TFSAs maximized. This should deplete them in about 5 years. At that point, they can start withdrawing the $10,000/year from their TFSAs. They may need less at that point, since their RRIFs will then have a higher minimum withdrawal after they convert all their RRSP to RRIF.

Q/ They own two term life insurance policies valued at a combined $1 million that will mature in a few years. “Should we renegotiate at that time? Is it a good idea to have life insurance to cover death taxes and the capital gains implications of passing our estate on to our two adult children?” asked Joanne. “Or should we be giving our children their inheritance sooner rather than later? Why wait for death and taxes? And how do we do that? Where should the money come from?

A/ The answer to this depends on how much inheritance they want to leave for their kids. They will already get their home and cottage that could be an inheritance of $750,000 for each child based on today’s values, plus whatever is left from their investments.

There is a conventional wisdom that you should have insurance to pay for taxes on death, however it is usually not necessary. Today, they would leave an estate of $3.6 million without insurance. In a worst-case scenario, they may pay $1 million tax on the death of the 2^nd one of them, but that still leaves an estate of $2.6 million.

Their policies will be quite expensive to renew now that they are older. You still pay the same tax on death when you have insurance. It just means you leave a larger estate. Is it important to them to leave a larger estate?

Their one possible reason for having life insurance is their cottage, if their kids would want to keep it. If they sell it, then they can easily pay the capital gains tax. However, if they want to keep it, they will have to pay the capital gains tax from other resources. However, they are highly likely to have enough investments to pay for it.

Giving their kids an inheritance sooner is a challenge for them, since they are only 15% ahead of their goal. That is a decent margin of safety, but not much excess.

Their investments are almost all RRSP or RRIF, so they would have to pay a lot of tax to give them away now. If they want to give the kids an early inheritance, the best choice is probably to give them the cottage sooner. There would be capital gains tax to pay, but that should be far less than amounts from their RRIFs.

They may have personal wishes about how much they want to leave for their kids. However, the best advice is probably to make sure they have enough for themselves and the lifestyle they want, so that they never need anything from their kids.

Their own financial independence is a gift for their kids. Many people today need to help their aging parents financially and it can be a burden. Financially independent parents are a gift.

Q/ “Sometimes we think we should be drawing $8,000 (net) a month from our RIF but worry we might run out of money,” said Walter. “Can we afford to do this?

A/ They can afford it and provide for their retirement, but withdrawing $8,000/month (net) from their RRIF would cost a lot more tax.

Their OAS and CPP would be about $21,000/year each, assuming they have their CPP split. That means they should withdraw $36,000/year each from their RRIFs and LRIF. That is $6,000/month total (before tax). Their minimum RRIF withdrawal would be about $6,500/year if they converted all their RRSP to RRIF, so they are doing the right thing by keeping almost as much in their RRSP as their RRIF. That keeps the minimum withdrawal lower, so they can withdraw only $6,000/year until they turn 72.

At age 71, they will have to convert the rest of their RRSP to RRIF, so then they should take the minimum required withdrawal, and then top it up with a bit from their non-registered or TFSA to get to their desired lifestyle.

Q/ Right now we’re working with a stock broker and tax accountant but neither one has been able to give us a clear strategy and we don’t have a financial plan that shows us how to best move forward.

A/ Investment people may be good at investing and tax accountants are good for minimizing your current year taxes, but neither typically gives you a proper financial plan. Free financial plans from banks or advisors are usually worth what you paid. Paying an unbiased fee-for-service financial planner for a quality financial plan can give you clear insight on exactly what to do, which can minimize your risk of running out of money and minimize your tax. Your financial plan is the GPS for your life. It gives you peace of mind that you are doing everything right and confidence that you can enjoy your life knowing exactly what you can afford for life.

Ed