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Strategies to Make Your Money Last Longer in Retirement and to Reduce Taxes

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Lorne Zeiler, Portfolio Manager and Wealth Advisor, was one of the experts interviewed on current strategies that can be used by investors to reduce overall taxes paid in retirement and to the estate. Lorne Zeiler focused on the benefits of gifting.

gam-masthead
Written by:
Special to The Globe and Mail
Published November 11, 2020

Most people spend decades saving and investing for retirement. Once they get there, the focus shifts to spending their hard-earned money – and maybe leaving something behind for family or charities.

The key is having enough money to live comfortably in retirement, while also continuing to generate investment income and reducing taxes, where possible. It helps to have a financial strategy, including which accounts to draw from and when, to help meet your retirement needs and goals.

Below are some tips for managing money in retirement, to make your assets last longer.

Maximize government benefits

Most Canadians contribute to the Canada Pension Plan (CPP) or the Quebec Pension Plan (QPP) during their working years, benefits that are paid out in their retirement years. Many Canadians also qualify for other government benefits such as Old Age Security (OAS) and the Guaranteed Income Supplement (GIS).

These benefits together can provide a total of about $25,000 in retirement income for the average Canadian, says Carol Bezaire, senior vice-president of tax, estate and strategic philanthropy at Mackenzie Investments.

The OAS and GIS government benefit programs aren’t based on the amount contributed over a person’s working life, but are instead dependent on marital status and income. It’s why Ms. Bezaire says it’s important to maximize any available tax credits that can affect your income level, such as the federal age amount non-refundable tax credit, which is available to individuals who are 65 or older and can be claimed on your personal income tax return.

“If you plan your other retirement income wisely, you can create a cash flow that allows you to access as much in government benefits as possible,” Ms. Bezaire says.

Make tax-efficient withdrawals

Kathryn Del Greco, vice-president and investment adviser with Del Greco Wealth Management at TD Wealth Private Investment Advice in Toronto, says most of her clients use their non-registered savings and investment accounts as their first source of cash flow in retirement, letting the more tax-efficient accounts such as the registered retirement savings plan (RRSP), registered retirement income fund (RRIF) or tax-free savings account (TFSA) continue to benefit from tax deferral or avoidance, in the case of the TFSA, for as long as possible. The plan will, of course, vary depending on the client’s age and other factors, such as the start of a company or government pension payout.

Ms. Bezaire recommends investors review their non-registered investment mix to favour investments that generate capital gains, which are currently the most tax-efficient form of income. She also suggests minimizing investments that generate interest and foreign dividends, while favouring Canadian dividends and corporate class mutual funds. Interest income is 100-per-cent taxable, and dividends from foreign investment are not eligible for tax credits, unlike Canadian investments. “Be careful with dividend income,” she says. “It is also used in calculating the OAS and GIS clawbacks.”

For most registered plans, such as RRSPs and RRIFs, tax will have to be paid on the amount of any withdrawals as income. To get cash flow from these deferred capital gains, Ms. Bezaire recommends selling some investments each month to get the cash flow you need by using a method called a systematic withdrawal plan (SWP). These types of withdrawals can be set up monthly, quarterly or annually. With a SWP, investors are taxed on the capital gain or loss triggered from the withdrawal, which has preferential tax treatment, while the balance is a return of your original investment, which is not taxable.

Consider pension-splitting

For couples in which one partner has significantly greater pension income than the other, pension-splitting can be an effective way to reduce taxes in retirement, says Jamie Golombek, managing director of tax and estate planning at Canadian Imperial Bank of Commerce.

The government allows Canadians to split up to 50 per cent of most pension income with their spouse.

Mr. Golombek says that, for each $10,000 of pension income allocated to a spouse, the tax savings could be up to $3,000 annually, depending on which province you live in and the difference in tax rates between spouses. He notes the income reduction can also help preserve some income-dependent benefits from government programs such as OAS.

Go ahead and gift

Gifting assets isn’t just a kind thing to do, but can help reduce taxes in an estate, says Lorne Zeiler, vice-president, portfolio manager and wealth advisor at TriDelta Financial in Toronto. In Canada, there are no taxes on gifting assets, for either the giver or receiver, unless an asset is sold before the gift is made.

One strategy Mr. Zeiler favours is opening TFSA accounts for kids that can be funded annually. “They are likely in their prime spending years,” he says. “so saving may be difficult and by opening TFSAs, this allows the gifted assets to grow tax-free.”

Also, gifting money to children or a charity can provide support when they need it most.

Use your home

Retirees shouldn’t overlook their homes as a potential part of their retirement plan. “A home is often the most valuable asset people will own in their lifetime, which means they may want or need to use it to help fund their retirement,” Mr. Golombek says.

One option is to rent your home, or part of it. You will be taxed on rental income, after deducting related costs, which may include expenses such as utilities and maintenance. Another option is downsizing to a smaller home with fewer expenses, particularly if the upkeep of a larger home becomes too onerous.

