Shaun, 54, and Kara, 52, who live in Calgary, have $815,000 of their savings in U.S. stock and retirement funds. They also have TFSA and RRSPs in Canadian investments. How do they draw down their portfolio to minimize taxes so that they can achieve $60,000 annually in income starting in four years?
What they own
|RRSPs||$580,000 ($250,000 in a spousal RRSP)|
|Company stock||$440,000 (U.S.) (Microsoft)|
Shaun C. is 54 years old and his wife Kara is 52. The couple lives in Calgary but for several years Shaun worked in a managerial position at several large U.S. based companies, including seven years living and working the U.S. contributing to both a 401K (a U.S. retirement savings plan similar to an RRSP) and company stock purchase programs, and the bulk of the company stock that he holds is Microsoft.
“We’ve been back in Canada for more than 10 years now,” says Shaun. “I’m hoping to retire within the next four or five years, around age 58 and so was thinking about diversifying my portfolio and more importantly, am wondering how to unwind these U.S. dollar assets.”
The couple own their own home, worth about $600,000 and have no plans to sell it or downsize. Their assets include RRSPs worth $580,000 ($280,000 of that in a spousal RRSP), $120,000 in TFSAs combined, $375,000 U.S. in Shaun’s 401K, $440,000 U.S. in a stock plan that holds mostly Microsoft stock, and a Defined Benefit pension that will pay him $1,000 U.S. month when he retires. “My holdings of company stock are higher than I’d like but the growth and dividend history over the past five years have been impressive with still a lot of room for continued growth,” says Shaun.
Right now, the RRSP and TFSA holdings are currently invested in 85% equity and 15% fixed income and cash. “For our 401K we are invested in a target fund that rebalances over time (2030 target date) and currently 2/3 is invested in equities and 1/3 in fixed income/cash,” says Shaun.
The couple is debt-free and hopes to be empty nesters within two or three years. They are also maxing out their savings by topping up each of their RRSPs and TFSAs each year. “When we do retire we’d like to spend a couple of months a year vacationing in the U.S. so there’s a need for some U.S. dollars but what is a good strategy for unwinding both Shaun’s company stock and 401K to minimize the tax impact and generate the $60,000 a year income we’ll need for travel and expenses?” asks Kara.
What the pro says
“Shaun and Kara will have no trouble retiring in four to five years with an after-tax income of $60,000 a year indexed to inflation”, says Allan Norman, a chartered investment manager with Atlantis Financial in Barrie, Ont. “However, I question if $60,000 a year is enough when family income is $140,000 now, and how much will a traditional financial plan really help them?”
Allan Norman dived into the family’s finances a little deeper by:
- Confirming $60,000 makes sense when the family income is $140,000;
- Taking a look at the big picture to see what retirement income is possible. Then;
- Identifying financial planning strategies and tactics, and answering Shaun and Kara’s questions.
Here’s Allan’s advice: The assumptions I’m using are 5% annual return on investments, 2% for inflation, and I have their home appreciating at 3%. I estimate Shaun’s CPP at $9,000/yr. at age 65, due to time working in the U.S., and Kara’s at $1,000/yr. because she was a stay-at-home mom most of the time. I’ve converted the American holdings to Canadian at a rate of $1.20.
Is $60,000 reasonable when Shaun is earning $140,000, which is $100,700. net after tax? He’s maxing out his RRSP and their TFSAs each year so that leaves them with about $75,000 a year to spend when adding back the RRSP tax refund. Their children will be 22 and 28 in four years, so their spending needs should be lower. Based on their current lifestyle, $60,000 in retirement seems reasonable.
As a cautionary note, whenever you set a fixed retirement income, i.e. $60,000, it tends to over-estimate the amount of money you need to have saved just prior to your retirement. This is because people normally spend less in their 80s than they do in their 60s, and when you inflate the $60,000 through retirement those last 10 years of funding require a lot of additional savings.
Looking at the big picture, Shaun and Kara can easily retire in 2023 with $60,000 a year indexed at 2% annually to age 90 and beyond. They’ll be leaving their children an inheritance of about $7.2 million each which is equal to about $3.5 million in today’s dollars. If they are not concerned about leaving a large inheritance they could easily spend $100,000 and still leave an estate of about $2.2 million.
It’s here that I think Shaun and Kara will get more value with ongoing coaching around their lifestyle and spending decisions than a traditional plan will give them. What I mean by that is to identify and model the things they’d like to do, when and for how long, and how much will they cost. Experiment! Become comfortable spending the money, knowing your spending is being monitored against a plan.
It’s tough for some people who’ve built wealth over their lifetime, to turn around and spend. Shaun and Kara, is one of your goals to leave a large estate to your children?
