Retirement Planning - Part 2: When a Meltdown is a Good Thing!

This Time, With Pictures!

In my previous post, I shared a link to the Retirement Income Calculator. (Just did it, again.) It's definitely worth the time to play around with it. But, if you don't want to, right now, I'll walk you through how my plan works, without using my actual data. I'm also going to go through sections out of order, to help see how things look.

Also, I'm not, in any way, an expert in any of this, nor am I telling you that this is the best/only way to go for retirement. It's just the strategy that I'm planning on using. 

Go talk to a professional. Make your own choices.

General Information

The first section of the Retirement Calculator sets up your life expectancy and your retirement income goal. For this demonstration, we'll pretend we're a 50 year old male whose income is $75,000 a year. For this, I chose to have an income goal of $60,000 (in today's dollars). 

The year you're born and gender at birth determines your life expectancy. A male born in the 70s is expected to live to 85; a female is 88. (My kids' generation adds a year.)

Using those numbers, we get a chart that looks like this:

Old Age Security (OAS)

We're now skipping to this section of the Calculator because it's the easiest. It asks about where you live. Let's assume the person has lived in Canada their whole life. It also asks when you want to start taking your OAS. In my previous post, I wrote that taking it later is beneficial. Since that is what I'm going to do, let's show what that looks like for our friend, here, taking it at Age 70.

Just under $12k, in today's dollars until he's 75, then there's a 10% bump to just over $13k. Nice.

Income taxes aren't withheld for OAS, but you can request it. There is something called a "clawback" for high income earners, but that won't be necessary for this demo because we won't hit that number, here.

A note to my Canadian friends who might be living, or have lived, abroad. You can still qualify for OAS, but at a reduced rate. Look into it.

Canada Pension Plan (CPP)

Whereas OAS is based solely on where you've lived during your lifetime, CPP is based on how much you've contributed to the plan. To find out what your pension estimate will be, you'll have to log into your My Service Canada Account. The more years you've maxed out your CPP, the higher your number will be. (If you don't know, and don't want to bother to find out, the Calculator will give you an average value to use.)

I'm going to use $1000 and, once again, push off receiving it until 70.

This is where things get interesting, as far as the planning goes. As you can see, this person, at 70 years old, will be receiving about $30k a year in benefits. Essentially half of what their retirement goal is. (And, once again, these are today's dollar values. The actual pension is indexed to inflation, so it will be higher when the time comes.)

Another thing to keep in mind about the $30k is that it's well within the lowest tax brackets, both provincially and federally. For a British Columbian, right now, a total of about 20% would be paid in taxes from those numbers. Currently, like OAS, CPP does not withhold taxes, but you can request it.

Miscellaneous Income

For the purposes of this demonstration, and because I don't have to plan on this myself, I'm skipping the Employer Pension and Other Income sections of the Retirement Calculator.

Retirement Savings

Think of your CPP and OAS as the bones of your retirement plan. For our fictional person, we now have to pack $30k worth of meat onto those bones to hit his $60k retirement goal. At least, it has to happen after age 70.

The only way this will work with our Registered Retirement Savings Plan (RRSP) is if we have investments in our Tax Free Savings Account (TFSA). So, we're going to look at the RRSP Meltdown Strategy to go from the age this guy retires to his 70th birthday.

But let's start at age 70 and go backwards from there.

How do we make up the $30,000 annual income deficit after age 70? One word: DRIP!

Dividend Reinvestment Plan (DRIP)

Okay, that's an acronym and three words. Sue me. 

Since I use Questrade (referral code: 646431618477353 for $50 deposit into your new account) for my self-directed -- I don't have anybody but myself to blame for my investments -- TFSA, they charge a small fee for every stock-related transaction. To help avoid this, enrolling in a DRIP eliminates that fee. Do you miss out on buying low and taking advantage of that purchasing power? Yes. Is it less stressful? That's the plan! I like set-it-and-forget-it, myself.