If you sell your home and it qualifies for the principal residence exception, you will not be taxed on the capital gain, Mr. Golombek says. If it is not your principal residence, you will generally be taxed on 50 per cent of the capital gain.

If you can sell your current home and can get more money after tax than it would cost to buy or rent a new home, you may be able to put the difference toward retirement savings, he says.

Get retirement-ready

We make career plans, vacation plans, even dinner plans, but too often people don’t make a plan for what can be their most important stage in life: retirement. And while having a plan sooner, rather than later, is always recommended, it’s never too late to seek the help of an adviser to figure out how to make your assets last in retirement.

“If you haven’t done a financial plan yet, now is the time to do so,” says Ms. Del Greco.

It’s crucial for retirees to have a clear understanding of their expenses, cash-flow needs, sources of income and taxes, Ms. Del Greco says.

Working with an adviser can help investors assess their current financial situation and identify objectives to help them maintain the quality of life they’re seeking in retirement.

“Because your time horizon is not as long as it once was when you were younger, decisions you make today will have a significant impact on your ability to enjoy your retirement years stress-free,” Ms. Del Greco says.

Advisers can also help investors assess their risk tolerance, which may be less in retirement with the focus on preserving wealth.

Ms. Del Greco recommends retirees maintain one or two years of their income needs in safe, liquid, low-risk investments, which gives them the flexibility not to have to sell equity positions at a loss during a period of volatility.

Lorne Zeiler
Presented By:
Lorne Zeiler, CFA®, iMBA
Senior VP, Portfolio Manager and Wealth Advisor
lorne@tridelta.ca
416-733-3292 x225

Tips on How to Get the Most from your RRSP

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Lorne Zeiler, Portfolio Manager and Wealth Advisor at TriDelta Financial, was one of the experts asked about strategies to maximize the benefit of RRSP accounts and how to reduce overall taxes based on the timing of withdrawals and use of Spousal accounts.

gam-masthead
Written by:
Special to The Globe and Mail
Published February 7, 2020

The season for Canadians to make their last minute contributions to their registered retirement savings plans (RRSPs) for the 2019 taxation year is in full swing. The investment industry is pulling out all the stops to educate Canadians on the advantages of putting their retirement nest eggs in these tax-deferred vehicles.

But while Canadians hold a total of more than $40-billion in their RRSPs, there remains a lot of confusion over what they actually are and how they work.

We spoke to three investment experts on the front lines to find out some of Canadians’ biggest RRSP misunderstandings.

Sara Zollo, financial advisor, Sara Zollo Financial Solutions Inc. at Sun Life Assurance Co. of Canada

One thing most Canadians understand is the immediate tax break that comes with an RRSP contribution. Each dollar invested is deducted from taxable income, which results in a tax refund from our highest tax bracket.

But Ms. Zollo says many people don’t understand that those contributions and any gains they generate are taxed fully when withdrawn.

”People think that it’s not a big deal. ‘I need some extra money, I’m just going to take it from my RRSP.’ You’ve just done two negative things: You’ve added that income to your taxable income for the year and you have now lost that contribution room,” she says.

The tax implications of withdrawing from your RRSP are the same as contributing – but in reverse. Each dollar is added to total taxable income in the year it’s withdrawn. Those in a higher tax bracket could actually be paying more taxes than they saved when they made their contribution.

To make matters worse, allowable lifetime RRSP contribution space is limited and not regenerated once a withdrawal is made. Ms. Zollo says many Canadians confuse this aspect of the RRSP with a tax-free savings account (TFSA), in which contribution space is regained the year after a withdrawal is made.

She notes that many of her clients are aware of the exceptions to the rule if funds from an RRSP are withdrawn for a down payment on a first home or to go back to school – provided they are returned to the RRSP after a certain time period.

In any other case, she says, the best time to withdraw from an RRSP is during a year when the plan holder’s taxable income is low. That’s usually in retirement, but it can also be during difficult times.

“If somebody lost their job and they have no other source of income, that’s a worthwhile time to revisit an RRSP withdrawal,” she says.

Lorne Zeiler, vice-president, portfolio manager and wealth advisor, TriDelta Investment Counsel

When an RRSP holder turns 71, the plan must be converted to a registered retirement income fund (RRIF). A RRIF is like a reverse RRSP: Money goes out instead of going in.

Once an RRSP is converted to a RRIF, the Canada Revenue Agency requires minimum withdrawals based on the total amount in the plan, which could result in withdrawals in a higher tax bracket. If the amount reaches a certain threshold, Old Age Security (OAS) benefits could be lowered or clawed back.

Mr. Zeiler says many Canadians aren’t aware they can lower their tax bills earlier in life by converting their RRSPs to RRIFs before they turn 71.

“It’s a phenomenal time to take [assets] out from an RRSP or RRIF, if they’re quite large, because that might be your only or main source of taxable income, so you could withdraw it at a very low tax rate,” he says.

Mr. Zeiler says it might make sense for investors with high-value RRSPs to make the conversion to an RRIF before they begin collecting OAS or Canada Pension Plan (CPP) benefits, which are included as taxable income.

