Posted by Optimize on January 1, 2021

Financial Facelift

Building a stable foundation for philanthropy

Author: Warren MacKenzie, Head of Financial Planning at Optimize Wealth

DIANNE MALEY

Special to The Globe and Mail January 1, 2021

Lucy and Lance have substantial savings, a mortgage-free house in the Toronto area and no children. With most of their net worth tied up in their $2-million house, and no defined-benefit pensions, they wonder how much of their savings they’ll need to live comfortably and perhaps pay for nursing home care when they are old. The rest they want to give to charity now while they are living rather than later in their wills.

Lance is 60 and working part time. His income dropped substantially last spring because of COVID-19. Lucy is 64 and no longer working.

Lance is thinking of setting up a foundation to give away much of their wealth to charity even if it means downsizing their house and moving to a less expensive place in the future. Lucy is not so sure. Their retirement spending goal is $100,000 a year after tax.

“Does setting up a foundation to manage charitable donations make any sense?” Lance asks in an e-mail. How much can they afford to give away?

We asked Warren MacKenzie, head of financial planning at Optimize Wealth Management in Toronto, to look at Lance and Lucy’s situation.

WHAT THE EXPERT SAYS

Lance and Lucy have managed their money wisely and are now financially independent, Mr. MacKenzie says. They have numerous philanthropic causes that they want to support throughout their retirement. First they need a financial plan to assure them that their standard of living – and their charitable giving – are sustainable, the planner says.

Their $100,000 retirement spending target comprises $55,000 a year for basic lifestyle spending, $20,000 a year in travel and discretionary spending and $25,000 in charitable donations. The planner has factored in

nursing home costs of $100,000 a year in today’s dollars for each of them when they turn 85. His forecast assumes a 4-per-cent average rate of return on their investments, a 2-per-cent inflation rate and that they downsize to a condo in 2034. “Based on these assumptions, they can spend and donate as planned and still leave an estate of more than $1-million if they each live until 95,” the planner says. Much of that would be the value of their condo.

Lance is planning to delay Canada Pension Plan benefits until he turns 70. “This makes perfect sense because he has other sources of income, and by delaying the start of CPP, his annual benefits will be higher by 42 per cent.”

At 70, Lance and Lucy will have converted their personal RRSPs and their locked-in group RRSPs from work to RRIFs and life-income funds. At that time, their cash flow will consist of $101,000 in withdrawals from their registered accounts plus their combined CPP and Old Age Security benefits, which are estimated to be $59,000 a year in future dollars. Their cash outflow will have risen to $83,000 for basic spending, $12,000 for travel, $31,000 for charity and $34,000 for income tax.

There are some things Lance and Lucy can do now to minimize the income tax they’ll pay over their lifetime, Mr. MacKenzie says. Lance’s employment income is just $12,000 a year, so he does not have enough taxable income against which to deduct his charitable donations of $25,000 a year. The planner suggests Lance withdraw at least $30,000 from his RRSP to add to his income. By doing so, he will get a tax break for his charitable donations and take full advantage of the low rates of tax on the first $44,740 of taxable income.

When Lance is 65, he should convert both his personal RRSP and his locked-in RRSP to an RRIF and life-income fund for two reasons, Mr. MacKenzie says. First, he will then be entitled to the federal pension tax TD Canada Trust Tower 161 Bay Street, 45th Floor Toronto, ON, M6J 2S1 1-866-209-6862

credit of $2,000 (claimed on his tax form), and second, he will then be able to split the RRIF income with Lucy, who is in a lower income tax bracket. “Splitting his RRIF income will reduce the overall tax that is paid and reduce the possibility of any clawback of their Old Age Security benefits,” the planner says.

Lance asks about setting up a charitable foundation, but this is not the most efficient way to carry out their philanthropic goals, Mr. MacKenzie says. A foundation involves substantial legal and accounting costs. “A better solution is to use a donor-advised fund such as Canada Gives,” the planner says. A Canada Gives Foundation account offers the same funding choices as a private foundation but with lower administrative costs. “By using a donor-advised fund, they will get an immediate tax deduction for the amount of the donation, but they can distribute the funds to one or more charities over a number of years,” the planner adds.

They should also be aware of the donation strategy that involves flow-through shares of qualifying junior resource companies, Mr. MacKenzie says. This strategy consists of several steps. The donor invests in flow-through shares through a broker that offers the service and the donor gets a 100-per-cent Canadian exploration expense deduction. If the donor is in the top marginal tax bracket, the CEE deduction could reduce the real cost of the investment by 50 per cent, the planner says.

The donor could then donate the shares to the charity and get another income tax deduction for the charitable donation. The charity would then sell the shares to a “liquidity provider,” a middleman financial institution, for a prearranged price. “The bottom line to this strategy is that for the same after-tax cost to the donor, the charity could get more than double the amount it would have under a simpler and more common donation strategy,” he says.

