At 57 and once again alone, Eileen envisions a future that is very different from what she could have imagined. She still lives in the family home in an expensive Toronto dormitory community, but now it’s mortgaged at about half its value. She also retained ownership of the family cottage.
Eileen would like to retire from her well-paid executive position at age 65. She brings in between $350,000 and $400,000 a year in salary, bonuses and company stock. She also has substantial savings and investments.
“Do I have to sell my house to be able to pay off the mortgage before I retire? Eileen asks in an email. “Or is it better for me to stay where I am?” She thinks she couldn’t afford anything in her current neighborhood without taking out another big mortgage.
Two of her four young adult children still live at home, but one is going to college soon and the other is thinking of moving in a year or two. The children are between 18 and 28 years old.
Eileen also asks what is the best way to set things up if she wants to give $40,000 to each of her children.
His retirement spending goal is $70,000 a year after tax.
We asked Amit Goel, portfolio manager and partner at Hillsdale Investment Management Inc. in Toronto, to take a look at Eileen’s situation. Mr. Goel holds the Chartered Financial Planner and Chartered Financial Analyst designations.
What the expert says
With a modest lifestyle and a substantial investment portfolio, Eileen can easily achieve her goals, Goel says. She can retire two years early at age 63, spend 10% more after retirement, and give twice as much money — $80,000 instead of $40,000 — to each of her four children. His forecast assumes an annual post-retirement growth rate of his portfolio of 5.5% per year, net of fees and expenses.
Eileen’s house will be too big once the children have all moved out, says Mr Goel. He suggests that he sell it in 2023 for an estimated $2.7 million, buy a smaller home for $1.5 million, and pay off his existing mortgage. “The smaller residence plus the cottage will still represent more than 50% of his net worth and will continue to provide exposure to real estate growth,” the planner said.
Being debt free will reduce Eileen’s anxiety level and help her focus on other financial matters. Once the mortgage is paid off, Eileen will save about $60,000 a year, he notes. The extra savings “will help her build her retirement portfolio and provide cash to give money to her kids.”
Eileen asks about a tax-efficient way to donate $40,000 each to her four children spread over the next few years. She can contribute to their Tax-Free Savings Accounts and the first recently announced Tax-Free Home Savings Accounts, or FHSAs. Children could claim tax benefits on the FHSA, which is due to launch in 2023, and invest the funds “early and aggressively”. When they decide to buy their first home, investment gains and potential withdrawals will be tax-free, the planner says.
For the TFSA, Eileen can fulfill the contribution room of $6,000 for each child from 2023 to 2027, for a total of $30,000 each over five years. “It also aligns well with his earning years.”
For FHSA, she can give a maximum of $8,000 a year for five years, or $40,000, to each of her children when they start earning money. The children will receive a tax refund for these contributions. Assuming a 25% tax refund, or $10,000, the gift will be worth $50,000 to each child. “Indeed, each of his children will receive $80,000 compared to the $40,000 originally planned.”
Alternatively, Eileen could structure the donations as loans, Goel says. The children would have to pay Eileen a minimum interest rate, currently around 1%, but soon to reach 2%, according to the planner. The interest would be taxable in Eileen’s hands. Once the children reached their highest earning years, they could repay the loans, “which would further strengthen Eileen’s retirement plan,” says the planner.
When Eileen retires, her investment portfolio should be between $2 million and $2.5 million. To ensure an optimal risk-return distribution, Eileen could divide her investment portfolio into three separate compartments with different objectives. For safety and emergency funds, Eileen should maintain three to five years of cash requirements ($300,000 or 15-20% of her portfolio) in cash, guaranteed investment certificates and other cash equivalents.
To defeat inflation, it could create a second bucket of stable growth stocks. It can be a combination of low-volatility, dividend-paying, and tax-efficient investments with the potential to grow or beat inflation over the long term. Those stocks could make up 40-60% of Eileen’s portfolio, he says. “This could include tactical inflation hedging exposure to the energy, commodities and industrials sectors.”
For her legacy or long-term holdings—the portfolio that Eileen may never need or spend—she should invest more aggressively. This will help him beat inflation and have enough to pay for emergency medical bills in his old age if the need arises, Goel says. This could represent 20-30% of the portfolio.
His investment strategy could be as follows: when the markets are up, sell more and fill his cash reserves. When markets are subdued, remove one year of cash requirements. When the markets are down, don’t sell anything. Withdraw funds from cash reserves. Finally, when the markets are down, “be brave and smart and buy more!” said the planner.
To smooth her taxes and reduce the amount of income she will have to withdraw when she converts her registered retirement savings plan to a registered retirement income fund, Eileen could withdraw from her RRSP portfolio between age 63 and the time she will convert it to a RRIF at age 71. “We assumed an annual RRSP withdrawal of $100,000 from age 63 to 70,” says Goel. This strategy will reduce his total taxable income at age 71 to $125,000 per year. He suggests that Eileen claim Old Age Security benefits at age 65, when her taxable income might be closer to the lower income threshold for OAS clawback. Depending on her income, she could qualify for 20 to 40 percent of the full OAS benefit, he says. He suggests that Eileen delay her Canada Pension Plan benefits until she is 70.
Status of customers
The people: Eileen, 57, and her four children
The problem: Should she sell her house and buy a smaller one? What is the best way to give money to your children? How should she invest for her retirement?
The plan: Sell the house and get rid of your debts. Consider contributing to tax-sheltered plans for her children. Invest in a balanced portfolio and tap into your RRSPs as soon as she retires.
Gain : A clear path through the transition years from a high profile career to a comfortable retirement.
Net monthly income: $17,835
Assets: Shares $286,000; TFSA $72,000; RRSP $1,005,000; Registered Education Savings Plan $73,000; residence $2.2 million; cottage $600,000. Total: $4.2 million
Monthly expenses: Mortgage $4,790; property tax, house and cottage $795; property insurance $355; cottage electricity $150; household electricity $250; heating $100; maintenance $100; water heater $35; garden $100; vehicle insurance $260; other transportation $380; groceries $800; clothing $200; gifts, charity $220; vacation, travel $200; cottage maintenance $100; meals, drinks, entertainment $130; club membership $70; online subscriptions $70; pets $20; course $135; health care, insurance $725; Internet, cell phones $345; RRSP $790; RESP $435; TFSA $865; purchase of shares $1,915. Total: $14,335.
Passives: Residence mortgage $1,173,000 at 1.5%
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