Assuming Matilda fully retires at 60, does not sell the house and remains in good health, she should convert her professional corporation to a holding company with minimal business overhead.Christinne Muschi/The Globe and Mail
Matilda, a self-employed physician, is 50 years old and on her own again with three children. The youngest is still at school and living at home. The older two attend university, where they live in residence.
Through her professional corporation, Matilda gets income from clinical work, emergency-room shifts and research. She is not a member of an employer-sponsored pension plan and needs to take care of her own retirement planning.
Matilda owns a detached home in a good Toronto neighbourhood on which only a small mortgage remains outstanding.
Matilda’s questions: When can she exit the work force while maintaining an after-tax spending power of $140,000 a year? Is downsizing advisable? How should she draw down her savings?
We asked Barbara Knoblach, certified financial planner at Money Coaches Canada, to look at Matilda’s situation.
What the expert says
Matilda’s corporation bills about $325,000 a year before-tax from which she pays herself a salary of $171,000 a year plus the occasional dividend, Ms. Knoblach says. After deducting personal income taxes and CPP contributions, this generates an average after-tax income of about $9,380 a month. She also gets child support.
After paying business expenses and corporate income taxes, Matilda should be able to set aside around $115,000 a year in corporate savings and investments, the planner says. She incorporated in 2020 and has current corporate assets of $536,000. “This underpins my expectation that the corporation will play a major role in wealth creation for Matilda,” Ms. Knoblach says.
Matilda’s only debt is the mortgage on her home with a balance of $215,000. Assuming she renews the mortgage soon and pays an interest rate of 5 per cent for the remainder of the term, the mortgage is projected to be paid out in full by 2030, when Matilda is 57.
The forecast assumes an inflation rate of 2.1 per cent, a rate of return on investments of 5.6 per cent and that the funds last to when Matilda is 95 years old.
When can Matilda exit the work force?
First, the planner explores how things look if Matilda retires in January, 2038, at the age of 65. She would be debt-free by then. Matilda would have after-tax spending power of about $164,000 a year, higher than her target amount. She would run out of money by the age of 95 but she would still own her house.
Next, the planner projects what might happen if Matilda steps away from work at the age of 60 and at the age of 55. If Matilda retires at 60, she’d have spending power of $122,000 a year, short of her target. Her mortgage would be paid off.
The scenario in which Matilda leaves the work force at the age of 55 “does not provide such a rosy picture,” Ms. Knoblach says. “She would have fewer years of earnings and more years in retirement to support herself.” She would have after-tax spending power of $82,000 a year and she’d still have a mortgage to pay.
The above scenarios assume that Matilda owns her house throughout her retirement years.
“Matilda confirms that she could extract $1-million in equity from the house and still buy an adequate property in the same neighbourhood,” Ms. Knoblach says. Suppose she downsizes in 2028, pays out the mortgage and buys a smaller place for cash. She could add the rest of the proceeds to her investments.
In this case, her spending power would be $219,000 a year if she retires at the age of 65, $165,000 a year if she retires at the age of 60 and $121,000 a year if she retires at the age of 55 – short of her spending goal even with the downsizing.
Assuming Matilda fully retires at 60, does not sell the house and remains in good health, she should convert her professional corporation to a holding company with minimal business overhead. A holding company does not receive income from active work, but the investment in the corporation can be drawn down slowly to supplement the owner’s other income sources.
Matilda may find it advantageous to switch to dividend compensation and lower the overall draw once her mortgage has been paid out.
While taking dividends from the business, Matilda could also implement strategies to draw down her RRSP and to convert the funds held in this account into after-tax dollars. To the extent that RRSP monies are not required for Matilda’s living expenses, she should invest the after-tax proceeds in her TFSA (keeping to her contribution room) and thereafter in her non-registered account. Provided she is still healthy, Matilda should delay collecting government benefits until she is 70.
If she manages to implement a significant drawdown of her RRSP before 70, she may be able to collect at least some Old Age Security benefits, which are income-tested.
Funds held in Matilda’s non-registered investment account and in her TFSA should only be accessed late in life: “I recommend that Matilda fill up her TFSA contribution room each year either with funds drawn from her RRSP or with funds from her non-registered account,” Ms. Knoblach says. The TFSA should be invested aggressively for the long term and eventually passed down tax-free to her children.
For now, being in a high tax bracket, Matilda should continue making annual RRSP contributions, the planner says. Her marginal tax rate (the percentage of taxes paid on the last dollar earned) is 48 per cent, and her average tax rate is 34 per cent. A $20,000 annual RRSP contribution could lower her marginal tax rate to 43 per cent and her average tax rate to 29 per cent, the planner says.
Matilda has investments in a non-registered account while also having TFSA contribution room. Matilda should prioritize the TFSA over any non-registered investments, the planner says. If she doesn’t have sufficient income from active work to make both an RRSP and a TFSA contribution, she should consider transferring some of the funds held in her non-registered account to the TFSA to benefit from tax shelter.
Client situation
The people: Matilda, 50, and her three children.
The problem: When can she afford to retire? Should she downsize her house? How should she draw down her savings and investments?
The plan: Work to at least the age of 60, continuing her current savings rate. Consider downsizing at some point. When she retires, explore switching from salary to dividend income from her corporation.
The payoff: A better understanding of what is possible financially.
Monthly net income: $12,630 variable.
Assets: Corporate cash account $158,420; cash in bank $27,635; savings account $43,900; GIC $20,270; non-registered stocks $107,795; corporate investment account $378,060; TFSA $98,765; RRSP $693,370; registered education savings plan $105,755; residence $2,400,000. Total: $4-million.
Monthly outlays: Mortgage $3,445; property tax $1,115; water, sewer, garbage $115; home insurance $105; electricity $210; heating $250; house cleaning $500; maintenance $650; garden $60; transportation $565; groceries $1,070; clothing $515; gifts, charity $285; vacation, travel $2,185; dining, drinks, entertainment $500; personal care $400; club memberships $220; pets $50; sports, hobbies $160; subscriptions $40; miscellaneous $80; doctors, dentists $300; drugstore $110; health, dental $40; phones, TV, internet $465. Total: $13,435. Some expenses may be covered by corporation.
Liabilities: $215,625 ($168,480 at 1.59 per cent and $47,145 at 1.89 per cent).
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