Looking for the right strategy to draw down retirement income

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Every retirement plan requires one of two tax strategies. This couple should defer tax as long as possible, one expert says

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The number of Canadians retiring is on the rise. In 2021, 233,000 people in Canada retired. In 2022, that number jumped to 307,000. After years of building wealth, they are now tasked with figuring out how to strategically draw down their savings to meet their cash-flow needs while minimizing tax and ensuring they have enough to see them through retirement.

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Toronto-based retirees Greg*, 60, and Kelly, 45, are also parents to a two-year-old, adding another layer to their retirement draw-down planning. Since leaving his career in finance and $200,000-a-year salary in 2020, Greg, a do-it-yourself value investor, has focused his investment strategy on dividend-paying stocks (largely based in North America) and away from growth and long-term capital appreciation.

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Today, he and Kelly generate $127,500 a year from dividends, capital gains and interest. Their target is to generate $100,000 a year in tax-free dividend income.

The couple has $154,000 in tax-free savings accounts (TFSAs), $1.2 million in registered retirement savings plans (RRSPs) and $1.4 million in stocks. They maximize their TFSA and registered education savings plan contributions each year, but stopped contributing to Kelly’s spousal RRSP because they expected their incomes would be increasing due to capital appreciation and dividend growth.

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Greg plans to start accessing a defined-contribution employer pension plan when he turns 65, which should pay out $2,500 a month. Kelly does not have an employer pension. Their monthly expenses are $4,800 and they have no debt.

They would like to know the best strategy for drawing income from their pension, RRSPs, Canada Pension Plan and Old Age Security. They do not have life insurance because of the wealth they have accumulated, but wonder if they are missing some benefit in terms of estate planning.

Kelly also claims $16,600 a year in rental income from leasing out the basement of their home. The goal when Greg first retired was to travel, but COVID-19 and the birth of their first and only child have changed their vision for retirement.

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They started actively hunting for a more family-friendly home in January, when residential real estate prices were down 20 per cent from last year, but they’ve come up against bidding wars. They’re looking to spend $2 million and have $800,000 sitting in cash ready to use as a down payment when they find the right house.

Their current home is valued at $1.4 million and Greg wonders if they should sell it to pay for a new one or keep it and rent it. Based on rental rates in their neighbourhood, he believes they should be able to rent it for $4,000 a month.

This fall, their child will attend preschool, which will cost between $8,000 and $10,000 a year. They also plan on private elementary and high schools, which they estimate (based on today’s prices) will cost at least $10,000 to $15,000 a year. ”Do we need to generate more income to fund it?” they wonder.

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What the experts say

“Every retirement plan requires one of two tax strategies: defer tax as long as possible or take income at the lowest tax bracket to avoid higher tax rates in the future,” fee-for-service financial planner, tax accountant and blogger Ed Rempel said.

He believes Greg and Kelly should opt for the first strategy, which will allow them to invest and grow the tax saved today, and more than cover future tax costs. Planning for a low taxable income from age 65 to 72 for Greg will also allow the couple to qualify for up to $10,000 tax-free income per year from the Guaranteed Income Supplement (GIS).

“Therefore, they should leave their RRSPs and wait to convert to RRIFs until age 72,” he said

Rempel also recommends Greg return to investing for growth, not income.

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“There is a belief that retired people need income. That is false,” he said. “They need cash flow.”

He points out dividends are taxed higher than deferred capital gains and punitively for people who qualify for the GIS.

There is a belief that retired people need income. That is false. They need cash flow

Ed Rempel

“Greg’s belief they can get $100,000 in Canadian dividends tax free is only accurate if they have no other income and are below age 65,” he said. “At age 65, the first dollar of dividends gets a 70-per-cent GIS clawback.”

Rempel’s advice: Live off the withdrawals from non-registered growth investments. Both should start drawing OAS at 65 (this is necessary as part of the GIS strategy) and CPP at 70 for Greg and 60 for Kelly.

“Equity investors should make a higher return on their investments than the implied five-per-cent per-year return from delaying CPP and OAS,” he said.

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Graeme Egan, a financial planner and portfolio manager who heads CastleBay Wealth Management in Vancouver, said the couple should consider more geographic diversification in the portfolio in the form of international stocks or low-cost international equity exchange-traded funds (ETFs), and introducing bonds to reduce volatility and risk.

“Given Greg is a moderate investor and has a focus on capital preservation, he could consider using bond ETFs in the RRSPs or high interest savings account/T-Bill ETFs, which are yielding solid interest income, and are less volatile than bonds, but the yield will decrease when interest rates start to decline,” he said.

With respect to financing a new home, Rempel recommends selling their current home and using $600,000 of the $800,000 garnered to pay for it.

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“Then borrow against the new home to buy investments worth $600,000,” he said. “This is the only way to get a tax deduction for the mortgage.”

Another option to offset reduced investment earnings is for Greg to start CPP when they buy the new house.

“For tax planning purposes, he could apply to have his CPP split with his wife given she would no longer have the rental income to report,” Egan said.

Both planners agree the couple do not need life insurance given their investments and asset base.

Affording private-school tuition should also not be a problem. Their retirement income is more than enough to maintain maximum RESP contributions and meet their cash-flow needs.

* Names have been changed to protect privacy.

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