Originally Published by The TaxLetter Vol. 25, No. 8, August 2007   www.adviceforinvestors.com

Can you afford to retire? Calculating the cost of not working Eileen Reppenhagen, CGA

In BC, as in other provinces, the legislation governing retirement age has changed. You no longer are required to retire at age 65. As boomers approach retirement age in large numbers, the fear that there will be no one to replace their skills and experience has translated into an easing of mandatory retirement rules. Pension plans usually have early retirement options with a reduced pension topped up by an interim payment that stops at age 65. The interim payment is meant to encourage early retirement by simulating Old Age Security (OAS) and stops when OAS starts. What to do The answer as to whether you can afford to retire is one of cash flow. Currently, your income may be much higher, but you also pay tax at higher rates. Contributions to pension, CPP, and union dues stop when you start your pension. Post-retirement after-tax cash flow may not be significantly different than your current after-tax cash flow. In fact, not only might you have more time, you might have about the same available cash. Add in the new pensionsplitting rules, and for the first time ever, the lower-income spouse might have higher income and pay more tax. That’s why if you elect to split your pension income in 2007, the latest news is that your tax paid on that pension will be automatically split pro-rata to avoid huge over and underpayment of tax by the spouses. The retirement landscape is definitely changing. Financial planners often claim that your cash flow requirements will be about 80% of your current requirements. Ever wonder what you are spending that will miraculously reduce your cash required by 20% because you no longer work? Will you stop eating or eat less? Restaurants have portion controlled seniors’ menus in recognition of appetite loss as we age. Is that it? Will you spend less because you’ll no longer be incurring transportation costs to go to work? What about clothes, hairstyles, makeup, shoes, transportation? Surely that isn’t 20% of what you take home. There is this odd phenomenon I’ve often observed, where people who retire find the funding to replace cars and furniture around the time they retire. Maybe when you start eating less and stop buying clothes, nylons, shoes for working, all that extra cash funnels right into furniture and cars. What changes about your cash flow is obvious once you stop to think about it. What stops? Those deductions from your paycheque that you never see in the first place, that’s what stops. CPP, Employment Insurance, union or professional dues, and RRSP or pension contribution payments stop. You stop contributing when you starting making withdrawals (and remember, new tax rules have extended the mandatory RRSP conversion to the end of the year in which you turn 71). If you are self-employed, you have been paying twice as much CPP as someone who is working, because employers pay half. On the flip side, you are not paying EI premiums if you are selfemployed or own your own company. Where do you look for information? Start with your pay deductions on your pay stubs and follow through to your T4 and your tax return. Reconcile your pay stub to your T4 to see what ends up on your tax return. Consider a list of your spending habits, annual and monthly commitments, essentials, debt service, and remainder. Count up your inflows and outflows. If you aren’t tracking your spending habits, it might be time to start. Computer savvy? A money management program like Quicken is a great way to track your spending. If you fear Internet banking, you don’t have to use the Internet to download your transactions, but it does make it easier. You can still use Quicken without the Internet. An adding machine and a trusty pen and paper work, too. When should you collect CPP early? Request a Statement of Contributions to decide if dipping into your CPP early makes cash flow sense. Draft "what if" cash flows for as long as you expect to live. You might think you have to live a really ong time to make up the shortfall on your CPP. But consider this: If you start collecting CPP, you stop paying CPP contributions. If you are employed, the contributions are 4.95% of salary, maximum $1,989.90, and if self-employed, 9.9% of salary, maximum $3,979.80. How would you decide?  Service Canada has a series of Case Studies . You need your Statement of Contributions to decide.  Then draft ‘what if’ cash flows ‘til you die.  The hardest part is deciding the end date.  If Aunt Clara lived to 102, how does it bode for you?  Check out the Retirement Income Calculator available on the Service Canada website.   If you stop working for about a month or two at age 60, or you earn less than the amount specified, which for 2005 was $828.75 per month, you can start to collect CPP early. At age 60, you would collect about 70% of what you would collect if you waited until you reached age 65. If you will have some income after you start collecting or you will be eligible for the Guaranteed Income Supplement after age 65, you might want to consider starting to collect CPP anytime after age 60. Remember, you must apply six months in advance. You can also apply for the Child Rearing Dropout Provision and share your CPP with a spouse/partner. Why would you want to trigger CPP early? In 2007, your CPP maximum earnings at age 65 would be $863.75 per month x 12 = $10,365. If you triggered CPP at age 60, you would collect $863.75 x 12 x 70% = $7,256. Yes, CPP is taxable income. At rates between 21% and 44%, you are collecting $3,109 less than you would if you waited, but you are no longer paying those contributions of as much as $1,989.90 for an employee or $3,979.80 for a self-employed person. What else should you consider? CPP maximum is calculated as [($43,700 – $3,500) x 4.95%] and double that for self-employed persons. If you are employed, your employer is saving $1,989.90 a year once you trigger your CPP early. Consider using these future savings as leverage to negotiate a two month leave with reduced pay. Take two months off, save your employer several thousand dollars a year for the next five years, what’s that worth? If you go back to work or become self-employed after triggering CPP early, CPP benefits continue even if you earn employment or self-employment income for the rest of your life. CPP benefits increase annually with the average cost of living as measured by the Consumer Price Index for the rest of your life once triggered. You will probably continue to pay union dues and EI if you are employed after commencing collection of CPP, but not if you are self-employed. Other taxable benefits or benefit plan premiums may or may not change if you take early retirement. You may find yourself paying your own extended health and dental premiums, which are a medical expense. It may take a bit of work to coordinate triggering CPP if you have to apply so far in advance, because you must have stopped working during the month before and the month of your first payment, or alternatively, your income must be below the acceptable threshold. If you collect GIS at 65 or older because you do not have a company pension, you may collect more GIS if your CPP is less. About 40% of seniors collect the Guaranteed Income Supplement (GIS), usually those without a company pension. If you collect less CPP, GIS tops up the difference at age 65. The current trend is toward "personal business," with self-employed individuals carving out a niche market. Small business is much larger than personal business. Compare income of IBM or Microsoft with a local business with an individual working from home. Small is a relative term: "Personal" business is more like a "micro-business" than a "small" business. If you stop working for someone else and start working for yourself between age 60 and 65, you may be relatively cash-flow neutral on CPP if you are not in the higher tax brackets. Each situation will be different. It may be that it pays to take CPP early. Who knows if you will live to 72, 80, or 92? There are lots of factors to consider, including health, lifestyle, savings inside or outside of an RRSP, your pension, and your other income-producing assets. Your bottom line How much are the extra costs that you incur to work? A personalized evaluation (see the Case Study below) of before and after cash flow might shift your perspective about your plan to work past 55, 60, 65, or 71. You just might be surprised by the calculations, and it might alleviate the fear about whether or not you can afford to retire.