Other benefits of an early conversion include lower fees for RRIF withdrawals and avoiding a mandatory withholding tax on RRSP withdrawals.

“You can open a RRIF, convert as much of your RRSP into that RRIF and have a source of income. As long as you’re only taking the RRIF minimum, there’s no withholding tax,” he says.

Mr. Zeiler says another common misunderstanding is that spousal RRSPs are irrelevant now that income-splitting is allowed for couples when they turn 65. Spousal RRSPs permit one spouse to contribute to another spouse’s RRSP and deduct that contribution from the former’s income.

The final objective is to withdraw more RRSP dollars in a lower tax bracket in the lower-income spouse’s hands during retirement, but he says a spousal RRSP is a good form of income-splitting if the spouse retires before 65.

“It only works if it’s a couple, one has a significantly higher income and the other one is more likely to retire early,” Mr. Zeiler says.

He cautions that withdrawals cannot be made from a spousal RRSP until at least three calendar years after a contribution, or it will be taxed in the contributor’s hands.

Mr. Zeiler also says a spousal RRSP is a good hedge in the event the federal government no longer allows income-splitting after 65.

”There’s no limitations to income-splitting today. Who knows? In the future that could change,” he says.

Evelyn Jacks, president, Knowledge Bureau Inc.

Although March 2 is the RRSP contribution deadline, it’s only the deadline to apply any contributions against income from 2019.

Ms. Jacks, a tax expert, says many RRSP holders don’t realize they can carry their contribution room forward indefinitely.

“If your income was unusually lower in 2019 than you expect it to be in 2020 or future years, you can choose not to take the deduction for the contribution that you made and carry those deductions forward to a future year when you expect your income to be higher,” she says.

RRSP contribution limits accumulate by 18 per cent of the previous year’s income. The maximum for the 2019 taxation year is $26,500.

Ms. Jacks blames much of the confusion on the drive to focus on annual contribution deadlines for a quick tax refund and not big-picture tax savings.

“People should think of their RRSPs all year long,” she says.

Lorne Zeiler
Presented By:
Lorne Zeiler, CFA®, iMBA
Senior VP, Portfolio Manager and Wealth Advisor
lorne@tridelta.ca
416-733-3292 x225

FINANCIAL FACELIFT: Can Olivia and Larry retire early with an ideal income of $10,000 a month?

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Below you will find a real life case study of a couple who are looking for financial advice on how best to arrange their financial affairs. Their names and details have been changed to protect their identity. The Globe and Mail often seeks the advice of our VP, Wealth Advisor, Matthew Ardrey, to review and analyze the situation and then provide his solutions to the participants.

gam-masthead
Written by:
Special to The Globe and Mail
Published January 10, 2020

People with ambitious financial goals are wise to start planning well in advance. So it is with Olivia and Larry, both 38, who hope to retire from work in their late 50s with substantially more discretionary spending power than they have now.

Larry brings in $125,500 a year plus bonus in a senior management job. Olivia earns $65,000 a year in education. They have a daughter, 4, whom they want to help get established financially when the time comes.

First, though, they plan to sell their Toronto-area house and move back to Montreal soon to be close to family and friends. Larry’s income is not expected to suffer in the move, but Olivia’s could be cut in half. Also, her defined benefit pension entitlement will be lower than if she stayed in her current job.

In 20 years or so, when they retire from work, Olivia and Larry hope to travel extensively, which partly explains why they have set their retirement spending goal so high: $120,000 a year.

“Can we retire early with an ideal income of $10,000 a month after tax?” Larry asks in an e-mail.

We asked Matthew Ardrey, a financial planner and vice-president at TriDelta Financial in Toronto, to look at Larry and Olivia’s situation.

What the expert says

Mr. Ardrey starts by reviewing the couple’s cash flow. According to Larry and Olivia, they spend everything they earn and sometimes have to dip into their tax-free savings accounts (TFSAs) to keep up with their car payments.

Yet when Mr. Ardrey runs the numbers, Larry and Olivia provided, he finds they actually have a surplus of $12,800 a year. (Income includes tax refunds from RRSP contributions.)

“This is a significant difference and does not even account for Larry’s variable bonus, which he requested to keep out of the projection,” the planner says. Because most people know what they earn and save, “we can assume the difference lies in the spending part of their budget,” Mr. Ardrey says. “Thus, a full review of their budget and spending is recommended.” In his analysis, the planner assumes they are spending the extra $12,800 a year on outlays not listed in their monthly expenditure form. That would include items such as household maintenance and repair, for example.

They are saving $650 a month to Larry’s RRSP, which his company matches 100 per cent, $160 to their child’s registered education savings plan (RESP) and $150 each to their respective TFSAs. Olivia contributes $600 a month to her work pension plan, an amount that is estimated to drop to $300 a month when she begins working in Montreal.

