With this couple’s financial assets earning less than the rate of inflation, they ‘d do better if they were to own dividend paying stocks
Situation: Couple near retirement has all financial assets in GICs and cash earning less than inflation
Solution: Raise returns with guaranteed annuity income or dividends that enable tax savings
Elise still works on a production line, earning $55,000 a year before tax. They also have net rental income of $5,400 a year. Together, they bring home $11,465 per month after tax.
Ernst has retired and has received long-term disability for many years. Elise hopes to stop work in April. They want a pre-tax retirement income of $50,000 a year.
When Elise can quit work, what is not certain is. She can do it in a few months or in a few years. The timing depends on how well they can finance their years of leisure.
All in cash and GICs
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C. to work with Ernst and Elise. What is not so good is that their approximately $1.94 million of financial assets are comprised of GICs and $80,000 is in low interest savings accounts. A $200,000 rental property generates $5,400 annual net rental income, which is 2.7 per cent of current estimated value, or a 6.75 per cent return on the original cost of $80,000.
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At present, the return for the $1,938,200 of investments other than their rental property at an assumed rate of 2 per cent per year is just $38,764 before tax. Add in continuing net rent of $5,400, estimated Canada Pension Plan benefits of $7,000 when each is 65 and Old Age Security at $7,004 per year each and their total pre-tax income will be $72,172. If they apply age and pension income benefits– RRIF income qualifies as pension income– they would pay tax at a rate of about 10 per cent to allow for zero tax on TFSA cash flow and have $5,400 per month to spend.
On the one hand, they have reached their retirement goal, but their investment returns are below the rate of inflation and are, in fact, negative after inflation and tax. They would do better if they were to own dividend paying stocks whose prices tend to appreciate with rising corporate earnings and dividend payouts.
Tax gains from stocks
Assuming each partner has $7,000 CPP benefits, $7,004 OAS benefits and $8,000 of RRIF payments, for a total of $22,004, each could have $15,000 of dividend income which, given the dividend gross up and dividend tax credit, would work to eliminate federal tax. Because provincial tax is based on federal tax, they would pay no tax.
The difference between cash held in Savings and gics accounts with government insurance and no possible loss but guaranteed loss to inflation and investment with market risk and probable compensation for inflation and some growth as well is stark.
” I prefer to have inflation rather than risk losing money in the market,” Ernst says. “Our expenses are much less than our income now and much less than they will be even if our purchasing power goes down because of inflation. I could not sleep with the risk of losing money in bonds or stocks.”
There is another way for the couple to take on market risk. Index-linked GICs, sold by chartered banks, guarantee return of all money invested with zero return if their underlying investment indexes lose value and some return, usually about 60 per cent of index performance, if the defined market rises.
Assuming a 3 per cent return after inflation, an annuity purchased for $929,000 and running for 33 years to exhaust all capital and income would pay $44,700 per year. On top of rental income, CPP and OAS, it would create a risk-free base income of $77,712 before 10 per cent assumed tax or $5,828 per month after tax.
The balance of the retirement portfolio could be in dividend growth stocks. The combination would offer guaranteed income from half the couple’s capital and at-risk income from dividends and asset price growth to add to income and spending choices, Moran explains.