Family Finance: With strategies such as income splitting and paying down a mortgage, his goal should be achievable

Married couple Tom,* 61, and Judy, 63, are at an inflection point. Judy retired just over a year ago and loves it. Tom plans to retire in two years. He’s happy to retire sooner, if possible, so long as they can achieve their target after-tax annual retirement income of $120,000 indexed to inflation.

Tom and Judy have built an investment portfolio valued at approximately $1.16 million, largely in registered retirement savings plans ($620,000) and Judy’s locked-in retirement account ($460,000). These accounts are 75 per cent invested in equities. They also have approximately $80,000 in tax-free savings accounts, with 65 per cent invested in equities.

If Tom does retire in 2028, he will be eligible to receive an annual defined benefit indexed employer pension income of approximately $100,000 with lifetime survivor benefits for Judy valued at 66 per cent of the pension.

They are confident they have enough money to see them through retirement. Their financial focus now is tax efficiency and how to strategically draw down the wealth they have accumulated.

Should Tom delay his employer pension until age 65 or later to minimize the couple’s tax costs? At what age should they start receiving Canada Pension Plan (CPP) and Old Age Security (OAS) benefits and begin withdrawing from their RRSPs?

When Tom does retire, the couple are considering a shift to a bicoastal lifestyle. This could potentially see them divide their time between British Columbia, where their son lives, and their longtime home of Nova Scotia, where they own their principal residence and a cottage.

At this point they are exploring their options and looking for advice to determine the most financially responsible approach. For example, should they purchase or rent a home in British Columbia, where house prices are much higher than Nova Scotia but where tax rates are much lower? Should they sell their principal home, currently valued at approximately $750,000, to help fund a new home on the West Coast and keep their East Coast cottage to use in the summer – at least for the next few years?

Tom asked, “If we cleared $750,000 from the sale of our home in Nova Scotia, what is the outer envelope that we could spend on a new home in British Columbia that would effectively mean breaking even in terms of the additional mortgage debt versus the tax benefits of changing our province of residence?”

The cottage is conservatively valued at $500,000 and has a mortgage of approximately $190,000 at 3.99 per cent for the next three years. The only other debt Tom and Judy have is a $70,000 home equity line of credit against the cottage. If they do purchase a home in British Columbia and take on a mortgage, when they are ready to sell their cottage those proceeds could be used to pay down that additional debt, if that is the best option.

The couple don’t want the emotional comfort of being debt-free to create a blind spot in how they move forward. “We know that the choices we make now are really important,” said Judy.

According to Ed Rempel, a fee-for-service financial planner, tax accountant and blogger, for Tom to retire in two years and achieve the couple’s desired retirement income of $120,000 after tax, he and Judy will need $510,000. They have $1.16 million. “They are 128 per cent ahead of their goal – a comfortable margin of safety.”

There is no need to delay the pension. Instead, Rempel recommended income splitting when the pension starts and taking advantage of the higher rates of return from their investments.

“It is common to only look at how much the pension would pay without considering how much more they should be able to get with more investments. Pensions typically are based on an actuarial formula that uses a rate of return of about five per cent. Tom and Judy’s investments are about 75 per cent equities, which should give them a higher rate of return. That means they would likely lose a bit of lifetime income by delaying the pension,” said Rempel.

“Deferring CPP from age 60 to 65 generates an implied return of 10.4 per cent a year on investments they would have to withdraw to provide the same income. Deferring to age 70 provides an implied return of 6.8 per cent – roughly the same as their equity investments, which offer more flexibility but would be quite unlikely to beat 10.4 per cent. It is probably best to start CPP and OAS at age 65,” he said.

When it comes to their proposed bicoastal lifestyle, Rempel said the maximum home they could afford with a safety margin is about $1.25 million.

“The same income gives them $5,000 a year more after-tax in B.C. versus Nova Scotia. That would pay for a mortgage about $125,000 higher. If they sell their home for $750,000 and clear just over $700,000 and pay for a mortgage of $125,000, that gets them a home in B.C. of about $850,000 with the same cash flow,” he said.

“They have about $800,000 more than they need for their desired lifestyle. They should keep between $100,000 and $200,000 at least as a margin of safety. That means they could use up to $600,000 to make mortgage payments. They could withdraw four per cent a year or $24,000 a year, which would be about $17,000 a year after tax. That could make payments on a mortgage of about $400,000.”

Rempel said it is best to not factor in the sale of their cottage right now as they may keep it for many years.

“Many seniors with mostly or all equities in their portfolios could generally afford a significantly higher lifestyle if they keep a large mortgage with the same amount of investments. Their equity investments should have a higher rate of return after tax over time than normal mortgage rates.”

*Names have been changed to protect privacy.

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