Transcript Financial Planning

Prior to and during retirement
FINANCIAL PLANNING
Topics Covered
1.
2.
3.
4.
5.
6.
How much
Sources to fund retirement
Investing
Insurance
Going non resident
Other things you may find of interest
How much
That depends!!
• Rule of thumb says annual income should
be about 70% of pre retirement income
• Individual planning should be
undertaken, taking into consideration
expenses, cash flow and lifestyle choices
How Much
• Start with current household budget
• Ask what current expenses will no
longer apply once retired
• What expenses might arise as a result
of retirement
How Much
• Net worth statement will assist in the
exercise
• Review desired lifestyle versus what
you can reasonably support
Do It Yourself - Websites
• https://srv260.hrdc-drhc.gc.ca/EnglishApp/INT_01.asp
• http://www.morningstar.ca/globalhome/rrspplanne
r/index.asp
• http://www.fiscalagents.com/toolbox/index.shtml#
tb2
Once you have some facts, figures and
estimates, consider seeing a specialist
Keep an open mind to options
– Working longer before retirement
– Reduce retirement needs/expectations (eg.
Rent a boat for a week instead of buying)
– Save more before retirement
– Attempt to earn more on investments
– Pay off more if not all debt before retiring
– If MSP, dental and/or extended health is
currently covered by an employer,
alternatives?
Do not procrastinate adjusting your
retirement plan or putting the plan into
action
Sources to fund retirement
• Government – Old Age Security/Canada
Pension
• RRSP/RRIF/Annuities
• Registered pension plans
• Part time work/contracting
• Non registered investments and other
assets
Old Age Security (OAS)
• For eligible Canadian residents and certain former
residents of Canada commencing at age 65
• Current maximum monthly payment $491.93, indexed
every calendar quarter based on CPI
• Qualify for full pension if resident in Canada for 40 or more
years after age 18
• If do not meet the 40 year test, may be eligible for prorated payment
• Human resources suggest you apply six months before
your 65th birthday
• Can receive retroactive payments for up to 12 months if
you apply after age 65
Old Age Security (OAS)
• As long as have lived in Canada at least 20 years after
age 18, then payments will be made even if you leave
Canada. If you fail 20 year test, payments can be
suspended after 6 months absence from Canada,
restarting upon return to Canada
• Guaranteed income supplement over and above OAS
payments if income low enough (current threshold $14,256
before any OAS)
• Watch out for claw back – kicks in at net income above
$62,144 (threshold rate for 2006, indexed annually) and is
calculated as net income less threshold x 15% to a
maximum of OAS paid for the year.
Canada Pension Plan (CPP)
• Contributions generally required from business
and employment income to this federal plan
• Each calendar year, currently first $3,500 of
earnings exempt from contribution
• Current total annual contribution rate 9.9% of
annual pensionable earnings
• Contribution requirement is either split between
employee and employer or paid in full if self
employed
Canada Pension Plan (CPP)
• Current maximum pensionable earnings $42,100
• Therefore total current annual contribution
($42,100 - $3,500) x 9.9% = $3,821.40
• To collect, must have contributed, reached at
least 60, substantially ceased working if under 65
(must not work month before and during month
benefits commence – can go back to work
after)
• For each month you commence collecting
before age 65, benefits reduced by ½ of one
percent
• Therefore if commence collecting at age 60,
monthly receipt will be 30% less than what would
be paid if waited until 65
CPP (cont)
• For each month after age 65 that you
wait to retire and collect, monthly receipt
is increased by ½ of one per cent to a
maximum of 30% (age 70)
• Once you commence to collect you do
not make any further contributions to the
plan
• Current maximum monthly benefit
$1,031.05 ($12,372.60)
• Can share benefits with spouse such that
each will end up receiving even monthly
amounts
CPP (cont)
• Sharing can be applied for any time after
both spouse reach age 60 and at least
one in receipt of benefits
• Credit splitting will normally apply upon
separation or divorce based on time
together
• Survivor benefits continue for spouse and
orphaned children
• Death benefit to a maximum of $2,500
paid to the estate upon application
Registered Retirement
Savings Plan (RRSP)
• Generally three types – Life insurance
company plans, other financial institution
plans and self directed
• Life insurance plans normally offer
deferred life annuities
• Other financial institution plans normally
invest in savings deposits, term deposits
and GIC’s. Some add certain mutual
funds and pooled fund trusts
Registered Retirement
Savings Plan (RRSP)
• Self directed or self administered – you can
select the qualifying investments to be
made
