Posted by Canadian Dream on January 18, 2010
Since the beginning of the New Year I’ve been rolling around the idea of semi-retirement in my head. It’s an option that I can say that I haven’t done too much work on before and I’m starting to understand why. In normal retirement type planning you have a lot of variables to deal with like how much you spend, savings rate, inflation rate, rate of return, when you want to retire….you get the idea. All of this items require some thought and decisions about each variable. When looking at semi-retirement a lot of those values become less firm. I’m asking myself new questions like: when do I want to start semi-retirement, when would I like to switch to full retirement, how much should I assume I make during that period, does my wife want to work at all during this…the list goes on and on. The problem is semi-retirement can be just about anything or everything you want.
So trying to define a scenario has so far been a much bigger problem than I initial thought possible. Yet out of this infinite possibility matrix I’m starting to define some rough guidelines to help me hash out a scenario. So in no particular order here are some of my initial guidelines:
- I can start semi-retirement any time once the mortgage is paid off, so in three years time. Yet I would like to have a cash reserve to cover most of our basic expenses (~$18,000/year) so I will likely work for a few years beyond that. Also I’ll need to build up a bit of a cash reserve that I’ll need for regular full retirement later on. So I’m thinking about three or four years of work beyond that which would put me at about 38.
- I want to keep my ‘required’ working salary in semi-retirement to a lower level (~$10,000/year) so if one of use can’t work for some reason that we won’t end up with a major problem down the road. We just deal with having less money for those extra things in life.
- My wife wants to keep working a bit once we switch to semi-retired. She would likely just stop taking new young kids and focus only on the older ones so as they age she will slowly get out of the business as the kids get older and no longer need care. The implication of this decision is we won’t even consider a move to a smaller house until our youngest son is in high school, which is about when I turn 44.
- Our full retirement will not start until I turn 60 or if we end up with the money to do it sooner. So if we earn more than we need in the semi-retired phase it can be rolled over to accelerate the full retirement date if we want.
- My work in semi-retirement will likely be more than just a single job and will depend heavily on what interest me and what opportunities come up. I’m currently not planning on doing any additional engineering work, but I suppose I could consult a bit if I want. It would depend on the project and who I would be working with.
So perhaps a good question to ask here is why bother with looking at semi-retirement at about 38 when you can early retirement at somewhere between 43 to 45? Well the reality is I’ve always planned on working a bit post early retirement, by going semi-retired I’m just actually putting in that income into the plan for the first time. So by considering that concept I just take advantage of that income to leave my day job a bit sooner.
So have you ever considered a semi-retirement? Is so, what did you include in your scenario? Or what would you change about my guidelines above?
Posted by Canadian Dream on January 15, 2010
When you have a TFSA, an RRSP and an open investment account, which assets will ideally go in which accounts? These are general ideas to keep in mind while planning your TFSA contributions.
Once there are funds inside the TFSA, a huge benefit is that income and capital gains are not taxed. The practical application is that transactions no longer trigger tax consequences, much like inside an RRSP. A TFSA is very useful for high turnover trading. If you are investing (or speculating) using a strategy that frequently sells positions, it would result in realized gains and losses in an open investment account. Within an RRSP, the taxes are all paid at withdrawal. But in a TFSA, those gains are never taxed.
Generally, it is recommended to put fixed income (bonds and GICs) inside an RRSP and capital growth (equity) in an open investment account. There are two benefits to having the fixed income inside the RRSP: avoiding paying taxes on the income and keeping the slow growth in the RRSP. Since the RRSP withdrawals will eventually all be taxed, it makes sense to keep the total as low as possible. High-yielding securities could then pose a difficulty. Take, as an example, 5% preferred shares at $20. They will grow from $20 to $25 at maturity (often years in the future) and pay $1.25 per year taxable income each year. The RRSP will shelter the income, but it will also increase the value. A TFSA is the perfect account for an investment like this.
The general strategy in regards to types of income is: interest or business income, dividends, capital gains, return of capital. This assumes that you believe you will earn the same return in each case. Some examples of each type of income follow. Interest income is usually paid by bonds and GICs. Business income is earned from income trusts, although this will be taxed in 2011 and become like dividends. Dividends are usually paid on preferred shares and common shares. Capital gains come from growth in market value, usually from common shares or junk bonds. Finally, return of capital is often paid by REITs (real estate investment trusts). Because they have depreciation, the income they pay may not be taxable. It may eventually be classified as capital gains. The choice isn’t so simple, because you may expect greater growth from capital gains (buying growth stocks cheap), it may be best to hold that investment in a TFSA, instead of a GIC at 3%.
One strategy using TFSAs is available to all adult couples: income splitting. The government doesn’t really care who makes the TFSA contributions. If a couple has only one income, or two incomes in different tax brackets, it will probably make sense to have one spouse contribute to both TFSAs. That way, it is possible to use more TFSA room. If one spouse makes $20,000 per year and the other makes $80,000 per year, it doesn’t really matter who pays which bills. $10,000 can be used (in 2010) to contribute $5,000 to each TFSA, regardless of who earned the money. It is possible that, in retirement, there will be enough money in each TFSA that the couple can choose who will make their other withdrawals in order to minimize the total tax bill.
