Max and Erica also want to travel more as a family and eventually give each of their children a property.Christopher Katsarov/The Globe and Mail
Max is a corporate executive earning $205,000 a year. Erica has her own management consulting company that nets about $150,000 a year after expenses. He is 54 and she is 42. They have two young children, 4 and 8, and a mortgage-free house in the Greater Toronto Area. They also have an investment property.
The couple are looking to the day maybe five years from now when they can leave behind their high-stress, full-time jobs and work part-time.
In the meantime, they want to buy a roomier house, which would entail borrowing, buy a second investment property, and provide for their children’s higher education. They also want to travel more as a family and eventually give each of their children a property.
How much income would they need to maintain their standard of living if they decide to work part-time? Max asks in an e-mail. Their semi-retirement spending goal is $120,000 a year after tax. “It’s a puzzle,” he adds. “We’d like to see how realistic all of it is, or if we need to adjust/make sacrifices on any of these.”
We asked Shay Steacy, a certified financial planner at Modern Cents, an advice-only financial planning firm based in Mississauga, to look at Max and Erica’s situation.
What the Expert Says
With Erica being just 42, their financial plan and retirement projections need to cover more than 50 years in the future, meaning they would have to revisit their plan regularly as the years go by, Ms. Steacy says.
A good place to start is to explore how their retirement projections would look if they continued working enough to cover their current living expenses, the planner says. They would only stop working when their investments, through continued growth and compounding, were sufficient to provide for their retirement.
Given their annual expenses of $120,000, they would need to earn a combined employment income about $160,000 before tax. If most of the income is earned by one spouse, the resulting higher marginal tax rate would mean a higher salary would be needed to net their required take-home pay.
“An additional $300,000 mortgage for the new home means total annual mortgage payments of around $20,000,” she says. “Higher expenses would require a higher salary. They’d need to target around $190,000 a year before tax, ideally split equally to minimize the tax payable.”
If they worked part-time until age 65 for Max and 60 for Erica, they should have enough investment assets to last for Max’s lifetime, based on his life expectancy, the planner says. “If they don’t want to work part-time that long or earn that amount of money, they would need to look at selling the family home at some point.”
“Making these financial decisions becomes about what the clients value,” the planner says. “Do they want to sacrifice an early retirement to provide large gifts to their children? Because in the scenario above, we haven’t even met their goal of buying an additional rental property to ultimately give to their children.”
Rather than buying, they may want to consider renovating their existing house instead.
“Selling and buying real estate has large transaction costs,” she notes. On the sale of their current home, real estate fees alone could be between $63,000 and $90,000. Then when they purchase their new home, they will need to pay land transfer tax. In the city where they live, a $2.1-million home would cost just shy of $40,000 in land transfer tax.
They would also want to factor in the interest costs for the mortgage they would have to take on.
Could they make changes to their existing home to make it more suitable? “What about a structure in the backyard that could serve as a home office?”
Max and Erica have $200,000 of unused contribution room in their tax-free savings accounts that could be generating tax-free income in retirement. Meanwhile, Erica has a balance of $325,000 in a high-interest savings account inside her corporation that could be used to make contributions to their TFSAs.
“These clients should talk to their accountant about their specific situation,” Ms. Steacy says. “I’d recommend that Erica start to take out more income from the corporation than she currently is, so they can take better advantage of their unused TFSA room and invest in their RRSPs.” The accountant could work in conjunction with a financial planner.
“Because the clients have no defined benefit pension, an additional benefit to Erica’s taking out more income from the corporation in the form of a salary is that contributions would be made to the Canada Pension Plan,” she says. “CPP contributions are an amazing way to secure a lifelong income, indexed to inflation.”
The planner suggests a good starting point would be for Erica to take enough salary to maximize CPP contributions, which is currently around $71,000 a year, she says.
As to government benefits, “given the lack of other defined benefit pensions, I’d encourage them to defer taking Canada Pension Plan and Old Age Security benefits until age 70,” Ms. Steacy says. If they defer to age 70, they will receive benefits that are 42 per cent higher in five years for CPP and 36 per cent higher for OAS.
“There is a great opportunity in the years between when they stop working entirely and when they start receiving CPP and OAS to implement an RRSP meltdown strategy,” the planner says. “In these years their taxable income would otherwise be extremely low, so the overall tax they will pay on withdrawals from their RRSPs/registered retirement savings plans and [locked-in retirement accounts] will be lower than if they wait until age 71,” and start taking mandatory minimum withdrawals, she says.
They should both take advantage of $2,000 of tax-free income they can receive through accessing the pension tax credit at age 65. They would need to convert at least a portion of their RRSPs to RRIFs or their LIRAs to life income funds or LIFs.
When Max is 65, he can also start to split his pension income with Erica, even though she will only be 53. When Max is 70 and receiving OAS, any pension income he can split with Erica could serve to reduce any OAS clawback he might otherwise have.
Currently, they have an investment property with a value of $750,000 and a cost base of $425,000. The property has a net-negative cash flow of $1,500 a month after mortgage payments and other expenses. Whether they sell the property or gift it to their children, they will have to pay tax on the capital gain.
Rather than giving property, they should consider gifting funds to their children instead, starting when each child turns 18, Ms. Steacy says. “This way, they can take advantage of the TFSA and first-home savings account room the kids will become entitled to each year,” the planner says. Currently, these amounts are $7,000 and $8,000, respectively, or $15,000 per year.
Client Situation
The people: Max and Erica, 54 and 42, and their children, ages 8 and 4.
The Problem: Can they partly retire in the next five years while continuing to meet their spending goals?
The Plan: Work part-time for at least five years after retiring, earning enough to cover their expenses. Take larger corporate withdrawals. Consider renovating rather than selling their home and rethink the idea of buying a second investment property.
The Payoff: A better understanding of the trade-offs that may be necessary.
Monthly net income: $13,050.
Assets: Bank account $10,000; primary residence $1,800,000; investment condo $750,000; registered education savings plan $51,000; Max’s RRSP $715,000; Max’s defined contribution pension plan $45,000; Max’s employer shares $16,000, Max’s TFSA $2,000; Erica’s RRSP $335,000; Erica’s defined contribution pension plan from previous employer $60,000; Erica’s LIRA $4,500; Erica’s TFSA $1,000; Erica’s corporate account $325,000; other (vehicles, boat) $60,000. Total: $4,174,500.
Monthly outlays: Rental condo cash flow deficit $1,500; property tax $844; water, sewer, garbage $150; property insurance $179; electricity $100; heating $125; maintenance $350; transportation $1,200; groceries, clothing $1,200; child care $300; gifting, charitable, vacation, travel $1,400; dining out $400; health care $150; communications $200; RRSPs $1,500; RESP $416; professional dues $100. Total: $10,014. Surplus goes to saving.
Liabilities: Home equity line of credit for rental property $457,000 at 5.34 per cent.
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