Henry and Clara are in their mid-fifties and wonder if they are financially ready for their eventual retirement. Henry works for the government and earns about $120,000 a year. Clara is an engineer.
“I got ditched in early 2020 and it took me six months to find a contracting job,” Clara wrote in an email. “It made me realize that while my experience is required, finding a job in an industry where most of your colleagues are in their thirties will be difficult.” So I set up a company and started working on a contract, billed about $150,000 a year.
“Although I love working and have no plans to retire anytime soon, we would like to know when I can retire financially,” Clara wrote. “We don’t have children, so there will be no one to take care of us in our old age,” she adds. “We want to make sure we can afford a really great nursing home if we ever need one.”
Clara’s severance pay ran out at the end of last year, so she’s wondering how she should compensate herself now that she’s a registered contractor. She has not yet received a salary from her company. “As of 2022, how can I get income from different accounts and sources with tax efficiency?” She asks.
Henry plans to retire after about five years, at the age of 60. Clara wants the option of not having to work after that point.
Henry has a set pension, which is restricted by inflation. Can they retire when Henry turns 60 and maintain a retirement cash flow of $10,000 a month after taxes? Clara asks.
We asked Fabio Campanella, certified financial planner and co-founder of the Campanella Group in Oakville, Ontario, to take a look at Henry and Clara’s situation. Mr. Campanella also holds a Chartered Professional Accountant, Chartered Accountant and Certified Investment Manager.
What does the expert say?
Clara and Henry are healthy and want early retirement, says Mr. Campanella. They have been powerfully saved all their lives. Henry plans to work for another five years, and Clara is confident in her ability to work as an independent contractor at least until then and possibly longer.
Henry’s pension will pay $55,500 a year, including a bridge benefit from $10,500 to years 65, and $45,000 a year thereafter, linked to inflation.
“Clara is an incorporated contractor that earns active income through her own Canadian-controlled business in Ontario,” the planner says. As such, her corporation is subject to a flat tax rate of 12.2 percent on active business income of less than $500,000 per year. Any income she earns from her company will be subject to personal tax at her marginal rate.
Henry earns about $72,000 a year from work after taxes and deductions. This leaves the couple with an annual shortfall of about $20,000 to maintain their current lifestyle.
“Because Clara is subject to a low flat rate tax rate, Clara is in a unique position to achieve significant tax deferrals by keeping as much money as possible in her company and investing through the company,” Campanella says. By doing so, they won’t have to unnecessarily withdraw profits and pay personal taxes, he says. They can distribute profits over several years. For example, if Clara earns $150,000 a year in the company but only needs half of it to cover expenses, she can pay a fixed amount of corporate tax in the first year (12.2 percent), then take half of her retained earnings in dividends for the year over and over Others in the second year.
If Clara gets a salary of $50,000 a year starting in 2022, she’ll pay personal taxes of about $7,500, or about 15 percent, the planner says. This would add another $42,500 per year to their combined income, or about $22,500 more than they need based on their current spending. That surplus cash can be invested in tax-exempt savings accounts, used as an additional emergency fund, or contributed to Clara’s RRSP, he says.
In addition, Clara will be able to save about $85,000 annually to invest in her company, says Mr. Campanella. “These retained earnings can be withdrawn in a tax efficient manner through corporate earnings over the course of Clara’s retirement.”
The situation for Henry and Clara is a little complicated as their savings and retirement income will be drawn from several sources, including Henry’s pension, government benefits, registered retirement savings plans, closed retirement accounts, tax-exempt savings accounts, cash accounts and businesses, says Mr. Campanella. The couple plans to start receiving the Canada Pension Plan and old-age insurance benefits at age 65.
The scheme says relying on most registered investments will result in a personal tax, as is the case with the CPP, OAS, Clara Corporation Account and Henry’s Pension Plan. TFSA accounts will be tax deductible, and unrecorded personal portfolio will be taxed only when capital gains are triggered and when underlying investments make taxable distributions (dividends and interest).
“To keep things simple and discreet, let’s assume that 100 percent of a couple’s retirement income is taxed at their marginal rates,” the chart says. “We will also assume an annual return on investment, adjusted for inflation and based on a balanced portfolio, of 3.02 percent on non-taxable accounts and 2.41 percent on taxable accounts.”
To achieve $120,000 in cash flow after taxes, a married couple would need about $150,000 in pre-tax income, or $75,000 each if the income could be split perfectly, says Campanella.
Henry and Clara’s retirement will come in two phases. The first stage occurs between the ages of 60 and 65, when they are not receiving government benefits, and the second stage between the ages of 65 and 90 when they will take a CPP and OAS. From age 60 to 65, if they both stop working, they will face a deficit of $94,500 annually ($150,000 pre-tax income required minus Henry’s $55,500 pension) which they will have to withdraw from their savings and investments. From age 65 to 90, their deficit will shrink to $68,000 per year because they will start collecting CPP and OAS.
“Using the above assumptions, and their initial investment balance of $2,148,000, Henry and Clara should be able to accumulate approximately $2.9 million in investable assets by Henry’s age of 60,” says Campanella. “Using simple math, a couple would need about 3.3 percent of their investment balance to fund the retirement shortfall between ages 60 and 65 and 2.4 percent thereafter,” he says. “This is within a reasonable range of an expected retirement draw in their portfolio and should be easily sustainable,” he adds. “In fact, the expected inflation and adjusted tax return on investments as calculated above will keep the pair almost indefinitely.”
As a backup, and to ensure they can buy a good quality nursing home if they need a home, says Mr. Campanella, the couple also has great value that they keep in their home. “In the worst case scenario, if their investments don’t work out as planned, they can capitalize on the value of their home or downsize to complement their retirement lifestyle.”
People: Henry, 55, and Clara, 54
the problem: How should Clara pay herself from her company? How can they withdraw in a tax efficient manner after they retire?
the plan: Clara earns a modest salary and lets the rest of her contractual income grow within the company. After she quits the job, she can make a profit.
Yield: More than enough to meet retirement spending needs.
net monthly income: 10,610 dollars
Origins: Its RRSP is $223,740; $741.505 from RRSP; His closed retirement account from his previous job $10,590; Her LIRA from her previous job $270,035; $120,050 from TFSA; Her TFSA is $112,345; Unregistered wallet $350,000; $130,000 home renovation cash savings; Retained earnings of the company are 190 thousand dollars; The estimated present value of his DB pension is $750,000; Residence 2 million dollars. Total: $4.9 million
Monthly expenses: property tax of $600; Water, Sanitation, and Trash $95; Home insurance $80; Electric and Heat $265; maintenance $200; garden $200; Transportation $635; Grocery $1,200; 200 dollar clothes; charitable gifts $200; Vacation, travel $2,000; Dining, drinks, and entertainment $780; Personal Care $150; club membership $60; $120 for sports and hobbies; Subscriptions $80; another $100 figure; Medicare $230; Communications $190; RRSPs $250; Pension plan contributions $1,070. Total: $8705
Liabilities: no one
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