A Case Study      What’s the bottom line? 2006 cash flow       S1 S2 Total Gross $87236 $12437 $99673 RPP/RRSP -5416   -5416 Union dues -564 -45 -609 Donations -8056   -8056 CPP -1911 -553 -2464 EI -729 -56 -785 Tax -15492 -141 -15633       0 Net cash $55068 $11642 $66710         2008 cashflow (after retirement settlement year)       S1 S2 Total Gross $39369 $43326 $82695 RPP/RRSP 0   0 Union dues 0 -45 -45 Donations -8056   -8056 CPP 0 0 0 EI 0 -56 -56 Tax -3072 -7363 -10435       0 Net cash $28241 $35862 $64103 The reduction in Gross combined income of $16,978 is offset by a reduction in payments for pension (RPP) and RRSP, union dues, CPP, EI and Tax at higher rates worked out to a reduction in cash flow of $14,371 for a net cash flow shortfall of $2,607. The questions: Can S1 afford to work? Gas, clothing, transportation, opportunity cost forgone… Can S2 stand having S1 under foot 24/7? I’ll leave it to you to figure out what they decided to do. Recently I did an estimate of cash flow for the year after retirement at 60 for a client who does have a pension and is considering early retirement at 60. During the year of retirement, there were other cash flow factors at play such as early retirement settlements and RRSP top up contributions and a discussion about eligible and ineligible payouts. We wanted to see what a normal year would look like after all the unusual retirement lump sums were paid out and transferred to RRSP’s. 2006 cash flow is straight off their tax returns. 2008 cash flow is estimated based on pension documents. This scenario included the following assumptions: Calculation of pension and CPP splitting to minimize tax $12,000 of partnership income for their jointly managed ‘personal business’ which will continue at current levels after early retirement of S1 Spouse S2 would continue to work part time

Tax Tip    If you retire and work part time as a Wal-Mart greeter (my dream retirement job) or are selfemployed and earn at least $3,000 net of various expenses, there may be incentive to report your earnings. Those medical expenses you paid for yourself or dependent relatives might be refundable up to $1,000 even if you pay no tax at all. So don’t forget to claim medical expenses on your tax return, even if you paid no tax, to calculate whether it will trigger the refundable medical expense supplement(RMES).

Eileen Reppenhagen, CGA, ACG, Certified QuickBooks ProAdvisor writes and speaks about accounting and tax.  She is a regular contributor to Canadian MoneySaver, The TaxLetter and Intuit’s award winning online publications for accountants and QuickBooks ProAdvisors, ProConnection Newsletter and Advisor Advantage.   All articles are copyright protected.  Most articles are not available for re-print unless you obtain permission from third parties.  Please respect copyright. For more information or permission to re-print please contact  If you obtain permisison to re-print an article, include this tagline:   "Eileen Reppenhagen, CGA is a Certified QuickBooks ProAdvisor and speaks and writes about accounting and tax.  Contact her at www.taxdetective.ca".