Some time in the next couple of years, Olivia and Larry would like to leave Ontario and return to Montreal. They would sell their house and purchase a smaller home in Montreal for about $600,000. “If we assume selling/moving costs of 10 per cent of the selling price, and that they pay off all their existing debts, they will need only a small mortgage of $30,000 for this transaction, which they can pay off in a few years at $1,000 a month,” Mr. Ardrey says.

The move to Montreal will affect their financial situation both positively and negatively, the planner says. Olivia’s income will drop about 50 per cent, which will also affect her DB pension. But their ability to save will increase because of the lower debt obligations. The planner assumes they direct these savings to their TFSAs and Larry’s RRSP. Any remaining surplus could go to a non-registered investment account.

The couple want to retire at the age of 57. Mr. Ardrey’s forecast assumes that at 65, Larry and Olivia will get 80 per cent and 60 per cent, respectively, of CPP/QPP (Quebec Pension Plan) benefits, and full Old Age Security benefits. Olivia’s pension estimate at age 57 is $27,182 a year in today’s dollars because of her reduced income. The couple’s baseline retirement spending target is $7,000 a month, plus $1,000 a month for five years to help their daughter, and another $2,000 a month for 25 years for travel.

Next, Mr. Ardrey looks at what Olivia and Larry can expect to earn from their investments. Their portfolio is 90-per-cent stocks and 10-per-cent fixed income, which produced a historical return of 6.1 per cent a year, he says. In retirement, he assumes their mix becomes more conservative (60-per-cent stocks/40-per-cent fixed income) and that they earn 4 per cent a year net of investing costs.

“Based on these assumptions, they fall short of their retirement goal,” Mr. Ardrey says. “They run out of savings in 2059 when they are 78.” (They would still have Olivia’s pension, their government benefits and their residence.)

If Olivia retired at 57 and Larry worked to 59, “they will reach the break-even point in their retirement spending,” the planner says. To have a surplus, they would have to work even longer, spend less or achieve a better rate of return.

To generate better returns, they could make some improvements to their investment strategy, he says. Larry’s group RRSP is well diversified, but their other investments are almost solely in five Canadian large-cap stocks. This lack of diversification “is adding significant risks,” the planner says.

As long as their portfolio is less than $500,000, they should consider broad-based exchange-traded funds, he says. ETFs offer low-cost diversification by company, asset class and geographic location. Once their portfolio passes the $500,000 threshold, they could consider hiring an investment counsellor or portfolio manager, Mr. Ardrey says. These firms charge a fee based on the size of the portfolio and have a fiduciary duty to act in their clients’ best interests. Investment counsellors tend to offer their clients investments that are not available on publicly traded markets – such as private debt and equity funds – designed to provide steady returns that are not subject to the ups and downs of financial markets.

Client situation

The people: Larry and Olivia, both 38, and their daughter, 4

The problem: Can they afford to retire at the age of 57 and spend $10,000 a month even if Olivia’s income drops?

The plan: Olivia retires as planned, but Larry works another two years to 59. They take steps to diversify their holdings and improve their net returns.

The payoff: Goals achieved.

Monthly net income: $11,685

Assets: Cash $3,120; his TFSA $74,020; her TFSA $66,350; his RRSP $125,510; her RRSP $16,210; estimated present value of her DB pension $42,250; RESP $13,160; residence $1.1-million. Total: $1.44-million

Monthly outlays: Mortgage $3,165; property tax $505; home insurance $60; utilities $300; transportation $650; groceries $570; child care $510; clothing $265; car loan $660; gifts, charity $540; vacation, travel $415; dining, drinks, entertainment $660; personal care $145; other personal $145; life insurance $150; cellphones, internet $170; RRSP $650; RESP $160; TFSAs $300; her pension plan contribution $600. Total: $10,620 Surplus of $1,065 is spending unaccounted for.

Liabilities: Mortgage $526,640; line of credit $26,865. Total: $553,505

Want a free financial facelift? E-mail finfacelift@gmail.com.

Some details may be changed to protect the privacy of the persons profiled.

Matthew Ardrey
Presented By:
Matthew Ardrey
VP, Wealth Advisor
matt@tridelta.ca
(416) 733-3292 x230

FINANCIAL FACELIFT: What can I do to be more financially successful as I enter my 40s?

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Below you will find a real life case study of an individual who is looking for financial advice on how best to arrange their financial affairs. Their name and details have been changed to protect their identity. The Globe and Mail often seeks the advice of our VP, Wealth Advisor, Matthew Ardrey, to review and analyze the situation and then provide his solutions to the participants.

gam-masthead
Written by:
Special to The Globe and Mail
Published November 8, 2019

Philip has a well-paying government job with a defined benefit pension plan, for which he is “fortunate and grateful,” he writes in an e-mail. He earns $112,000 a year in salary plus another $9,500 a year, net of expenses, consulting.

At 40, though, Philip is feeling uneasy about his prospects and wondering “how to better manage my finances for the near and distant future.” His near-term goals are to buy a new car and, in five years, a larger condo than the one-bedroom he owns now. In pricey Toronto, this would mean taking on a much bigger mortgage. He still has 23 years left to go on his existing mortgage loan.

