One of the tougher questions I often receive is how to invest a half million dollars. Most people have no idea where to start or what to do when they get that $500k. Today we’re going to talk about it in depth.
If you are not retired, if you are young and you’re continuing to work and these funds are meant to supplement your income at a future date, this would be what we would call a longer investment time horizon.
This money should form part of your eventual retirement plan. If you get 500k at an age while you’re still working, and the plan is to not draw on this income, then first of all, you should take a look at your financial plan. Take a look how this $500k impacts the future cashflow. Second of all, you should have a plan in place how to optimize the tax efficiency of this cash.
The first thing that I would suggest is to take a look at your TFSAs – your tax-free savings account – if you’re married or if you’re single. Either way, that should be either one or two TFSAs that are fully maxed out. Take a look at the maximum contribution amount and Max out your TFSAs. Why? Because all income that’s being generated in your TFSA is going to be tax-free.
Second of all, how high is your and your spouse’s personal income right now? If the income is high and the time horizon is long, your planner will likely suggest an RRSP contribution with a portion of that 500k.
Hopefully you’ve accumulated some RRSP contribution at some point, you can make the full contribution today and you can differ as to when you want to take the actual deduction.
That is something that you should absolutely consider. You’re either going to decide to put some in the TFSA, some in the RRSP, maybe you’re putting some in the RESP. If you have kids, you can actually go back and contribute some past prior years the RESP, so if you have two kids you could, for example, do $2,500 each for this year plus $2,500 each for last year.
That’s a quick $10k that you could put into the RESP. The government’s going to give you 20% of that. You’ve now increased your wealth. After that, if there’s no other room to put investments, the rest will likely form part of what’s called a non-registered account or perhaps a joint non-registered account if you’re married with your spouse.
Now the income that’s being derived in this account is taxable. On top of the income that you’re generating with your job, if you’re working, you now adding income to that through the non-registered accounts.
Optimize Tax Efficiency
It’s very important to make sure you are optimizing the tax efficiency of that portfolio. How would you do that?
Well, you would take a look at return on capital investments, you’d take a look at dividend paying securities. You take a look at anything that’s deferring a capital gain. If you can crystallize something into a capital gain, those are all taxed at a much favorable rate.
We’ve covered the situation where you’re still actively working, and this money is meant for the future; what if this money is now added in retirement? Maybe you’ve sold a condo, or a house, or a piece of farmland. Maybe you’ve inherited this money. Regardless, this money is now being added to your retirement plan on top of your other income. What do you do with that money?
The first thing I would want to do is take a look at the financial plan. How much money is coming in currently? To determine this, we must calculate the value of your CPP and OAS, all the money coming in through pensions and passive income, such as real estate investments.
Take a look at all of the income that’s coming in and determine if you are short on income and if this $500k can be used to supplement that. If we do, all right, let’s build a portfolio here. Let’s build something that’s going to generate tax efficient income for you.
If the money is needed now in lump sums to pay off either debt or expenses, then the choices are somewhat limited. You take some of that cash and use that cash directly to pay off some expense or some debt.
But if at the end of the day you end up with a surplus, let’s build a portfolio for income. Let’s structure something that is going to be tax efficient and let’s start drawing on that income in retirement.
Obviously, the time horizon’s a little different than when not in retirement. When you’re working, there’s going to be a lot more growth stocks. There’s going to be a lot more plays that are longer, a different profile of stocks will be in there.
Typically, the profile lead towards like a growth portfolio versus the conservative portfolio.
If you’re at retirement, then we might splash in some fixed income, some bonds, potentially get some income producing notes. Also, some real estate securities and some dividend paying stocks. But this will be a little bit more defensive, because if you’re retired, you’re drawing on that income.
If this money is coming through a pension, a locked in retirement account (LIRA), or maybe a conversion, a rollover from spousal transfer on death of a spouse, well then, the assets go into what’s called a registered account.
That would be either a LIRA, perhaps a RRIF, or maybe it’s an even an RRSP. If you’re acquiring that $500k that way, then the plan is less cumbersome because you don’t have to worry about the taxable consequences because it’s in a registered account.
However, you’re going to have to factor in the withdrawal of that as income because every dollar that you withdraw from that registered account is now taxable.
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