• Contributions based on “earned income”,
the most common inclusions being
employed and self employed income
• Limit for deductible contribution in a year is
determined according to the following slide
RRSP’s (cont)
• Maximum deduction for 2006 is $18,000,
increasing to $19,000 for 2007
• Contributions can be made during the
year or within 60 days of year end
• 1% excess contribution penalty can apply
• Can contribute certain property such as
stock or bonds
RRSP’s (cont)
• Spousal plans can be established to make the
spouse the annuitant of the plan, but the total
contribution limit above applies
• Qualified investments in a plan can include
GIC’s, bank deposits, most bonds and debt
obligations, shares and units traded on
prescribed stock exchanges, gold and silver
• Most common non qualified investments are real
property, commodity futures, listed personal
property, precious gems and shares of most
private companies
• Can invest in your own mortgage but this is not
necessarily a good thing to do
RRSP’s (cont)
• By December 31 of the year you reach age 69,
you must either collapse plan, transfer to a
Registered Retirement Income Fund (RRIF), an
annuity or any combination of the three
• Complete withdrawal will likely attract large
income tax liability
• RRIF essentially carries on like the RRSP except
there is a required minimum annual withdrawal,
but no maximum
• Annuity usually guarantees some fixed stream of
income, usually for some guaranteed period or
the rest of your life
• Annuities can be indexed, have surviving spouse
entitlements amongst other options
Registered Pension Plan (RPP)
• Can be an extremely lucrative benefit of
employment
• Pension administrator can provide options and
amounts based on anticipated retirement date
• Plans include defined contribution, defined benefit
and individual pension (IPP) plans
• IPP may make a better choice than an RRSP for an
incorporated professional who is at least 45 and has
regular personal income in excess of $75,000
• If at least one spouse has a RPP, keep in mind the
desire to build up assets evenly
Part time work
As John Kenneth Galbraith suggested when asked
about making returns from investments, it is
tough to beat a steady pay cheque
• Assuming you genuinely want (or need) to work past
“normal” retirement age, consider some or all of the
following:
– Impact on CPP
– Impact on pensions
– What you will net based on marginal tax rate after all
other income
– Capital outlays if you are starting your own
business/working as a subcontractor
– Your health
– Are you really going to enjoy working versus time for
leisure
– Start planning 1 to 5 years before taking on the new
role
Investments, non registered
and otherwise
• Investments built up before and during
retirement can provide income and as
needed return of your capital (normally
upon sale)
• Keys to keep in mind over and over again
– Diversification and Allocation
Investments, non registered
and otherwise
• Assets accumulated can include:
–
–
–
–
–
–
–
Your interest in your practice
Stocks
Bonds
Commodities
Real estate
Precious metals
Collectibles
Unless you are Warren Buffet, you should
normally plan on diversifying your assets
amongst most if not all of the above
Investments, non registered
and otherwise
• The purpose of diversification and allocation
is to reduce risk
• Risk from currency, inflation, interest rates,
politics, market amongst others
• Be brutally honest with yourself and your
tolerance for risk
Example of risk
Investments (cont)
Date
Trading Days
P/E at high
T-bond yield
Decline
09/03/1929
719
20.6
3.8%
-40.0%
03/10/1937
654
11.3
2.5%
-14.9%
05/29/1946
1020
16.2
2.1%
-23.2%
01/05/1953
617
9.4
2.8%
-13.0%
07/12/1957
960
13.0
3.7%
-19.4%
02/09/1966
912
17.6
4.6%
-25.2%
08/25/1987
780
19.7
8.9%
-36.1%
07/16/1990
657
13.6
8.6%
-21.2%
08/06/1997
1723
23.7
6.4%
-10.6%
10/13/2006
906
18.3
4.8%
The last line in the above table has been left blank as the
story is still unfolding
Investments (cont)
• Looking at the last period, we note the Dow has
now gone over 900 days without even a 10%
correction
• Current advance is among 5 longest advances
without correction ever recorded
• Above table summarizes advances of 600 days
or more before at least a 10% correction
• Declines listed are not necessarily bear markets
but extent of drop before the next 10% increase
• Lower price earnings (pe) ratios and interest
rates than current are more the norm
• Some pundits suggest even if current market
advances further 10% or higher, likelihood of
retention is extremely remote
Investments (cont.)
• If diversifying into real estate, this is over
and above your principal residence
• Consider carrying costs such as annual
property taxes and any upkeep
• If going to earn rental income, do you
really want to be a landlord with the
inevitable calls at 2 am concerning the
blown hot water tank or do you hire a
property manager
Investments (cont.)