Long term, Philip’s goal is to retire from work at age 58 and maintain his lifestyle. He recognizes that these might be competing goals. “I’ve been managing my finances to the best of my knowledge, reading up on budgeting and investment strategies, and now worry if I’m on the right track,” he writes. “What can I do to be more financially successful as I enter my 40s?”

He asks, too: “Am I saving enough for retirement at 58 with a desired after-tax income of $70,000? Am I investing my money wisely? Will I be in a position to purchase a bigger condo in five years?”

We asked Matthew Ardrey, a financial planner and vice-president of TriDelta Financial in Toronto, to look at Philip’s situation.

What the expert says

In reviewing the initial numbers Philip submitted, Mr. Ardrey detected a few things that seemed out of whack. As it turned out, Philip had overstated his consulting income and understated his expenses. After adjusting his income, there is still some missing money, the planner says. Philip is saving about $850 a month outside his registered retirement savings plan. “The remaining $895 per month is real budget leakage,” the planner says. “The first thing Philip should do is a full and complete review of his budget.”

Philip acknowledged this in a follow-up e-mail. “I’m clearly not accounting for all my expenses and travelling,” he writes. “I need to be more mindful of this.”

Next, Mr. Ardrey looks at the car purchase. He assumes Philip buys a new car at the beginning of 2021, taking $5,000 from his savings for a down payment and making monthly payments of $300 for five years. If interest rates stay low, he could likely finance the car at zero interest “or near to it.”

Philip is contributing about $12,200 a year to his defined benefit pension plan, plus making $3,100 a year in additional voluntary contributions (AVCs) to a work RRSP run by his pension plan manager. He is putting $10,200 a year into a savings account.

When Philip sells his condo and buys a larger one in 2025, he will no longer be able to tuck away $10,200 a year in his savings account, the planner says. The condo purchase price, adjusted for inflation, is assumed to be $911,000. Not only will he have transaction costs, Philip will have to pay off his existing mortgage. Mr. Ardrey’s forecast assumes Philip takes on a new mortgage of $590,000 at 4 per cent interest, amortized over 25 years. His payments will rise to $3,092 a month from $1,705 now. Unless he makes extra payments, he will still have a mortgage balance of about $344,465 outstanding when he retires from work in 18 years. To pay off the mortgage before then, he would have to make extra payments of $8,800 a year, putting a strain on his finances, the planner says.

At age 58, Philip will be eligible for an unreduced pension of $73,000 a year, plus a bridge benefit of $15,250 a year to age 65. “Both are indexed to inflation, which is assumed to be 2 per cent,” Mr. Ardrey says. By then, Philip’s spending target will have risen in line with inflation.

Philip’s spending goal is over and above any mortgage payments he might still be making, the planner notes. “Based on these assumptions, Philip would fall short of his goal,” Mr. Ardrey says. By the time Philip turned 65, he would be running budget shortfalls of about $45,000 a year in future dollars, the planner says. This would fall after his mortgage was paid off – assuming he could hang in that long – but he would still be in the red by about $20,000 a year.

“He would need to reduce his retirement spending by $1,000 per month or work another six years until age 64,” the planner says. By working longer, his pension would be larger and the number of years he would be retired smaller.

What if Philip stays put and doesn’t buy the more expensive place?

Suppose, instead, he moves his savings ($59,000) to a tax-free savings account, tops it up to the maximum ($63,500) and contributes $6,000 to it each year? With savings of $10,200 a year, that would leave him with $4,200 to put into a non-registered investment account. Both the TFSA and the non-registered account would be invested in a balanced portfolio of stocks and bonds. The assumed rate of return would be 5 per cent, Mr. Ardrey says.

These small changes could be enough to enable Philip to achieve his goal of retiring at 58 and spending $70,000 a year, the planner says. “The big differences would be the better rate of return than he is getting in his savings account, the continued ability to save each year that he is working and a smaller mortgage, hence smaller mortgage payments, in retirement.”

Philip has been using his savings account as an emergency fund, Mr. Ardrey says. “Instead of holding large amounts of cash, I’d suggest he use a secured line of credit against his home.”

Client situation

The person: Philip, 40.

The problem: Can he afford to buy a bigger place and still retire early with $70,000 a year?

The plan: Work longer, invest the cash stash and consider putting off the condo upgrade entirely.

The payoff: Recognizing that he can’t achieve all of his goals at once and may have to make some choices.

Monthly net income: $7,940

Assets: Savings account $59,000; chequing account $5,000; RRSP and AVC (additional voluntary contributions) $63,000; estimated present value of DB pension $376,800; residence $610,000. Total: $1.1-million

Monthly outlays: Mortgage $1,705; condo fee $455; property tax $200; home insurance $30; hydro $35; car insurance $250; fuel, maintenance, parking $355; groceries $250; clothing $55; vacation, travel $200; dining, drinks, entertainment $950; personal care $35; club memberships $35; other personal $25; health care $20; disability insurance $200; phones, TV, internet $125; RRSP $255; pension plan $1,015; spending that is unaccounted for $895. Total: $7,090. Surplus $850 to savings

Liabilities: Mortgage $345,000

Want a free financial facelift? E-mail finfacelift@gmail.com.