Related: Pension income splitting explained
The challenge in putting together a plan with only the financial information is that I can only make suggestions based on financial strategies and tactics. The lifestyle and spending decisions Shaun and Kara plan to make will have a much bigger impact on the plan’s outcome, which is why it’s better to create the plan together and this is where I think traditional planning fails.
With retirement four to five years away I can’t be specific but I’d recommend following this general approach:
- Draw about $75,000 a year from the 401K.
- Don’t have the stock dividends reinvested.
- Stop making spousal RRSP contributions.
- Shaun should delay CPP until he has depleted the 401K, around age 66.
- Elect to split CPP.
- Maximize their TFSA and consider using their children’s TFSA for themselves.
Each year in retirement Shaun and Kara will want to anticipate their upcoming taxable income and adjust accordingly, particularly in those years when they are starting CPP and OAS.
Most of Shaun and Kara’s money is held in taxable accounts, and it was a great strategy to follow when they were accumulating money, but now they have to deal with the tax. Ideally, most or all of the registered money will be withdrawn by their late 80s.
The 401K has the most complications, so Shaun should start to draw from it first, $75,000 a year. He will deplete the 401K around age 68 and at that time convert his RRSPs to RRIFs and draw from them.
A 401K is a U.S. retirement savings plan similar to an RRSP. Shaun can transfer the 401K to an RRSP but it is not a simple process and if he wants to do this it needs to be done while he’s working. Tax will be paid in the U.S. but he’ll get offsetting tax credits that can be used against his Canadian income.
It’s also possible to maintain the 401K in the U.S. and split the income as pension income in Canada, but it’s tricky. There’s tax in the U.S. and an offsetting tax credit in Canada but only Shaun can use the credit so depending on his income, he may not be able to retrieve the U.S. tax paid if he is splitting his income with Kara.
If Shaun is going to convert the 401K to an RRSP or split the income, he should work with a Canadian-based U.S. tax accountant.
Most of the non-registered money is held in Microsoft stock with an adjusted cost base (ACB) of about 50% of the market value. Shaun’s wondering if he has too much money in one stock but at the same time he likes Microsoft’s prospects and he likes the dividend. Be aware that foreign dividends are taxed as income and are not eligible for the dividend tax credit.
Shaun should stop having the dividends reinvested back into Microsoft and use them to purchase other investments or supplement their retirement income. When a market drop comes there may be an opportunity to sell some Microsoft and purchase another investment with similar upside potential. Shaun holds the stock in U.S. dollars which is nice to have when planning extended vacations to the U.S.
Shaun has contributed enough to Kara’s spousal RRSP and he should switch back to making contributions to his individual RRSP. Once they’ve retired, or possibly before, Kara should draw money out of her spousal RRSP to make TFSA contributions. Note that they have to wait two full calendar years, generally the third year after the last contribution, before Kara can draw from the spousal RRSP and be taxed at her tax rate.
Shaun and Kara should split their CPP when they apply to receive it. Shaun may have a bit of OAS clawback until his 401K has been depleted at about age 68 so he would start his CPP then. He will have to check this at that time. Kara would start CPP at age 65. I don’t see a financial gain or loss by waiting to draw CPP at age 70 so if they want to increase their guaranteed income they could delay CPP to age 70.
Finally, Kara and Shaun should keep maximizing their TFSA throughout their lifetime and they should even consider maximizing their children’s TFSA as well, with the understanding that it’s Kara and Shaun’s money. Concerns about doing this would be that the children may decide to keep the money for themselves (it’s their account) or in the future, there may be a marriage breakdown.
Related: The four phases of retirement
Using their children’s TFSAs is a good tax savings strategy assuming all of the relationships are good. In most cases, it will be a while before children will need a TFSA. When Shaun and Kara’s children need a TFSA, Shaun and Kara will withdraw their money tax-free, and then the kids can contribute. Plus, I bet at some point Shaun and Kara are going to help their children with things like weddings or a down payment on a house, so why not save that money in their children’s TFSA?
Shaun and Kara have done a great job managing their income and building wealth so that they can retire at age 58 and 56 with an annual income of $60,000. Their biggest challenge may be feeling comfortable spending their money. My suggestion is to do an annual check on their plan for two reasons to confirm:
- Next year’s income strategy against the backdrop of anticipated taxable income; and
- That they’re on track and it’s ok to spend more.
Earlier in the article, I mentioned that people’s lifestyle and spending choices should be modelled because they’ll have a much bigger impact on a plan’s outcome than financial planning tactics and strategies. Here is an older video, not related to Shaun and Kara, which demonstrates this:
Allan Norman, M.Sc., CFP, CIM, Atlantis Financial
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