Finance

Smart planning, investments put this indigenous couple’s retirement on solid ground

‘Tax law, ambition and frugality will give this couple a very comfortable retirement’

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An indigenous couple we’ll call Henry, age 45, and Marissa, 34, live with their two-year-old son, Evan, on tribal land in Quebec. Henry and Marissa run several businesses and own rental properties in Canada and abroad. Henry is both a businessman and an instructor at a nearby university. Together, they have $2.246 million in assets and $704,308 in mortgages for their residence and a small office property. Their net worth is $1,541,953.

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Their cash flow covers allocations of almost $17,000 per month. Though much of that is loan repayment, the balance includes significant monthly savings.

Henry and Marissa are in a special situation, for they have the tax benefits of their indigenous status and a blend of incomes, some exempt, others not. Their financial situation is strong but complex. We’ll unravel it and calculate their retirement income.

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There are several key questions in this case. “How can we manage our investments to achieve long-term goals and figure out the best tax strategy for investments that are both on reserve and off?” Henry asks.

Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Henry and Marissa.

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Indigenous status and taxes

The planning of Henry and Marissa’s future and retirement must take into account their tax status, for some income generated on reserve is not taxed while other income flowing from entities off reserve, such as a rental property in the tropics, are subject to foreign taxes and Canadian tax treaties.

Debt management is the first issue they must address. They have two mortgages with interest rates of 2.97 per cent — that’s for Henry and Marissa’s house — and 3.09 per cent for the office building. The commercial property generates $7,100 per month or $85,200 annual rent. The sum value of the rental, the office building and a foreign property is $1.33 million. That’s a gross return of 6.4 per cent. However, when we take into account the mortgages, the rent, after costs, represents an after-tax return on equity of 10 per cent. The commercial property should be kept. It’s lucrative and a good return on capital, Moran says.

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The $7,100 in monthly rental income is tax-free. Henry also draws $7,200 per month from his business, largely tax free, and $833 per month from his teaching job — which is taxable but offset by tax credits. Marissa generates $4,800 per month in salary. All that adds up to $19,933 of  monthly income on which they pay no income taxes because the basic exemption exceeds Henry’s taxable teaching income.

The couple’s expenses are $16,796 per month, largely free of sales taxes. They are spending a modest $4,417 per month on living expenses with debt service and savings excluded. They make accelerated mortgage payments on their house.

Future income

Henry wants to work to age 65. He will be entitled to Old Age Security, currently $625 per month. So will Marissa at 65. That’s $7,500 per year for each.

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Evan, age 2, has $4,000 in his RESP. The parents add $2,080 per year and receive grants of 20 per cent of contributions, pushing total contributions to $2,496 per year. Quebec adds a further 10 per cent for total annual contributions of $2,704 per year. If they maintain contributions and grants, the RESP will have a value of $58,000 when Evan is ready for post-secondary education. That will cover four years of tuition and books at any Quebec university. If Evan lives at home, he may even emerge from his baccalaureate studies with sufficient funds for another degree.

Henry has $110,261 in his TFSA, the result of contributions and investment appreciation. If that sum grows at three per cent per year for 20 years to Henry’s age 65, it will have a value of $199,171. That sum, annuitized to be spent over the following 36 years to Marissa’s age 90 would be $8,857.

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They have no RRSPs because they pay very little income tax, and RRSPs make little sense in this context, Moran explains. Some investments are taxable. Debt costs them about three per cent of taxable assets, mainly property. With $704,308 of mortgages at about three per cent, they pay $11,306 per month. Take off actual interest, $1,760 per year, and $9,546 per month is going back into their pockets.

If they are debt-free in six years with accelerated mortgage payments, they can continue to save what they now pay on mortgages. That’s $11,306 per month or $135,672 for 14 years. With the assumption of growth at three per cent after inflation, it will become $2,387,680 in 2021 dollars at Henry’s retirement date. If reinvested at three per cent after inflation, this sum can generate $106,180 per year to Marissa’s age 90.

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Retirement income

When Henry is 65 in 20 years, he will have $7,500 from OAS, $8,857 from his and Marissa’s TFSAs, an estimated $106,180 from normally taxable savings, and $85,200 from rent for total annual income of $207,687. That’s $17,300 per month.

When Marissa is 65, she can add $7,500 per year from OAS for total family income of $215,187 mostly not taxed. That’s $17,932 per month.

Blending tribal business that is not taxable and thus justifies no RRSP savings with taxable income from teaching off-reserve allows very rapid accumulation of capital based on low tax rates.

“Tax law, ambition and frugality will give this couple a very comfortable retirement,” Moran explains. They are complying with relevant rules and making good use of their tax status. They already have a vacation property in the tropics they might use in retirement. They have earned their prosperity.”

email [email protected] for a free Family Finance analysis                        

Retirement stars: Five retirement stars ***** out of five

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