Next, the planner looks at Lance and Lucy’s investments. Their combined personal and group RRSPs total $1,228,500. “The current asset mix – 63-per-cent equities and 37-per-cent cash and fixed income – has served them well over the past decade, but now, when markets are near all-time highs, they should shift to a lower-risk, goals-based portfolio,” Mr. MacKenzie says. That is a portfolio that takes only as much risk as necessary to achieve their goals.

The planner’s calculations show that with a 50/50 split between equities and fixed income, Lucy and Lance can reasonably expect to earn an average rate of return of 4 per cent a year, “which is enough to achieve their goals,” he says.

If they are concerned about running out of money later in life, they may want to consider buying an advanced life deferred annuity, or ALDA, the planner says. This option is similar to a life annuity but its payments can begin as late as the end of the year the individual reaches 85. “There are pros and cons to the ALDA, but if they were to move some of their RRIF capital into an ALDA, they would have a guaranteed income (in addition to their government benefits) and no more investment decisions would have to be made.”

CLIENT SITUATION

The People: Lance, 60, Lucy, 64.

The Problem: How much of their savings can they afford to give away to charitable causes?

The Plan: Draw up a financial plan showing estimated income and expenditures. Consider a foundation such as Canada Gives.

The Payoff: The pleasure of using some of their net worth to achieve their philanthropic goals.

Monthly net income: $2,065.

Assets: Bank accounts $19,000; non-registered mutual funds $400,000; his TFSA $22,500; her TFSA $22,000; his RRSP $514,000; her RRSP $73,000; his employer pension plan (locked-in RRSP) $363,500; her employer pension plan (locked-in RRSP) $278,000; residence $2,000,000. Total: $3.69-million.

Monthly outlays: Property tax $750; home insurance $170; utilities, garbage $310; garden $50; transportation $315; groceries $600; clothing $60; gifts $200; charity $1,250; vacation, travel $1,500; other discretionary $250; dining, drinks, entertainment $750; personal care $20; sports, hobbies $225; subscriptions, other personal $225; health care $100; phones, TV, internet $390. Total: $7,165. Shortfall has been covered by non-registered funds.

Liabilities: None.

Warren MacKenzie is Head of Financial Planning at Optimize Wealth Management

Want a free financial facelift? E-mail finfacelift@gmail.com.

Some details may be changed to protect the privacy of the persons profiled.

DIANNE MALEY

Special to The Globe and Mail January 1, 2021

Lucy and Lance have substantial savings, a mortgage-free house in the Toronto area and no children. With most of their net worth tied up in their $2-million house, and no defined-benefit pensions, they wonder how much of their savings they’ll need to live comfortably and perhaps pay for nursing home care when they are old. The rest they want to give to charity now while they are living rather than later in their wills.

Lance is 60 and working part time. His income dropped substantially last spring because of COVID-19. Lucy is 64 and no longer working.

Lance is thinking of setting up a foundation to give away much of their wealth to charity even if it means downsizing their house and moving to a less expensive place in the future. Lucy is not so sure. Their retirement spending goal is $100,000 a year after tax.

“Does setting up a foundation to manage charitable donations make any sense?” Lance asks in an e-mail. How much can they afford to give away?

We asked Warren MacKenzie, head of financial planning at Optimize Wealth Management in Toronto, to look at Lance and Lucy’s situation.

WHAT THE EXPERT SAYS

Lance and Lucy have managed their money wisely and are now financially independent, Mr. MacKenzie says. They have numerous philanthropic causes that they want to support throughout their retirement. First they need a financial plan to assure them that their standard of living – and their charitable giving – are sustainable, the planner says.

Their $100,000 retirement spending target comprises $55,000 a year for basic lifestyle spending, $20,000 a year in travel and discretionary spending and $25,000 in charitable donations. The planner has factored in

nursing home costs of $100,000 a year in today’s dollars for each of them when they turn 85. His forecast assumes a 4-per-cent average rate of return on their investments, a 2-per-cent inflation rate and that they downsize to a condo in 2034. “Based on these assumptions, they can spend and donate as planned and still leave an estate of more than $1-million if they each live until 95,” the planner says. Much of that would be the value of their condo.

Lance is planning to delay Canada Pension Plan benefits until he turns 70. “This makes perfect sense because he has other sources of income, and by delaying the start of CPP, his annual benefits will be higher by 42 per cent.”

At 70, Lance and Lucy will have converted their personal RRSPs and their locked-in group RRSPs from work to RRIFs and life-income funds. At that time, their cash flow will consist of $101,000 in withdrawals from their registered accounts plus their combined CPP and Old Age Security benefits, which are estimated to be $59,000 a year in future dollars. Their cash outflow will have risen to $83,000 for basic spending, $12,000 for travel, $31,000 for charity and $34,000 for income tax.

