Jim and Catherine are just retired at age 65. They have both had good jobs with pension plans. The have each received a meaningful inheritance. They own their home and a cottage, both bought decades ago. The net worth is around $2.6 million dollars and their pretax income combined from pensions, Canada pension, Old Age Security and investments is nearly $135,000. Their cost of living including significant charitable donations is $88,000.
They have more than $25,000 per year they can invest.
The projection of their future is quite attractive. Life is good.
Suppose Jim dies at age 82. How big a deal would that be? Many people it would matter but maybe not so much. After the cost of living would go down some.
In their case, one of life’s little tricks appears. Catherine’s income before taxes would fall 20% from the combined total they had the previous year. Down $40,000. Pensions with 60% survivor options and loss of Old Age security and Canada Pension benefits because of the overall maximum payout allowed.
The oddity. Taxes would go up. Roughly $12,000 up. All in, disposable income shrinks more than $50,000. That has an adverse effect on cash flow and ultimately on the estate.
Where there was once a surplus each year their is now a shortfall.
Given the investments they owned, this is not a crisis by any means. It is however an unpleasant surprise. And we all know how much we love financial surprises. No one likes to liquidate their savings to meet ongoing living costs. This is where hasty decisions can happen. Sell the cottage, downsize home, are not so rare.
Hasty decisions because of a surprise are seldom good ones. The fundamental problem is selling the family home is hugely risky. Buying something is less risky. Why? Because if you don’t like it you can sell and move on. What if you sell the home and regret that choice. Could you get it back? There should be a time to think and surprises often remove that option.
I think most people who have reached retirement have also come to grips with the idea that one or the other will die first. What they have not noticed is how much of their income depends on continued life.
It is often not an insurmountable problem, like in this case, But your plan should accommodate that it will happen. Be aware.
Some things don’t make much sense. Like income goes down and taxes go up. This is a family situation with a near perfect income split because of the agility to move pension income around. When all the income lands on one tax return evil things happen. All of one person personal exemptions are lost and what was their income appears on top of what the other person already has.
The message – Income splitting is a powerful tool. Take advantage of it. But be aware of what happens when it stops.
Surprises lead to weak decisions. You can influence what you can anticipate. Have a Plan B.
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I build strategy and fact-based estate and income plans. The plans identify alternate ways and alternate timing to achieve both spending and estate distribution goals. In the past I have been a planner with a large insurance, employee benefits, and investment agency, a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business. I have appeared on more than 100 television shows on financial planning, have presented to organizations as varied as the Canadian Bar Association, The Ontario Institute of Chartered Accountants, The Ontario Ministry of Agriculture and Food, Banks – from CIBC to the Business Development Bank.
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