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By Julie Cazzin with Allan Norman
Q: Our retirement is fast approaching and we’re not sure what to do. I’m 68, self-employed, incorporated, with a family trust and a holding company of which I am the sole shareholder. In addition to my small Canada Pension Plan (CPP) and Old Age Security (OAS), I’m drawing dividends of $120,000 per year and there’s enough income left annually to dividend $60,000 to my holdco as well as to pay my wife Rita, 59, a salary of $40,000 per year for bookkeeping services. I’ll probably work until I’m 75. Rita also has a regular job and earns $90,000 per year. As for assets, we have a very nice, well-kept $2.5-million home, plus $170,000 of cash in my holdco. Our total debts come to $400,000 and Rita expects an inheritance of $700,000 in five to 10 years. Plus, we’ve put two kids through university. Can we retire soon? — John and Rita
FP Answers: John and Rita, you’ve done well. You have a good family income, nice home, business and business structure, and you’ve put your two children through university. Perfect. Well, almost. Apart from the $170,000 inside the holdco, you have no cash investments, registered retirement savings plans (RRSPs) or tax-free savings accounts (TFSAs). And, John, even though you’re taking your OAS, it is all being clawed back.
Maintaining your current lifestyle throughout retirement is not possible with $170,000 of savings. But it becomes possible through a combination of working longer, reducing your lifestyle expenses and/or a dependency on your home equity and future inheritance. I think that if you had been given just a little more guidance along the way, you’d be in a much better situation today.
It would have helped to get a sense of how much money would be enough to support your lifestyle over time. Just an awareness of that number can have a positive impact. Of course, you may have always planned to use your home equity and inheritance to support your retirement, but I’m going to assume you did not.
John, you started your CPP and OAS when you turned 65. Your CPP is low because you paid yourself dividends and didn’t contribute to CPP. It’s not uncommon for me to hear of business owners drawing dividends to avoid CPP contributions because they believe they can do better than CPP if they invest on their own. But they often say they haven’t started investing yet when I ask how their investments are doing, so be careful.
As for your OAS, John, you are past the point where you can stop your OAS and defer it to age 70. You only have six months from the time of starting OAS to stop it and defer it to age 70. Reasons for deferring the OAS include a 36-per-cent increased benefit if it is deferred to age 70 from 65, and avoiding the claw back of some of your income between age 65 and 70. In your case, you may continue to lose your OAS up until age 75 when you plan to retire.
A possible solution is making Rita a shareholder of your holdco with a different class of shares. With Rita as a shareholder and you, John, over the age of 65, your holdco can pay Rita dividends. Maybe, John, you can reduce your dividends enough to be able to keep your OAS and at the same time pay dividends to Rita in the amount of your reduction.
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Of course, this will be dependent on Rita’s taxable income. If the dividends are going to increase her taxes by more than your OAS, then it is not worth it. However, it may make sense if there is a time when Rita stops working and you are still working, especially if you’re using tax-free capital from the expected inheritance or home equity.
There is currently $170,000 in the holdco sitting in cash earning almost no return. John, you likely didn’t know that money in a holdco could be invested and maybe that’s why it’s in cash. Right now, you have the option of keeping the money in your holdco or moving $140,000 or less to your RRSP, without tax implications, to use up your past RRSP contribution room of $140,000.
The advantage of keeping money in the holdco is the preferred tax treatment of dividends received personally. In retirement, the low tax rate on dividends combined with tax-free capital draws from home equity and the inheritance may mean a very low tax rate, and eligibility for additional government benefits and credits.
The negative side of investing in the holdco includes ongoing accounting fees, and that the taxable amount of interest, dividends and capital gains is taxed at about 50 per cent, depending on the province of registration. There is a refundable dividend tax mechanism that will reimburse some of the tax paid when a dividend is paid to you, John, but the future growth on the extra tax is lost.
With some of these thoughts in mind, it may make sense for you both to seek an adviser’s help to draw up a workable financial plan that will continue to support your current lifestyle over your lifetime.
Allan Norman provides fee-only certified financial planning services through Atlantis Financial Inc. and provides investment advisory services through Aligned Capital Partners Inc., which is regulated by the Investment Industry Regulatory Organization of Canada. Allan can be reached at email@example.com.
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