There are some things Lance and Lucy can do now to minimize the income tax they’ll pay over their lifetime, Mr. MacKenzie says. Lance’s employment income is just $12,000 a year, so he does not have enough taxable income against which to deduct his charitable donations of $25,000 a year. The planner suggests Lance withdraw at least $30,000 from his RRSP to add to his income. By doing so, he will get a tax break for his charitable donations and take full advantage of the low rates of tax on the first $44,740 of taxable income.

When Lance is 65, he should convert both his personal RRSP and his locked-in RRSP to an RRIF and life-income fund for two reasons, Mr. MacKenzie says. First, he will then be entitled to the federal pension tax TD Canada Trust Tower 161 Bay Street, 45th Floor Toronto, ON, M6J 2S1 1-866-209-6862

credit of $2,000 (claimed on his tax form), and second, he will then be able to split the RRIF income with Lucy, who is in a lower income tax bracket. “Splitting his RRIF income will reduce the overall tax that is paid and reduce the possibility of any clawback of their Old Age Security benefits,” the planner says.

Lance asks about setting up a charitable foundation, but this is not the most efficient way to carry out their philanthropic goals, Mr. MacKenzie says. A foundation involves substantial legal and accounting costs. “A better solution is to use a donor-advised fund such as Canada Gives,” the planner says. A Canada Gives Foundation account offers the same funding choices as a private foundation but with lower administrative costs. “By using a donor-advised fund, they will get an immediate tax deduction for the amount of the donation, but they can distribute the funds to one or more charities over a number of years,” the planner adds.

They should also be aware of the donation strategy that involves flow-through shares of qualifying junior resource companies, Mr. MacKenzie says. This strategy consists of several steps. The donor invests in flow-through shares through a broker that offers the service and the donor gets a 100-per-cent Canadian exploration expense deduction. If the donor is in the top marginal tax bracket, the CEE deduction could reduce the real cost of the investment by 50 per cent, the planner says.

The donor could then donate the shares to the charity and get another income tax deduction for the charitable donation. The charity would then sell the shares to a “liquidity provider,” a middleman financial institution, for a prearranged price. “The bottom line to this strategy is that for the same after-tax cost to the donor, the charity could get more than double the amount it would have under a simpler and more common donation strategy,” he says.

Next, the planner looks at Lance and Lucy’s investments. Their combined personal and group RRSPs total $1,228,500. “The current asset mix – 63-per-cent equities and 37-per-cent cash and fixed income – has served them well over the past decade, but now, when markets are near all-time highs, they should shift to a lower-risk, goals-based portfolio,” Mr. MacKenzie says. That is a portfolio that takes only as much risk as necessary to achieve their goals.

The planner’s calculations show that with a 50/50 split between equities and fixed income, Lucy and Lance can reasonably expect to earn an average rate of return of 4 per cent a year, “which is enough to achieve their goals,” he says.

If they are concerned about running out of money later in life, they may want to consider buying an advanced life deferred annuity, or ALDA, the planner says. This option is similar to a life annuity but its payments can begin as late as the end of the year the individual reaches 85. “There are pros and cons to the ALDA, but if they were to move some of their RRIF capital into an ALDA, they would have a guaranteed income (in addition to their government benefits) and no more investment decisions would have to be made.”

CLIENT SITUATION

The People: Lance, 60, Lucy, 64.

The Problem: How much of their savings can they afford to give away to charitable causes?

The Plan: Draw up a financial plan showing estimated income and expenditures. Consider a foundation such as Canada Gives.

The Payoff: The pleasure of using some of their net worth to achieve their philanthropic goals.

Monthly net income: $2,065.

Assets: Bank accounts $19,000; non-registered mutual funds $400,000; his TFSA $22,500; her TFSA $22,000; his RRSP $514,000; her RRSP $73,000; his employer pension plan (locked-in RRSP) $363,500; her employer pension plan (locked-in RRSP) $278,000; residence $2,000,000. Total: $3.69-million.

Monthly outlays: Property tax $750; home insurance $170; utilities, garbage $310; garden $50; transportation $315; groceries $600; clothing $60; gifts $200; charity $1,250; vacation, travel $1,500; other discretionary $250; dining, drinks, entertainment $750; personal care $20; sports, hobbies $225; subscriptions, other personal $225; health care $100; phones, TV, internet $390. Total: $7,165. Shortfall has been covered by non-registered funds.

Liabilities: None.

Warren MacKenzie is Head of Financial Planning at Optimize Wealth Management

Want a free financial facelift? E-mail finfacelift@gmail.com.

Some details may be changed to protect the privacy of the persons profiled.