Some details may be changed to protect the privacy of the persons profiled.

Matthew Ardrey
Presented By:
Matthew Ardrey
VP, Wealth Advisor
matt@tridelta.ca
(416) 733-3292 x230

FINANCIAL FACELIFT: Can Chelsea and Chad ‘make it all work’ with a second baby on the way and a possible career change?

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Below you will find a real life case study of a couple who are looking for financial advice on how best to arrange their financial affairs. Their names and details have been changed to protect their identity. The Globe and Mail often seeks the advice of our VP, Wealth Advisor, Matthew Ardrey, to review and analyze the situation and then provide his solutions to the participants.

gam-masthead
Written by:
Special to The Globe and Mail
Published October 4, 2019

Chelsea and Chad are earning big and saving mightily, but with a second baby on the way, Chelsea is mulling a possible career change that would cut her income substantially. They are both 34 with a toddler, a mortgage-heavy house in Toronto, and two rental condos.

Chelsea earns $250,000 a year in sales, Chad $115,000 a year in technology. Their condos – their principal residences before they got together – are both generating positive cash flow. With the “main breadwinner” taking a year off and big mortgage payments, they are wondering how to “make it all work.”

They ask whether they should continue paying down their home mortgage aggressively, and whether they should borrow against their rental units to invest. “There is a lot of money coming in and out of our accounts monthly, with property tax, condo fees, and so on,” Chelsea writes in an e-mail. They wonder whether they are managing it optimally.

“We just keep saving but with no clear goal in mind or understanding if our planning is sound,” she adds. They have a “strong desire to maintain a safety net,” and to have a “sound strategy for retirement.”

We asked Matthew Ardrey, a vice-president and financial planner at TriDelta Financial in Toronto, to look at Chad and Chelsea’s situation.

What the expert says

Mr. Ardrey started by running the numbers Chad and Chelsea provided for their income, savings and expenses. To his surprise, his software showed the couple had a $45,000 a year surplus – even after accounting for savings and tax refunds from RRSP contributions. “I believe this is significant leakage in their spending that they have not recorded,” he says.

“Because most people know what they earn and what they save, I can only assume this is being spent,” the planner says. He has included an additional $45,000 worth of expenses in their plan to account for the discrepancy. This takes their adjusted spending to $205,000 a year, including mortgage prepayments.

“This is the primary issue that Chelsea and Chad need to address before any others,” Mr. Ardrey says. “A material change in expenses will affect all financial projections and analysis, including making sure they have sufficient life and disability insurance,” he adds. “I recommend that they go through a detailed budgeting process as soon as possible.”

Both Chelsea and Chad have defined contribution pension plans or group registered retirement savings plans at work to which both they and their employers contribute. As well, they both make maximum contributions to their tax-free savings accounts.

In addition to the registered savings, they make an extra payment of about $12,000 each quarter ($48,000 a year) on their mortgage, and tuck away $2,000 a month ($24,000 a year) in a non-registered savings account. In the past, they have used this money for RRSP top-ups, TFSA contributions and mortgage payments. More recently, they have been setting it aside to help offset the drop in income during Chelsea’s mat leave. Chelsea will get 60 per cent of her salary for the first 16 weeks and employment insurance benefits thereafter.

Their rental properties bring in an additional $19,800 a year for Chelsea and $14,820 for Chad after expenses, but before taxes.

Chelsea and Chad have a $719,000 mortgage on their principal residence and a $42,000 mortgage on one of the rentals.

It is unfortunate that Chelsea and Chad have so little debt against their rental properties and so much against their principal residence, because the rental mortgage interest is tax deductible, but interest on their principal residence mortgage is not.

Although a common thought would be to leverage the equity in the rentals to pay off the principal residence, the Canada Revenue Agency has recently disallowed a similar strategy. For interest to be tax deductible, the use of the borrowed money must be to produce income, the CRA says. The intention of the transaction and the assets pledged for security are both immaterial in this determination. The agency is reviewing tax deductibility on a case by case basis.

Chad and Chelsea ask whether they should use their surplus cash flow to pay off the mortgage or invest. They might be better off financially investing, Mr. Ardrey says. That’s because the after-tax cost of the mortgage interest is low: 2.54 per cent based on the current mortgage rate on their principal residence.

“To break even on investing instead of making extra mortgage payments, assuming a 50 per cent tax bracket and earning interest income, they would need to earn 5.1 per cent on their investments,” he says. This would be even more appealing if they engaged in tax-efficient investment planning and had more of their returns coming from dividends and capital gains, Mr. Ardrey says.

