One of the key challenges retirees face when they shift from “wealth-accumulation mode” to “drawdown mode” is in the timing and optimization of multiple income sources.
These may include employer and government pensions, registered and non-registered investment income, annuities, any continuing earned income or business income, rental income and many more.
There may be as many as 26 distinct sources of income a retired couple may encounter, estimates Ian Moyer, a 40-year veteran of the financial industry. And it’s not as simple as merely maximizing each stream of income because tax brackets, clawbacks of government benefits and other considerations all interact in complex ways.
Moyer is, like myself, aged 65 and gradually dialling down on the financial services business he created: Ian C. Moyer Insurance Agency Inc., based in Ingersoll, Ont.
When he started to plan for his own decumulation adventure, five years ago, he felt there was very little planning software out there that was both comprehensive and easy to use. So, he hired a computer programmer and created his own package, now called Cascades.
Available to financial advisers for $1,000 a year (do-it-yourself investors can negotiate a price directly), I recently put Cascades through its paces for my wife and me. A few weeks earlier, I had done the same with Better Money Choices, a do-it-yourself program being developed by Doug Dahmer, the Burlington, Ont.-based founder of Retirement Navigator.
The first problem Cascades tackles is a common one: Is it more tax-effective if you draw down first on non-registered income sources, registered ones, or both? Or even tax-free sources like TFSAs? Like Dahmer, Moyer agrees the TFSA is generally the last mode the average retiree will want to tap. It’s there for estate planning, emergencies or perhaps long-term care at the end of life, Moyer said in a recent interview.
In our family’s case, in the first run the software took our inputs and concluded our ultimate estate would be a few hundred thousand larger if we drew first on non-registered funds, then registered, and finally TFSA. Non-registered first, it told us, defers the income taxes payable on registered investments, a strategy many retirees (and some advisers) intuitively feel makes sense.
However, Cascades permitted us to tweak our existing plan to maximize CPP by delaying receipt of benefits till 70. However, we would take Old Age Security (OAS) as soon as it is on offer at 65.
In the absence of both full-time employment income and CPP benefits between 65 and 71, we planned to bridge the gap by drawing down on our RRSPs (or creating early RRIFs in parallel) once we no longer occupied the top tax brackets. That, after all, has always been the purpose of RRSPs: get a tax deduction while you’re making top dollar, and withdraw from it in old age when you are in a lower bracket.
Cascades generates a comprehensive projection to age 102 that shows year by year exactly what your sources of income will be, any tax consequences and/or benefit clawbacks, and generally illustrates all the complex aspects of decumulation. You’ll be left thinking that by comparison, wealth accumulation was a relative snap!
I found you could enter the inputs in half an hour, assuming your data (including perhaps investment balances and your last tax return) are at hand. Moyer’s team create the results the next day, much of it automatically generated by the software, although some human mediation may be necessary.
The first inputs are naturally names and birth dates, with life expectancies obtained from the Society of Actuaries Annuity 2000 Basic Table. Income and savings are reported in “today’s dollars” by taking a present value at 2 per cent annual inflation, which is applied to CPP, OAS, pensions if applicable, tax bracket thresholds and tax credit amounts and others.
The program shows income snapshots at various ages, with precise estimates of OAS, CPP, DB pensions, registered and non-registered savings, business dividends and annuities and other income. It shows disposable income and taxes payable, and finally a net worth statement.
An investment summary shows graphically how non-registered savings slowly decline, how registered funds keep climbing till 2026 or so, and are exhausted around 2048. At that point, the non-registered and TFSA amounts are about equal: all the time the first two sources are falling, the TFSA keeps rising because it is, as Dahmer has dubbed it, the “never never” fund. Naturally, Cascades recommends shifting as much taxable savings to a TFSA as new room is generated with each passing year.
It’s fascinating to compare year-by-year outputs for both spouses. In our early years of retirement, my modest employer pensions are split with my wife for tax purposes, as she lacks such a pension. However, her RRSP and ultimately RRIF will be larger by a commensurate amount, and at some point, the program ceases splitting my employer pensions with her and begins to split her RRIF income with me. Some years there are modest OAS clawbacks, some not.
Projected rates of return vary from a Conservative 4 per cent (based on 70 per cent fixed income to 30 per cent equity), to a Moderate 5 per cent (60/40 asset allocation), 6 per cent Growth (40/60) and 7 per cent Aggressive (30/70). Asset allocation will affect tax rates for non-registered portfolios.
The program makes several recommendations. One was to manage sequence-of-returns risk using annuities or segregated funds; another is reducing taking registered income to avoid OAS clawbacks. It also calculates annual RRIF payments starting at age 72. The latter assume a 5 per cent rate of return and are projected to reach zero in our mid 90s. Both of these are in the OAS clawback zone, which reinforced my original notion of drawing down early on RRSPs in the second half of our 60s.
Throughout, the emphasis is on finding the “winning strategy,” defined as providing clients the highest estate value, net of taxes and fees, at the expected life expectancy.
All in all, a valuable tool, and one that if deployed while still contemplating imminent retirement or semi-retirement could well influence the timing of several key decisions. Dahmer says he’s pleased that others are waking up to the need for tax planning in the drawdown years: “Cascades provides a very good, easy-to-use introduction to these concepts.”
Jonathan Chevreau is founder of the Financial Independence Hub, author of Findependence Day and co-author of Victory Lap Retirement. He can be reached at [email protected]