Canadians now have more ways to save tax while saving and investing for their future. Each has distinct benefits and uses. The RRSP offers deductions, and I recommend making an RRSP contribution first if your income is over about $40,000. Many Canadians have debt, and I recommend paying down debt before making a TFSA contribution. This is especially true if the TFSA would hold fixed income and the debt has a higher interest rate. A TFSA is usually the lowest priority, unless it is for short term savings or for a high-yielding investment. In the comments, please share how you use your TFSA differently than your RRSP and debt repayment.
Robert is a Certified Financial Planner (CFP®) in Calgary who develops financial plans and also gives objective advice regarding all types of savings and investment products. He believes that not having money worries can allow people to spend their time in other meaningful areas of their life. Robert is married, has three children and is involved in his church, in his community association and in the school. Robert is on track to retire at age 42, although he and his wife plan to change careers and work for the benefit of children.
Posted by Canadian Dream on January 14, 2010
Because of the way Tax-Free Savings Accounts work, they don’t make sense for everyone. Just because you will have more TFSA contribution room this year, doesn’t mean you need to make a deposit. I will lay out some situations where making a TFSA deposit will generally result in financial benefit.
The first group who is likely to benefit from TFSA contributions is people with under about $40,000 of annual income. The first tax bracket ends around this level. You can find the exact amounts at: http://www.cra-arc.gc.ca/tx/ndvdls/fq/txrts-eng.html. Young people with income below this amount may expect to have greater earnings in future. If that’s the case, they could make a TFSA contribution now, and save their RRSP contribution room until they are in a higher tax bracket and it will result in a larger refund. In fact, they could even use TFSA money to make RRSP contributions later. Here’s an example: Jerry is a student, working a co-op semester. His income for the year is $25,000. If he made an RRSP contribution of $5,000, he could expect a tax refund of about $1,250. if he put the money instead into a TFSA, then waited until his first year of full-time work, he might be earning $50,000 per year. He could then withdraw the money from the TFSA (let’s assume it’s still $5000) and contribute it to the RRSP, earning a refund of $1,670.
The next group that will benefit from TFSAs is those who have a very high income and can complement full RRSP contributions. RRSP room equals 18% of the previous year’s earned income, with a maximum of $22,000 for 2010 (see: http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/rrsp-reer/cntrbtng/lmts-eng.html). If a person earns over $220,000 in a year, they will only be able to contribute 10% of thier income to their RRSP. A TFSA will afford them some limited additional room for tax-free savings. Other tax shelters for the wealthy include leverage, life insurance and income splitting, often with a corporation.
People over the age of 71 can find themselves in a similar position. At age 71, all RRSPs (and LIRAs) must be converted to RRIFs (and LIFs) and income withdrawn. The purpose is for the government to begin to collect the taxes that have been deferred. If the minimum withdrawal is greater than the retiree wants to spend, they can put the money back in a TFSA. Taxes must still be paid, but future growth or income is now tax-free.
A TFSA is also ideal for short-term or medium-term savings. Some examples might be an emergency (or rainy-day) fund, funds for a vacation, funds for a car or a downpayment for a house. If one were to save for a vacation, by making RRSP contributions, they would pay taxes on the full amount withdrawn and also not regain the RRSP room that was used. If they saved for a vacation outside of an RRSP, they would need to declare any income earned on their taxes each year. A TFSA is both more efficient and simpler. There is a program under the RRSP called Home Buyers Plan, that makes allowance to withdraw funds for a downpayment for a home. However, there are many rules that must be respected. Some examples include: neither spouse has owned a house in the five previous years, and withdraws must be paid back 1/15th each year over the next 15 years, or taxes paid. TFSAs have none of these restrictions and funds can be saved for any purpose.
If you have debt, you can have some of the benefits of a TFSA, without the restrictions. As an example, Angela has $10,000 of personal debt at 7% interest. If she has $8,000, she could put it in a savings account at 5% in a TFSA and pay no taxes on the interest income, but only if she has available contribution room. If she pays $8,000 toward her debt, she will avoid paying 7% interest. That savings is, of course, not taxable and puts her ahead financially. If the loan is revolving, such as a line of credit, she can borrow the money back if she needs it again. Assuming the TFSA would have held a savings account and the credit remains available, repaying debt is financially preferable to making a TFSA contribution.
TFSAs are most useful for people who have no debt and either have low income or high income and no RRSP room. If, like the majority of people, you have debt or pay taxes in the middle tax brackets, you may still find a TFSA useful for short or medium-term savings. Next time, we’ll look at strategies when deciding which assets to put in the TFSA instead of an RRSP or open investment account. In the comments, please share whether or not a TFSA makes sense in your situation.
Robert is a Certified Financial Planner (CFP®) in Calgary who develops financial plans and also gives objective advice regarding all types of savings and investment products. He believes that not having money worries can allow people to spend their time in other meaningful areas of their life. Robert is married, has three children and is involved in his church, in his community association and in the school. Robert is on track to retire at age 42, although he and his wife plan to change careers and work for the benefit of children.