• Real estate as we have seen recently can
appreciate quite nicely, but it is nowhere as
liquid as stocks or bonds and can be just as
subject to corrections, if not more so
• Consider the tax consequences well ahead
of any anticipated sale and year to year
compliance costs if earning rental income
• For precious metals, as a hedge and for
further diversification, consider holding up to
5% of your assets in the actual metal and/or
stocks/mutual funds dealing solely with this
category
Investments (cont.)
• Examining brokerage account, a rule of
thumb is that cash/bond component as a
percentage of total should equal your
age
• Therefore an account worth $1 million
held by a 55 year old could hold up to
$550,000 in bonds/cash with the
remaining $450,000 in equities
Investments (cont.)
• The equity component would likely be
spread across manufacturing, resources,
consumer, financial, utility and multi
sector stocks and trust units
• No one sector would normally be more
than 20% of the total equities or less than
5% and no one stock would mirror these
percentages within a sector
Investments (cont.)
• Mutual funds should be monitored to
meet these parameters in conjunction
with individual stocks
• A suggested allocation of equities in
foreign companies is up to 20% of total
equities
• It is highly recommended that the overall
account be reviewed and rebalanced
each year
• Preferred you rebalance by allocating
new money to required sector or
component versus selling
Investments (cont.)
• Alternative to holding bonds versus
bond mutual funds
• Laddered approach useful in
holding bonds
Investments (cont.)
This entails taking the total bond component,
dividing over the number of years you wish to
span (normally at least five) and invest that
portion of the funds in bonds with the required
maturity.
Example:
– Have $100,000 to invest in bonds
– Want to cover bonds maturing up to five
years from now
– Allocate $20,000 to a bond maturing in one
year, $20,000 to a bond maturing in 2 years
and so on
– When the one year bond matures, invest
proceeds in a bond maturing in 5 years
Investments (cont.)
• Review bond offerings and respective
qualities – Government, high corporate,
junk
• Bond mutual funds give opportunity for
larger diversification of bond holdings
and for capital appreciation on the
interest swings as well as foreign currency
exposure
• Some negatives with bond funds are
management expenses and possible loss
of capital
Investments (cont.)
• The closer you get to retirement, the more
ready cash (or near cash) you should
have on hand
• While still working, at least three months of
cash or at the very least, a line of credit
with a limit of 3 months cash needs should
be maintained
Investments (cont.)
• As approach retirement, this should
grow to 18 months with five years or
more covered by bonds or specific
fixed income investments
• As instruments mature and cash is
expended, should be replaced from
other investments
Investments (cont.)
• Personal preference would be to know
that have the next five years of outlays
covered with cash and maturing fixed
income investments
• Options to a savings account which pays
next to nothing could include money
market funds from companies such as
Altamira and Dundee which are
accessible within 24 hours and are
currently paying approximately 3.75% on
your money
Insurance
• Purpose is essentially to protect assets
• Consider life insurance, particularly if want to
replace coverage lost upon retirement
• Options for life insurance include term, term to
100, whole and universal plans
• Disability coverage
• Critical illness
• Long term care
Non residency
• Canada’s tax system based primarily on
residency
• If you are resident, then Canada taxes
worldwide income with various credits for
foreign taxes
• Otherwise, Canada will normally only
require a tax return if you have income
from:
– employment in Canada
– carrying on a business in Canada
– disposal of a taxable Canadian property
Non residency
• All other income sourced from Canada
normally subject to withholding tax, the
most common domestic rate being 25%
for which a tax treaty may provide some
relief
• Example of treaty relief – Canada – US
treaty, Canada can only withhold 10% on
most interest for resident of US in receipt
of interest from Canadian source
Non residency
• If you decide to become non resident of
Canada, must sever ties
• Date of severing ties, deemed to dispose of most
properties at fair market value
• Any gains as a result of deemed disposition
taxed on final part year resident return
• Part year resident return filed to date of
departure to include all world wide income to
that date plus normally any deemed disposition
gains and/or losses
• Properties exempt from deemed disposition
include real property in Canada, RRSP’s, RPP’s
etc.
Non residency (cont)
Other issues to consider before going non
resident of Canada:
– medical coverage – you will need to cancel
BC MSP on departure
– will you maintain OAS entitlement?
