Paul and Deirdre want to know how to make their money go the furthest in retirement.Carlos Osorio/The Globe and Mail
Paul and Deirdre are well fixed financially but like most people, they don’t want to pay any more tax than they have to. They’d also like to keep as much of their Old Age Security benefits as they can.
Paul is 64, retired, with a defined benefit pension from his employer that is paying $118,000 a year, indexed to inflation. That includes a bridge benefit that will end in January when Paul turns 65, dropping his lifetime pension to $94,085 a year with a survivor benefit of $71,000 a year. Paul splits his income with Deirdre.
Deirdre, who is 58 and also retired, has no pension. They have two children, 21 and 24, both still living at their suburban Toronto home.
Paul is in the process of “retiring” from his three-year-old incorporated consulting business. The corporation has $280,000 available for paying out dividends that will be subject to personal income tax, he writes in an e-mail. The plan is to withdraw the funds “at the most tax-efficient rate possible,” he says.
The problem is how to achieve that. Can he split the income with Dierdre? “Does my incorporated one-man consulting business qualify for the Canada Revenue Agency’s tax on split income (TOSI) exemption for taxpayers over age 65?” Paul is the sole shareholder. They also ask when they should start taking government benefits.
“What we really need to find is that sweet spot that makes my money – Canada Pension Plan, Old Age Security and business dividends – go the furthest.”
We asked Warren MacKenzie, an independent financial planner in Toronto, to look at Paul and Deirdre’s situation. Mr. MacKenzie holds the chartered professional accountant designation.
What the Expert Says
Paul and Deirdre have done very well for themselves, Mr. MacKenzie says. “Now they need to create a plan to enjoy their retirement.”
Paul is keen to find out whether he can use the tax on split income or TOSI rules to minimize income tax as well as any clawback of Old Age Security. “The TOSI rules are complicated,” the planner says. They change when the business owner ceases to operate an active business and holds investments in a holding company. “It is unlikely that Paul will be able to split the income he withdraws from his corporation with Deirdre, either through dividends or salary, but this is a question that Paul should explore in detail with his accountant,” Mr. MacKenzie says.
Either way, it wouldn’t make a huge difference to the value of their estate, he says.
“Based on the assumption that he will not be able to split the corporate income, I think the issue Paul should focus on is whether it makes sense to wind up the company in one year or over a number of years.”
The couple’s goals – outlined on the planner’s questionnaire – include spending less time thinking about investments, managing their capital wisely, keeping things simple, avoiding complications in the administration of their estate and taking advantage of tax-saving opportunities. Having a moderate-risk investment portfolio, a plan to wind up the company as soon as possible and giving “inheritance advances” to their children would be consistent with these goals, Mr. MacKenzie says.
They are also wondering whether they should start CPP at 65 or wait until 70, at which time the payments would be 42 per cent higher. They believe their active life – particularly travelling – will wind down by the age of 72. Based on family history, their life expectancy could be the early 80s, Paul says, so it makes sense for them to start CPP at the age of 65. The financial projections assume both Paul and Deirdre start CPP and OAS at the age of 65.
Paul and Deirdre have unused TFSA contribution room of more than $190,000.
The planner’s projections assume cash flow in 2025 will be $163,947, consisting of $14,975 from Paul’s CPP, $8,011 from his OAS, $95,961 from his DB pension and $45,000 from his holding company. The cash outflow will be $61,260 for basic expenses, $20,420 for vacations, $13,580 for payments on the mortgage and $21,378 in income tax, for a total of $116,638. The surplus of $47,000 a year can be moved in their TFSAs or used to pay down the mortgage.
Should Paul distribute the assets of the corporation all in one year or over a number of years?
“One choice would be to do all of this in 2025, in which case he would collect a non-eligible dividend of about $280,000, which, being received on top of his other income of about $120,000, and considering the dividend tax credit, would be taxed at an average tax rate of about 35 per cent,” Mr. MacKenzie says. In this case, the cash remaining after paying tax could be invested in their tax-free savings accounts, where they would earn tax-free income. Or the funds could be used to pay off the house mortgage. “This one-time lump sum payment would also cause all of Paul’s 2025 OAS to be clawed back.”
Alternatively, the wind-up and distribution could take place over five to 10 years. The average amount taken into Paul’s annual income could be $35,000 to $45,000. After taking into consideration the dividend tax credit, it would be taxed at about 20 per cent, which is a lower rate than if he took it all into income in one year. However, spreading out the income in that manner would result in a 30 per cent clawback of his OAS in each of those years.
Considering all factors, including the savings (on the Ontario surtax and annual corporation accounting fees) that would result by taking the income in one payment, there is almost no difference between winding up the corporation over one year or eight years, the planner says.
Over all, their asset mix is about 30 per cent equities and 70 per cent in a high-interest savings account (HISA), fixed income and GICs that will mature over the next two months. The equities are held in the RRSP accounts while the TFSA is 100 per cent in a HISA, yielding 5.5 per cent.
“It would be more tax efficient if the TFSA held the growth investments and the RRSP held interest-bearing investments,” he says. That’s because TFSA withdrawals are tax-free while RRSP/registered retirement income fund withdrawals are not.
Paul and Deirdre will be able to achieve their long-term goals with their existing investments, he adds. “This being the case, there is no need to change to a more balanced investment approach if they are happy with the current low-risk portfolio.”
Client Situation
The People: Paul, 64, Deirdre, 58, and their two children.
The Problem: How to keep taxes to a minimum and avoid or reduce the Old Age Security clawback. Can they split the corporate income?
The Plan: Consult an accountant about the TOSI rules. Either way, it will not make a huge difference to their financial plan or their estate.
The Payoff: The freedom to focus on enjoying their hard-earned retirement.
Monthly net income: As needed.
Assets: Bank account $7,200; HISA $23,000; corporation $280,000; his RRSP $29,000; her RRSP $189,000; residence $1,600,000. Total: $2,128,200.
Estimated present value of his DB pension: $1,800,000. This is what someone with no pension would have to save to generate the same income.
Monthly outlays: Mortgage $1,035; property tax $645; water, sewer, garbage $35; home insurance $125; electricity $10; heating $150; maintenance $100; transportation $510; groceries $1,825; clothing $145; gifts, charity $140; vacation, travel $1,665; dining, drinks, entertainment $350; personal care $200; pets $100; sports, hobbies $15; subscriptions $20; health care $125; life insurance $170; phones, TV, internet $155. Total: $7,520.
Liabilities: Mortgage $127,000 at 4.9 per cent.
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