For their children’s education, the annual RESP savings of $2,500 for each child will fall short of the future costs by about 50 per cent, the planner says. The current average cost of postsecondary education is $20,000 a year. Historically, these costs have outpaced inflation, so he assumes the education costs rise at the rate of inflation plus two percentage points. If Chad and Chelsea want to fully fund their children’s education costs, they will be in a position to do so at the time simply by redirecting the surpluses from their non-registered investing to the education expenses, he says.

Next, Mr. Ardrey looked at how Chelsea’s lower income would affect the family finances. If Chelsea changes careers, earning $125,000 a year, they will not be able to make extra payments to their mortgage for the time being. As well, they would not be able to add to their non-registered savings. They would have to reduce their spending by a significant amount: $20,000 a year after-tax, to $137,000 a year. That’s a reduction of the $48,000 for the extra mortgage payments and $20,000 of actual spending. This would continue until their first child is 12, in 2029. If they are both working full-time with good income, they will likely have to have some form of before and after school care, the planner says. By the time the older one is 12, most agree that they can be responsible enough to babysit.

The reduced savings would affect their retirement, but they would still be able to retire comfortably, Mr. Ardrey says.

Finally, Chad and Chelsea would benefit from having a full financial plan prepared, Mr. Ardrey says. “A comprehensive financial plan will create a road map for them to follow.” In their case, it is not the retirement that is unclear, it is the next 10 years, he adds. “Having a plan will help them make the right financial decisions for both today and tomorrow.”

Client situation

The person: Chad and Chelsea, both 34, and their children.

The problem: How to prepare themselves financially for the career change Chelsea is considering. Should they keep paying down the mortgage, or should they borrow to invest?

The plan: Draw up a budget that tracks their actual spending to determine where the leakage is. If Chelsea changes jobs, be prepared to cut spending and halt the mortgage prepayments for a few years.

The payoff: A clear road map across the next decade or so when their cash needs will be greatest to open roads later on.

Monthly net income: $22,900

Assets: Bank accounts $100,000; her TFSA $69,000; his TFSA $71,000; her RRSP (including group RRSP) $233,000; his RRSP $83,000; his DC pension plan $8,000; RESP $9,500; principal residence $1-million; her rental condo $700,000; his rental condo $350,000. Total: $2.6-million.

Monthly outlays: Mortgage $3,820; property tax $695; home insurance $160; utilities $160; maintenance, garden $75; extra mortgage payments $4,000; transportation $455; groceries $350; child care $1,300; clothing $200; gifts $50; vacation, travel $1,000; dining, drinks, entertainment $380; grooming $75; subscriptions, other personal $60; drugstore $10; life insurance $275; disability insurance $225; phones, TV, internet $70; RRSPs $3,500; RESP $210; TFSAs $835. Total: $17,905. Surplus: $4,995.

Liabilities: Residence mortgage $719,000 at 2.54 per cent; rental mortgage $42,000 at 3.15 per cent. Total: $761,000.

Want a free financial facelift? E-mail finfacelift@gmail.com.

Some details may be changed to protect the privacy of the persons profiled.

Matthew Ardrey
Presented By:
Matthew Ardrey
VP, Wealth Advisor
matt@tridelta.ca
(416) 733-3292 x230

FINANCIAL FACELIFT: Rosy projection for long European vacation, then retirement in B.C. hides ‘substantial risk’

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Below you will find a real life case study of a couple who are looking for financial advice on how best to arrange their financial affairs. Their names and details have been changed to protect their identity. The Globe and Mail often seeks the advice of our VP, Wealth Advisor, Matthew Ardrey, to review and analyze the situation and then provide his solutions to the participants.

gam-masthead
Written by:
Special to The Globe and Mail
Published August 2, 2019

To celebrate the sale of their house for an impressive sum, Dave and Deborah are planning a long European holiday followed by a big move: from Toronto to a popular retirement destination in British Columbia, where they plan to buy a new home.

Dave, who is 67 and self-employed, will be retiring from a successful career in communications. Deborah, who is 57, is self-employed in the human-resources field. She plans to continue working part-time after they return from overseas. Together, they have substantial savings and investments.

“Our big change is that we have just sold our house in Toronto for $1.7-million net and will be taking a year and a half to travel in Europe when the sale closes,” Deborah writes in an e-mail. “The idea is to invest the proceeds from the house sale in a self-directed [discount brokerage] account consisting entirely of dividend equities,” Deborah adds. “My husband doesn’t like bonds as an investment.”

They would live off the dividends while they are in Europe, Deborah adds, then use the lion’s share of the principal to buy a house in B.C. Dave manages their investments. “He is the first to admit he is not a professional investor and feels he’s in a bit over his head,” Deborah writes. Once they return to Canada, their retirement spending target is $90,000 a year after tax.

We asked Matthew Ardrey, a vice-president and financial planner at TriDelta Financial in Toronto, to look at Dave and Deborah’s situation.

What the expert says

When their house sale closes, Dave and Deborah plan to use $53,000 of the $1.7-million proceeds to top off Dave’s tax-free savings account, Mr. Ardrey says. They plan to invest the remainder in “dividend aristocrats” and live off the dividend income while overseas. When they return to Canada at the end of 2020, they plan to buy a home for an estimated cost of $1.3-million.