– do your due diligence on new country
concerning laws, tax rules and capital
restrictions
– ensure you are not caught up in the “grass is
greener” thought
Other – Consider Options with RRSP
If you are planning on leaving some or all funds in a
RRSP/RRIF to beneficiaries of your estate, consider:
– Whatever is in the plan at death will likely, for the most
part, attract the top marginal rate of tax
– In BC, this is currently 43.7%
– Assume you are currently 60, will live to 75, have no
surviving spouse on death, earn 7% per year on your
RRSP which has a current value of $1 million
– At death the plan would be worth approximately $2.8
million
– After tax, beneficiaries would receive approximately
$1.58 million
– As an alternative, cash out plan and pay full tax now,
leaving approximately $563,000
– Purchase life insurance policy with proceeds
– Upon death, beneficiaries could receive in excess of $2
million tax free
Other (cont)
• If currently in a partnership, consider your
exit strategies well in advance
• Draws are charged immediately against
your partnership capital account
• Income is only credited against the
partnership account at the fiscal year
end of the partnership
• Want to avoid full income inclusion plus a
deemed capital gain because of
unintended results impacting your capital
account
Other (cont)
• Incorporation related to a professional practice
and/or a holding company for investments can
be a desirable alternative to your status quo
• If a sole practitioner, it is relatively
uncomplicated to convert to practicing through
a company
• Consider some structures to replace an existing
partnership, or if just about to start a partnership,
review options for operating through corporate
vehicles.
• Some structures which have withstood Canada
Revenue Agency scrutiny are as follows:
Professional
Corporation
Professional
Corporation
Unincorporated
Proprietor
Professional Services
Central Professional
Corporation
Professional Services
Clients
Professional
Corporation
Professional
Employment
Agreement
Professional Services Agreement
- contribution of working capital
Professional
Corporation
- guarantee of loans
-subrogation of losses
Professional
Services
Agreement
Central Services
Corporation
Professional
Partner
Professional
Corporation
Employee
Independent Contractor
Partnership
Second Tier
Corporation
Partner
Partner
Partner
Partnership
Corporate
Partner
Other (cont)
• If you are contemplating the use of one
or more companies, consider the
following:
–
–
–
–
Setting up and using a family trust
Introduce spouse as a shareholder
Use a company for asset accumulation
Income splitting in conjunction with the three
prior items which in turn may minimize or
outright avoid the OAS claw back besides
reducing the overall tax cost
Other (cont)
• A more radical departure from the generally
accepted planning could include ceasing
all future CPP and RRSP contributions
• For CPP, note that once you approach age
50 and are contributing both the employee
and employer portions, to age 65, the return
on your contributions from age 50 to age 65
is approximately negative 6 % per year
• This assumes you started working at age 18
and commence collecting at age 65 until
age 85 with an inflation rate of 2%
Other (cont)
• For cessation of RRSP contributions, may be
easiest to review an example
• Assumptions:
– You have managed to accumulate an investment
portfolio in your company of $1 million
– You and your spouse are shareholders holding different
classes of shares and are both at least 65 years old
– The company can pay dividends to one or both
shareholders in any amounts
– The company earns a 7% return on the portfolio
consisting of $35,000 in dividends, $15,000 in interest
and $20,000 in capital gains
– The company incurs compliance and other expenses
annually of $5,000, leaving $65,000 income per year
For the purpose of the example we will ignore the
pending dividend rules for income tax purposes
Other (cont)
Notes:
• Net income in company is $55,000 after
deducting the non taxable portion of the
capital gain
• Taxable dividends received by the
company are from other Canadian
companies such that only Part IV tax
applies
• Your company pays $50,000 in dividends,
being $25,000 to each of you and your
spouse
• Net result in the company is total tax
owing of $4,557
Other (cont)
• The tax planner shows results for one
individual, but should be duplicated to
reflect both spouses – assumed you have
split CPP so both receiving exactly same
amount
• RRSP income based on minimum
withdrawal which would need
approximately $475,000 accumulated
each. RPP could just as easily be inserted
in place of the RRSP income and
withdrawal could be larger on less
accumulated balance
Other (cont)
Summary
• Cash left in the family would be $48,043 each
plus a total of $10,000 paid from the company as
a tax free capital dividend (for the tax free
portion of the capital gain)
• This gives a grand total for the year of $106,086
• Total tax paid would be $4,557 in the company
and $7,756 each personally for a grand total of
$20,069
• Based on a gross of $126,155, taxes are
approximately 16%
• Income levels for both spouses completely
avoids claw back of OAS receipts
Thank you for your attention
Questions???