Pricey paradise

By Evelyn Jacks & Doug Nelson | December 12, 2008 | Last updated on September 15, 2023
6 min read

Canada’s retirees often seek the Epicurean delights of the West Coast—a rather pricey paradise. But are the expectations of pleasure- seeking boomers and their savings really in sync?

Pension and retirement portfolios need to deliver the goods for clients seeking the ultimate retirement lifestyle, and ultimately careful planning and tax efficiency are the deciding factors.

Why is tax efficiency so important? First, it’s a component of real wealth—what’s left after tax, after the cost of investing and after in- flation. Tax efficiency can:

• Significantly increase investment returns; • Decrease the need to encroach upon accumulated capital; • Increase the growth of wealth in the retirement period; • Increase the amount of wealth transitioned to the next generation; and • Reduce the risk profile of the investment portfolio and the overall retirement plan.

When you manage real wealth, you should focus on pre- and posttax investments and resulting cash flow. Consider a client with a $100,000 investment portfolio, for whom you found $3,000 in tax savings through strategic income planning: pension income splitting, tax bracket and marginal tax rate management or RRSP planning. This additional $3,000 would increase the portfolio’s rate of return by 3%. When tax savings are added back into the client’s accumulated wealth, the difference in compounding earnings, and reduced capital encroachment can be significant.

Conversely, if investment income earned in the non-registered portfolio, when combined with other sources of income, violates one or more of the tax system’s various clawback zones, or transitions into higher marginal tax-rate territory, valuable after-tax income can be compromised, resulting in double-digit marginal tax rates. By keeping an eye on all aspects of tax effi- ciency, you can increase ROI. Ignoring tax consequences can thwart the portfolio’s output and future accumulation.

Tax-efficient retirement income planning adds real value to traditional tax and investment services. It allows advisors, who work together on both sides of the planning fence, to structure portfolios and increase after-tax investment returns. It also allows advisors to shore up inadequacies of typical asset allocation questionnaires and KYC forms. More importantly, it lets advisors avoid pitfalls encountered by retirees who can realize significant losses based solely on the month and year of retirement.

In planning for retirement, especially in cases where there’ll be a new province of residence, tax efficiency can significantly enhance both cash flow and capital appreciation, and offset in- flation. To be effective, though, you’ll need to sharpen the traditional tools.

Consider John, a 60-year-old single electrical engineer, who currently lives in Ottawa. He earns $100,000 a year at his government job. His pension will be $2,500 a month at age 60, when he also hopes to take a retirement package of $75,000 and semi-retire to Vancouver with his fiancé, Mary, who is drawing no taxable income from her family trust account. John is considering a hiatus long enough to tap into his Canada Pension Plan, then start a part-time business. He has a clear title home valued at $300,000, which he will sell in favour of condo life at the ocean; $30,000 in unused RRSP contribution room and the proceeds of a significant inheritance in his non-registered account.

John wants to know: When is the best time to move to BC and how will his investment strategy change? To answer that question properly, test these three strategies:

Strategy 1: Understand Cash Flow A large part of this strategy has to do with the size of personal tax pre-payments. John will have to anticipate making quarterly tax instalment payments now that he’ll earn most of his income from investments, pensions and self-employment. It will be important not to overpay, because the performance of the best allocated, most balanced and highest returning portfolio can be thwarted when clients needlessly withdraw capital.

Budgeting and forecasting, on an after-tax basis, is the answer. For this you need the assistance of software that can anticipate the after-tax dollars left once all expenses are allocated. Only then can you avoid encroaching unnecessarily on capital, and consider a plan for reinvestment of any and all tax savings available annually throughout the retirement period.

Strategy 2: Compare Inter-Provincial Tax Rates Residents of Canada are taxed on their worldwide income in Canadian funds, in the province where they live as at December 31 of the tax year. Understanding the differences between provincial tax regimes can provide you and your client with important planning opportunities. Since marginal tax rates are lower in BC (see charts), several immediate planning opportunities arise for those retiring to BC:

• Severance and RRSP room If John received all his proceeds in one year, he may find himself in a higher tax bracket than usual. John should be thinking about offsetting the tax on his severance package with any tax-free RRSP rollovers he may be entitled to and his unused RRSP contribution room, then calculate after-tax results in each province.

• Superannuation Under 2007 federal tax changes, John and his fiancé may have a significant windfall if they consider splitting the monthly pension income from John’s registered plan. He may also consider splitting his Canada Pension Plan premiums with his younger spouse. These changes to tax reporting will bring gains in both provinces, depending on the size of the pension.

• Non-registered accounts In optimizing John’s portfolio for a new provincial outcome, consider that BC has the lowest marginal provincial taxation on publicly traded shares in Canada. Canadians (with no other income sources) can earn more than twice the amount of dividends in BC before paying any tax, compared to Ontario. This can significantly affect fiancé Mary’s investment strategy. She’d like some income, as well as capital withdrawals from the trust.

• Budgeting for carbon taxes Any plans to move to BC must take into account the new Carbon Tax, which added 2.34 cents to a litre of gas in the province starting July 1. That will gradually rise to 3.51 cents on July 1, 2009, 4.68 cents on July 1, 2010, and 7.02 cents by July 1, 2012. The new Low Income Climate Action Tax Credit will offset this tax, and be paid together with the federal GST Credit quarterly. However, it will be phased out for families with net incomes over $35,000.

• Health-care premiums Both provinces require residents to pay a health premium to the public system; it’s $54 a month per person in BC, capping at $108 per month for a family of three or more. That’s often a surprise to new residents. Ontario taxpayers pay their Ontario Health Premiums based on income levels via their personal tax return.

• Coping with PST Provincial sales tax is 8% in Ontario and 7% in BC. Noteworthy in BC, however, is a 10% sales tax on liquor (compared to 12% in Ontario).

• Moving expenses are deductible This includes real estate commissions, travelling costs, and up to 15 days of temporary living costs in a hotel while the new home is being readied. Many of the additional costs of living within BC will be immediately offset by what can often be a five-figure deduction from income. However, there must be actively earned income at the new location, from employment or self-employment.

Strategy 3: Know and Explain Cost of Living Indexes, Gasoline Taxes The cost of living is higher in Vancouver than Ottawa; 10% higher, according to Statistics Canada. And Vancouver has the distinction of being the most expensive city in Canada to run a business. Also note the average price of a home in Ottawa is $295,000; in Vancouver it’s $575,000, and an affordable house may be situated far from the actual workplace. This means additional costs for gas, including the carbon tax. And don’t forget to factor in Vancouver’s additional 6 cents per litre transit tax on gasoline.

It’s important that BC pleasure seekers be sure about their decision: they’ll likely have a higher mortgage; in John’s case he would have to take on nondeductible debt of close to $300,000 more to live in a comparable home. It might be a good idea to rent first.

And never underestimate life planning. Many love the beauty of the new location—be it Vancouver or Miami— but find they miss friends and families and business networks once they’ve moved. It would be a shame to take a non-deductible personal loss on the new home in BC, to come back home and start again, much poorer.

With a sharper focus on after-tax ROI, a more dependable lifestyle can be anticipated, even in Lotusland. Coupled with realistic expectations and some solid life planning, retirement and pleasure seeking can indeed go hand in hand.

Evelyn Jacks & Doug Nelson