Mike and Miriam need advice on how to deal with the unrealized capital gains on their stock portfolio and how to pass the wealth to their only daughter.Jennifer Roberts/The Globe and Mail
In their first Financial Facelift five years ago, Mike and Miriam asked how best to arrange their retirement income to minimize tax, when to start collecting government benefits and when to start drawing on their registered retirement savings plans (RRSPs).
Their combined savings and investments back then totalled $2.5-million.
The planner’s advice was to delay government benefits to age 70 and start drawing down their RRSPs early in retirement to minimize the tax bill on their estate.
Mike, a retired consultant, is now 68 years old. Miriam, a retired manager, is 66. Today, their savings and investments have grown to $4-million. Neither has a company pension.
This time around, they ask how to deal with the unrealized capital gains on their substantial stock portfolio, and how to pass on generational wealth to their only daughter, who is 22 years old. Their retirement spending goal is $100,000 a year after tax.
We asked Anita Bruinsma, a certified financial planner and founder of Clarity Personal Finance, to look at Mike and Miriam’s situation. Ms. Bruinsma also holds the chartered financial analyst designation.
What the Expert Says
Mike and Miriam have more than enough savings to last their lifetime, Ms. Bruinsma says.
If they spend $100,000 a year, rising with inflation of 2.1 per cent a year, they will leave an estate of about $16-million, made up of a home worth $1.8-million and large balances in their RRSPs, tax-free savings accounts (TFSAs) and non-registered accounts.
“Mike and Miriam seem to be aware of this and wonder how to pass along this family wealth to their only child,” the planner says.
They also have a portfolio of stocks that have significant capital gains that they are wondering how to realize in a tax-efficient way. “While it’s a great strategy to invest to generate capital gains, a common problem is how to sell down these investments once there are significant capital gains,” Ms. Bruinsma says.
Mike and Miriam’s retirement income will consist of government benefits, investment income and at age 72, mandatory minimum withdrawals from their registered retirement income funds (RRIFs). So they need to take advantage of the next few years to sell down their stocks.
They have been long-time buy and hold investors and now have about $640,000 in capital gains in their non-registered account, which means about $320,000 of taxable capital gains.
With RRSPs and non-registered portfolios of this size, they will be paying a fair amount of tax over their lifetime; “it’s simply unavoidable,” the planner says. Fortunately, they still have a number of years where they can do some tax planning for their non-registered investments.
Mike has already started taking his CPP and OAS, but Miriam has not. They have both converted a small portion of their RRSPs to RRIFs, which means they are required to make small withdrawals every year.
A common strategy for large RRSPs is to withdraw before age 72 to smooth out income and lower taxes, the planner says. But if Mike and Miriam want to sell down their stocks, they might choose to defer taking money from their RRSPs/RRIFs for a few years and sell down their portfolio instead.
This means they will have even bigger RRIF withdrawals later in life and they will likely leave a RRIF balance in their estate. “This is not ideal since the entire account is deregistered in the year of the second spouse’s death and considered to be taxable income,” the planner says. “This is a trade-off they have to make.”
In the years before Mike turns 72, he will have about $22,000 to $24,000 a year in taxable income from CPP and OAS. He also has investment income of about $36,000 from dividends and interest. This means over the next four years between 2025 and 2028, he can generate some capital gains without facing a high tax bracket. For example, if he sold enough stocks to generate $20,000 of capital gains, he would likely be staying within one of the lower tax brackets. (This would be the third lowest bracket. The top end of the income range in this bracket is $93,132 a year and the marginal tax rate is 29.65 per cent.)
Mike should keep in mind that if his total income rises above $93,454, he will be subject to some OAS clawback. He would also jump up to the next tax bracket. “This isn’t necessarily a bad thing as the tax strategy probably offsets the small clawback,” Ms. Bruinsma says.
Miriam has even longer to sell down her investments since she is two years younger than Mike and has not started taking government benefits. In fact, Miriam has no taxable income beyond her investment income of about $35,000 a year and her small RRIF withdrawals. Miriam could generate about $40,000 a year in capital gains over the next six years and still stay in one of the lower tax brackets, the planner says.
This approach will allow them to realize about $280,000 of the $640,000 in capital gains over six years, the planner says. This probably means selling about 40 per cent of their portfolio. The question then is what do they do with this money now that it’s in cash?
They have indicated that they’d like to help their daughter with a down payment so the funds could go to her. By gifting this money while they are still alive, they can reduce their eventual probate fees. Since their daughter is 22, she is likely not earning a high salary. She could invest this money and garner a lower tax rate on the earnings than Mike and Miriam would pay. She could also use her accumulated TFSA room as well as open a First Home Savings Account to shelter some of the money from tax.
“It’s important that they work with an accountant or tax specialist before selling down large portions of the portfolio to make sure they understand the tax implications,” Ms. Bruinsma says. “There are lots of other tax considerations to bear in mind like income splitting, tax credits and deductions.”
As for their estate, one strategy is to leave the TFSAs to their daughter because there would be no tax implications upon their death. They could name her as a beneficiary and it would bypass their estate. This has the dual benefits of avoiding probate fees and allowing the funds to get to their daughter more quickly.
Client Situation
The people: Mike, 68, Miriam, 66, and their daughter, 22.
The problem: How to realize their capital gains, draw down their savings and pass on their estate in the most tax-efficient way.
The plan: Miriam defers government benefits to age 70. In the years before they have to start taking mandatory withdrawals from their RRIFs, they sell off some of their stocks, keeping their taxable income low enough to avoid the highest marginal tax rate, and gift the proceeds of the stock sales to their daughter for a down payment.
The payoff: First early steps to comprehensive estate planning.
Monthly net income: $8,400.
Assets: Cash $21,000; GICs $230,000; non-registered stocks $1,720,000; non-registered mutual funds $120,000; his TFSA $171,000; her TFSA $171,000; his RRSP $861,000; her RRSP $832,000; residence $900,000. Total: $5-million.
Monthly outlays: Property tax $490; water, sewer, garbage $50; home insurance $120; electricity $145; heating $85; maintenance $250; transportation $700; groceries $700; clothing $85; charity $210; vacation, travel $2,915; dining out $415; entertainment $85; sports, hobbies $85; health care $145; health, dental insurance $325; life insurance $50; phones $150; TV, internet $225; TFSAs $1,165. Total: $8,400.
Liabilities: None.
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