What the Retirement Calculator doesn't really do is take dividends into account as a source of income. All it does is take what you currently have, how much you plan to contribute to it, then factor in a growth percentage until you start to use it. In other words, it assumes you're going to start selling your shares once you hit 70. And that's not what we're going to do. The plan is to use those dividends as income, starting at age 70... maybe even later.

Let's pretend there's a company out there that pays a dividend of $0.10 per share each month, and the shares currently trade at $10.00CDN. If our guy purchased 5000 of those shares (for $50k), he'd have a $500 income from that after the first month. If this guy reinvested that $500 into more shares (via the DRIP), then he'd get about 50 more shares. Keep doing that, month after month, year after year, and by the time he's 70, he could have about 40,000 shares generating about $50,000 a year, tax free. 

But the market is volatile. Dividends aren't set. 

More on Shares that Pay Dividends

You can diversify your portfolio, buying shares from multiple companies, to help offset losses if one stock tanks. It's up to you what you want to do. I'm focused on an Exchange Traded Fund (ETF) which includes many different companies in a particular sector; diversification is built in and the ETF is managed by the company running it.

Another other issue with the Retirement Calculator is it takes what you've accumulated in your TFSA and divides it up for the number of years left in your life expectancy. In other words, if you plan to live to 85, but actually live to 95, then you'll only have your OAS and CPP to live on. Using the DRIP to age 70 gives you a passive income that will be around for as long as the shares are paying dividends.

Retirement Age

Remember our last chart, above? It starts at Age 70. We need to determine when our retirement age will be and how much we'll need in our RRSPs at that time.

Let's say our guy has $100k in his RRSP at 50, he contributes the maximum allowable 18% every payday, and retires at 65. Since he's using the RRSP Meltdown Strategy, he wants to burn through as much of his RRSPs before hitting age 70 as he can.

The Calculator makes that look like this:

Whoa! He's way above this income goal! Great!

Or maybe not. That's a fairly high tax bracket to be in.

What are his options? (Again, this assumes that he's covered from Age 70 onwards with his TFSA investments.)

1. Retire before age 65.
2. Draw down less of his RRSP in those first five years of retirement and draw upon it beyond his 70th birthday. As I mentioned, he's currently in a tax bracket where he's going to be losing money that he doesn't need to.
3. Take the surplus (taxes be damned!) and, if he has contribution room in his TFSA, increase his investments further in there. Doing so would have an impact on...
4. His retirement income goal might actually be too low. Maybe it could be higher?
5. When one retires, one's RRSP should be converted to a Registered Retirement Income Fund (RRIF). With a RRIF, your investments keep investing, you just can't add more funds to it. However, maybe this guy is married. A RRIF allows for income splitting. Perhaps his spouse doesn't have an income; he can split his RRIF money between them, lessening the tax burden he would otherwise face via putting himself in a much lower tax bracket.
6. Buy a boat, that Porsche he's always wanted, and a timeshare in a tropical location.

Maybe the answer is the first one. What would that look like?

Instead of retiring at 65, what if he retired at 63?

That works. 

Regarding the second point on the list above, unfortunately the Retirement Calculator doesn't allow for staggered RRSP withdrawals; it divides the estimated value from when you chose to retire and spreads it across the years you've chosen to draw from it. 

If our guy was over his goal by $45k each of those first five years of retirement, he could, for example, take that surplus and spread it over the next seven years, delaying drawing off his TSFA until he's 77. Doing so would likely result in an even better passive income from his dividends, because of the DRIP. He'd have to pay more in taxes, mind you, as RRSPs are taxable income.

Summary...

The RRSP Meltdown Strategy essentially shifts the tax burden to one's early retirement, allowing the TFSA/DRIP investments to grow.

If you're still saving for retirement, look at where your RRSP could take you, but definitely look at a TFSA and enrolling in a DRIP.

I highly recommend watching Adam Bornn's videos on YouTube. Very informative and he makes it all easy to understand.

Just about everything I mention in this post has nuance to it. Finances are complicated. I'm trying to keep it simple so the concept is clearer.