Want to learn how to manage your finances in retirement? Make a financial planning appointment with your parents.
I’ve had several potential clients reach out recently, not about their own situation, but because they are concerned about their parents’ finances. Sometimes it is a son or daughter who has read about high investment costs and wants to help mom and dad save money. They discover that their parents are still paying 2% or more for a large portfolio, and they are shocked.
The solution seems obvious: put everything in a few cheap ETFs and call it a day. That’s when I stop them.
Managing your own investments at 30, 40 or even 50 years can be easy. You choose a globally diversified ETF like VGRO or XGRO, set up automatic contributions and forget it. The goal is accumulation, not withdrawals, and taxes aren’t really an issue.
But a retiree over 65 with a RRIF, a LIF, a TFSA and a non-registered account full of GICs and dividend paying stocks? That’s a whole different puzzle. Managing money in the withdrawal phase is not easy. In fact, it’s one of the most complex parts of personal finance.
Related: Putting together the puzzle pieces for your retirement income
There is of course the investment side, but tax planning quickly comes to the fore. You need to know how much room there is within your parents’ top marginal tax bracket to withdraw from their RRIF without pushing them into the next one. Perhaps they can take a little more now to avoid higher taxes later, or even to replenish the TFSA each January.
There may even be room to trigger a small capital gain in the non-registered account while they are in a lower bracket.
At the same time, too much interest income from stacked GICs and high interest savings can push their taxable income higher than necessary. And that apparently clever ‘dividend-oriented’ strategy? It could even ensure that their old age security is recovered.
This is what I mean. I once saw a retiree with $500,000 in a non-registered account, fully invested in Canadian dividend stocks. On paper the portfolio looked fantastic: strong blue chip companies and a healthy income stream. But those dividends are brought up for tax purposes, meaning the income reported on their tax return is higher than the money they actually received.
When you combine that high income with RRIF withdrawals, pensions and government benefits, it can push you over the OAS clawback threshold. In her case, she actually paid a marginal tax rate of more than 40%, even though her “taxable income” didn’t seem that high. We restructured the portfolio to take a total return approach (more capital growth and less dependence on dividends) and the clawback disappeared.
Another example: a couple who took the opposite approach. Terrified that they would run out of money, they extracted as little as possible from their RRIFs. The accounts continued to grow, and by the late 1970s they were forced to make large minimum withdrawals, pushing them into higher tax brackets. They would have been better off in their 60s, perhaps to finance some travel or early gifts to their children and grandchildren, while keeping their tax rate lower and more flexible over time.
Related: Don’t Wait Until 70 – The Costly Retirement Planning Pitfall
I’ve also seen clients having to forgo cash or GICs for years because “the market looks risky.” The problem is that all that interest income is fully taxable at their marginal rate, which can unnecessarily push them into a higher bracket.
A better approach is to maintain a modest cash wedge within the RRIF – enough to cover a year or two of withdrawals – so they can weather short-term market turbulence without selling investments at a loss. In addition, capital gains can often be deferred for years and when realized, only 50% of the gain is taxable. Keeping excess cash within a TFSA, or using a mix of investment income sources, can make the entire plan more tax efficient.
Going through a planning exercise with your parents will also help you become familiar with the different types of tax slips that come with retirement.
Instead of a single T4, they can receive T4A slips for pensions and annuities, T5s for interest and dividends, T3s for income from mutual funds or ETFs, and T5008s for realized capital gains. You’ll learn how dividends, interest, and capital gains are taxed differently, and what types of income can be split between spouses to reduce household taxes.
It’s a real tax education that most people only get once they’ve already retired.
Related: So You’re About to Retire – The Financial Timeline for the First Year
And then there’s the big stuff: Do your parents know how much they can safely spend each year without jeopardizing their long-term plan? Do they want to leave a legacy, or would they rather give while they are still alive?
Many retirees spend too little money because they don’t know what they can afford. They could be living a richer life, taking that bucket list trip or helping their kids with a down payment, but they’re hesitant because no one has shown them the numbers.
When I meet families in this situation, I often ask about the parents’ relationship with their advisor. Do they receive tax-efficient withdrawal advice, or does it feel like they are asking for permission every time they want to withdraw money? Are their wills and beneficiaries up to date? Is there a clear estate plan, or do the children have to figure it out themselves later? These questions are often met with silence, followed by, “We’re not really sure.”
In many cases, I even recommend that parents stick with their existing full-service advisor. That surprises the adult children who contacted me in the first place. But if the advisor does real planning (coordinating taxes, withdrawals, and estate issues), then the value is there even if the costs are higher than what a do-it-yourself investor would pay. The parents are in good hands and their plan is not dependent on a saving of one or even two percent on costs.
Of course, there are times when change makes sense. Some advisors still operate under an outdated “set it and forget it” model, where they manage the portfolio but don’t offer much in the way of planning. In those cases, a hybrid option such as a robo-advisor can work well. Costs drop dramatically, the retiree still has access to human advice, and most transactions – RRIF withdrawals, TFSA contributions, rebalancing – can be automated and linked to their external bank accounts.
It can be a nice middle ground for both generations.
So here’s a challenge for my younger and middle-aged readers: Do you think you have this investing and retirement planning thing figured out? Go through a financial planning exercise with your parents. Look at all the moving parts – government benefits, pensions, RRIFs, TFSAs, non-registered accounts, annual spending needs, one-time goals and wealth wishes. You’ll soon realize that this isn’t just a matter of switching to VBAL and calling it a day. It’s about creating a flexible, tax-efficient plan that supports the life your parents want to live.
And if you do it right, you’ll not only help your parents make better financial decisions, but you’ll also get a head start on understanding what your own retirement will one day look like. After all, the best way to prepare for your future is to learn from theirs.
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