After seven and a half million years of meditative reflection, the massive square-headed supercomputer named Deep Thought produced an answer to the Ultimate Question of Life, The Universe, and Everything in Douglas Adam’s Hitchhiker’s Guide to the Galaxy. The Answer to this most important question, was simply “Forty Two”. When asked to elaborate on the answer, Deep Thought expressed annoyance and pent-up frustration over not having any idea what the actual question was.
The Hitchhiker’s Guide to the Galaxy was written in 1979, so not accounting for the crazy inflation of the 80s, Deep Thought was actually pretty close. The real answer is Fifty.
While not normally presented with deep philosophical questions the way that Deep Thought was, I’m often asked the Ultimate Question of Income. Most specifically, people would like to know what the exact ideal amount of income to take from their RRSPs is, and how much they need to save in order to get there.
There’s a lot of variables here, and a lot of assumptions that we have to make. First, we’re assuming that the primary goal is to pay the lowest amount of tax down the road while still benefiting from the RRSP contributions today. This may or may not work out for everyone. For example, if you could get a tax deduction at 36% today but would only have to pay tax at 25% in the future, it’s still probably better to take the 36% deduction, rather than paying the 36% today just so you don’t have to pay any down the line. Second, we’re assuming that it even makes sense to contribute to RRSPs to start with. Often times owners of private corporations will find it more efficient to just save within the corporation instead of issuing a salary and then contributing to RRSPs. And finally, we’re assuming that the investors are a couple of roughly the same age, can generate a 5% rate of return on their investments, want to stop working at age 65, and are starting from scratch.
If all of those assumptions hold water, then the answer is not Forty Two. It is Fifty. Or to be more exact, fifty thousand and twenty six dollars ($45,886 in SK). This is the answer to the Ultimate Question of Income – the basic ideal target of taxable family income to strive for at age 65 for ultimate tax efficiency.
This Ultimate Income number uses three pillars – government benefits, personal savings, and tax credits – in balance with each other to optimize income taxes. The tax credits pillar anticipates utilizing to their fullest possible extent all of the basic personal amounts, age amounts, and pension income tax credits. If the couple has regular qualifying medical expenses or charitable contributions, the Ultimate Income target is going to be higher. Even at the Ultimate Income level there will be some tax – 2.6% average tax in AB and 1.5% in SK – because some credits have different qualifying amounts for Federal and Provincial tax, but still overall a pretty lean tax rate.
The government benefits pillar is composed of both OAS and CPP, both of which are taxable. An average working middle-class (defined as $60K per year in lifestyle needs) Canadian couple could expect to receive about $15,000 from CPP and $13,700 from OAS once both members are age 65. This brings the amount of our Ultimate Income produced from the savings pillar down to $21,313 (AB) and $17,186 (SK).
Now we need to circle back to the original question, of Ultimate Savings. Based on income at the RRIF minimum factor of 4% at age 65, and assuming that the government stops changing their mind on the OAS minimum age, in order to produce generate Ultimate Income from the savings pillar, a couple would want $429,650 (SK) to $533,000 (AB) saved up in their RRSP and other registered accounts by age 65. The rest of their savings, for most middle class families this would mean at least half that amount, should be targeted to non-taxable income sources, such as TFSAs.
And finally, taking it one more step to answer the Ultimate Question of Savings. The chart below is based on the approximate age of the couple above, with an isolated goal of obtaining Ultimate Income from their investments starting at age 65. Note that the answers are based on a family amount for the couple, not per individual.
Age RRSP TFSA
20 $250 $125
30 $440 $220
40 $840 $420
50 $1,800 $900
While dedicating a portion of your income to savings in the amounts above cannot guarantee you’ll live an Ultimate Lifestyle, it should set you on track to receiving an Ultimate Income, which, if nothing else, is a fun academic exercise on how to pay near-zero tax while still maintain a middle-class lifestyle.
If you have questions on setting income goals for your family, or for more information on advanced tax and income planning, speak with a Certified Financial Planner today.
Written by Meagan S. Balaneski, CFP, R.F.P.
Meagan S. Balaneski, CFP, R.F.P CERTIFIED FINANCIAL PLANNER® Advantage Insurance & Investment Advisors Investment Funds Representative Manulife Securities Investment Services Inc.
The opinions expressed are those of Meagan S. Balaneski and may not necessarily reflect the views of Manulife Securities Investment Services Inc.