Mr. Ardrey’s calculations include spending of $120,000 a year in Europe (which would not be covered entirely by the dividend income), retirement spending of $90,000 a year after tax, an inflation rate of 2 per cent a year, and that Deborah earns $20,000 a year working part-time to the age of 65. Both save the maximum to their TFSAs each year, but they no longer contribute to their registered retirement savings plans. They delay collecting Canada Pension Plan and Old Age Security benefits until the age of 70 to get the higher payments.

In addition to their house sale proceeds, the couple have $685,000 in RRSPs and $98,000 in TFSAs. Dave also has $544,000 in a corporate investment account that he can draw tax-free.

Next, Mr. Ardrey looks at the couple’s existing investments. Their current asset mix is 9-per-cent cash equivalents, 1-per-cent bonds and 90-per-cent stocks and stock funds. Of the 90 per cent in stocks, 45 per cent is in Canada, 38 per cent in the United States and 7 per cent is international. The historical rate of return is 5.4 per cent. Because they have a substantial proportion in exchange-traded funds, their investment cost is only 0.39 per cent a year, leaving them with a rate of return net of costs of 5.01 per cent.

“Based on these assumptions, Dave and Deborah will be able to meet their retirement goals,” Mr. Ardrey says. Deborah would still have total assets of $5.3-million by the time she is 90, the planner says. If they wanted to spend more and leave only their home as an estate, they could increase their spending by $24,000 a year to $114,000.

What could go wrong?

“Though this projection looks quite rosy, I would be remiss if I did not address the substantial risk in their plan,” Mr. Ardrey says. “Equity volatility.” Including the house-sale proceeds, Dave and Deborah would have 96 per cent of their assets invested in stocks during their stay in Europe.

They’d be ignoring a basic rule of investing: Don’t invest money that is needed short term in marketable securities.

“What if, during their European dream vacation, stock markets had a major decline?” the planner asks. That would affect their retirement plans dramatically. He looks at a second case where their portfolio suffers a 20-per-cent drop during that time. Rather than being able to surpass their spending target, they’d have to pare it from $90,000 a year to $84,000.

Mr. Ardrey suggests some alternatives. The $1.3-million they’ll need to buy a new home in a year or so should be invested in guaranteed investment certificates, or GICs, where they’d be sure to get their money back. “The primary goal of these funds needs to be capital preservation,” the planner says. Dave and Deborah should keep in mind deposit insurance limits, he says. Canada Deposit Insurance Corp. insures Canadian-dollar deposits at its member institutions up to a maximum of $100,000 (principal and interest) for each account. For example, they could open an account in Dave’s name, another in Deborah’s and a joint account at each of four institutions for $100,000 each. “So they could fill their need with four institutions for most of the savings and $100,000 more at a fifth,” he adds.

“Another option would be to purchase the home in B.C. before leaving on their trip,” Mr. Ardrey says. This would remove any uncertainty about what they will have to pay.

With the remaining investments, Dave and Deborah should look at revising their strategy to reduce their stock-market risk, the planner says. They should have a balanced portfolio of large-capitalization stocks with strong dividends and a mix of corporate and government bonds of different durations. Although Dave isn’t keen on bonds, they could enhance their fixed-income returns – and reduce volatility in their portfolio – by investing a portion of their capital in carefully vetted private debt and income funds, Mr. Ardrey says.

These private funds can be bought through an investment counsellor. If they hired one and put a portion of their fixed-income assets in private debt and income funds, they would have a projected return of 6.5 per cent with 1.25 per cent a year in investment costs, for a net return of 5.25 per cent. That’s better than the 5.01-per-cent historical rate of return on their existing portfolio and it would reduce their investment risk.

Client situation

The person: Dave, 67, and Deborah, 57

The problem: How sound is their plan to invest the proceeds of their house sale in blue-chip stocks and live off the dividends for the time they are in Europe?

The plan: Invest the money needed to buy the new house in GICs, or consider buying the house in B.C. now.

The payoff: Greatly reduced investment risk

Monthly net income: $8,335

Assets: Cash $15,000; stocks $544,070; her TFSA $79,640; his TFSA $18,775; her RRSP $419,995; his RRSP $264,640, residence $1.8-million. Total: $3.1-million

Monthly outlays: Property tax $685; home insurance $195; utilities $250; maintenance, garden $125; transportation $400; groceries $290; clothing $175; gifts, charity $80; vacation, travel $200; personal care $90; dining, drinks, entertainment $255; subscriptions $35; doctors, dentists $165; drugstore $35; phones, TV, internet $280; RRSPs $1,500; TFSAs $900. Total: $5,660

Liabilities: None

Want a free financial facelift? E-mail finfacelift@gmail.com.

Some details may be changed to protect the privacy of the persons profiled.

Matthew Ardrey
Presented By:
Matthew Ardrey
VP, Wealth Advisor
matt@tridelta.ca
(416) 733-3292 x230
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