Decumulate & Downsize

Most of your investing life you and your adviser (if you have one) are focused on wealth accumulation. But, we tend to forget, eventually the whole idea of this long process of delayed gratification is to actually spend this money! That’s decumulation as opposed to wealth accumulation. This stage may also involve downsizing from larger homes to smaller ones or condos, moving to the country or otherwise simplifying your life and jettisoning possessions that may tie you down.

Why “Topping up to bracket” makes sense if you’re temporarily in a low tax bracket

My latest column in Wednesday’s Globe & Mail looks at a strategy called “Topping up to Bracket,” which can be useful to anyone who is temporarily in a lower tax bracket.

Click on the highlighted headline to access the online version, assuming you have Globe subscriber privileges or haven’t exceeded the monthly free click quota: A strong tax case for early RRSP withdrawals.

When might you be “temporarily” in a lower tax bracket than usual? This can of course happen when you lose a job or if you’re in your Sixties and transitioning between full employment (typically earning in higher tax brackets) and Semi-Retirement, when it’s tempting to “bask” in lower tax brackets.

Temporary because as Semi-Retirement progresses, you can end up moving back into higher tax brackets: for example, if you start to receive Old Age Security (OAS) at 65, then take Canada Pension Plan (CPP) a few years later, these are both taxable sources of income.

And the big hit can come at the end of the year you turn 71, when RRSPs must be converted to Registered Retirement Income Funds (RRIFs) or else annualized or cashed out. RRIFs entail forced annual withdrawal rates that keep rising between your 70s and your mid 90s.

So that makes “Topping up to Bracket” (a term used in a BMO Wealth Institute paper on the topic, published around 2013) a strategy not to be ignored. In practice it means making sure that in those low-earning years you at least bring into your hands each and every year the roughly $12,000 of untaxed earnings that’s called the Basic Personal Amount (BPA). And as the G&M column explains, it’s also a good idea to at least bring in the dollars that are in the lowest tax bracket (15% federally, 5% in Ontario), or roughly $42,000. There are of course higher tax brackets above that but the law of diminishing returns starts to kick in beyond the $42,000.

Note too that this is a “use it or lose it” proposition. If for example a year went by that you failed even to bring in even that $12,000 income that would not have been taxed, you can’t carry forward the opportunity to benefit from it the following year. You will of course have another opportunity for the BPA that year but it won’t double up because you neglected to earn low- or non-taxed income the previous year. Continue Reading…

What does tax reform mean for high-yield debt?

By Bradley Krom and Josh Shapiro, WisdomTree Investments
Special to the Financial Independence Hub

In an earlier post, we highlighted the likely impact tax reform could have on investment-grade (IG) corporate debt. In part two, we turn our attention to the high-yield (HY) market.1 While a reduction in taxes should benefit all profitable companies, other provisions could lead to tough choices for some less-credit-worthy borrowers. As we’ve seen during the most recent earnings season, HY still presents a mix of opportunity and risk. Below, we highlight the contrasting impact of lower tax rates and potential changes in the deductibility of interest expenses.

Big Picture: lower taxes, higher free cash flow and earnings

On net, the proposed tax plan is a positive for high yield. Lower statutory tax rates should result in higher profitability metrics, greater free cash flow and a boost to economic momentum/growth, while extending the credit cycle. While all businesses won’t be impacted the same way, we feel comfortable concluding that tax cuts should bias credit spreads tighter for riskier borrowers, on average. Similarly, an increase in economic growth could also push nominal interest rates higher.

What about Revenue Offsets?

While the top-line impacts we highlighted above should be broadly positive, we believe other elements of tax reform warrant closer attention: most notably, the so-called interest deductibility provision.

In the current environment, companies choosing to finance themselves with debt are permitted to fully deduct interest payments. As a result, companies have an incentive to finance themselves with debt as opposed to equity. In order to help dampen the fiscal impact of tax cuts on the federal budget, the current proposal would limit the deductible amount of interest expenses to 30% of EBITDA.

Fundamentally, this provision should have a much greater impact on the HY market. Given that risky borrowers tend to pay higher interest rates and (all else being equal) tend to deploy more leverage, the 30% cap on deductions should impact a larger percentage of the market. As we show in the chart below, HY companies with leverage of approximately 5.5x would likely be unable to fully deduct their interest expenses. In the second chart, we show that this makes up approximately 40% of the total market.2

Market Impact

While attempting to draw broad-based conclusions about individual companies can be tricky, a few key points stand out. In our analysis of firms with public financials, we estimate that 91% of CCCs will be unable to fully deduct their interest expenses. Continue Reading…

Retired Money: Early or Delayed CPP? Age 65 may be best compromise

My latest MoneySense Retired Money column has just been published, which tackles that perennial personal finance chestnut of whether to take early or delayed CPP benefits. You can find it by clicking on the highlighted headline here: The Best Time to Take CPP: if you don’t know when you’ll die.

That’s a pretty big “if,” of course since with rare exceptions, our futures are unknowable. As readers of the piece will discover, there is a fair bit of personal anecdotes there, which is hard to avoid in a beat known as “Personal Finance.” As the column notes, we’ve written before that in theory it makes sense to delay CPP as long as possible, since monthly benefits are 42% higher than if you took them at 65. And while you can take CPP as early as age 60, you’d pay a 36% penalty to do so compared to taking it at the traditional age 65.

Since experts are all over the place on this one and have valid arguments for either side, it’s interesting that in practice very few Canadians actually wait till age 70 to start their CPP, even if it is an inflation-indexed guaranteed-for-life annuity. Government stats show age 60 is the single most popular option: according to the federal government’s 2016 data, of the 312,251 who began collecting CPP that year, 126,954 did so right at age 60, with the second most popular start date being age 65, when 93,460 started to collect. Only 4,844 waited until 70.

The balanced case for the traditional age 65

As I relate in the MoneySense piece, I still haven’t started to collect CPP myself, even as my 65th birthday looms this coming April. Continue Reading…

Doing it: 50% more income in Retirement

By Mark Yamada and Ioulia Tretiakova

Special to the Financial Independence Hub

Nobel laureate William Sharpe described managing retirement assets as the “nastiest hardest problem in finance.” Living longer on a fixed pool of capital is only the start of a problem complicated by the myriad of possible personal and family needs and obligations that develop over a lifetime.

The need

Demographics are driving big change in the retirement market. Not only will Gen Y workers have fewer opportunities to save for retirement because of high predicted job turnover and reduced access to workplace pensions, but retiring baby boomers are being abandoned by the very industries created to serve them.

The pension, mutual fund and wealth management industries are direct responses to boomers joining the work force, but fewer retiring boomers meet the criteria for investment advisors who are compensated for growing assets. Retiree portfolios don’t get contributions and many are too small to qualify as brokerage minimums rise. Most mutual fund fees are too high for this cohort for whom costs are more important than ever before. The number of advisors is also shrinking, not only because of compensation and compliance pressures but also because advisors too are retiring.

Saving more, starting earlier and taking more risk are the accepted ways to improve retirement outcomes. Two or more of these options may no longer be available for retirees. A growing crisis in retirement savings is stretching an already extended social welfare system and new thinking is needed if disaster is to be averted.

Solutions not products

Our research motivation (Journal of Retirement and two Rotman International Journal of Pension Management papers) is a belief that investing can be improved to solve problems. The pension problem, for example, is best resolved by focusing on what workers really want, reliable replacement income in retirement rather than trying to pick the best performer every period. Consumers today want solutions. The investment industry is still about products.

Just as someone who only owns a hammer sees every problem as a nail, the industry has a singular focus on “maximizing returns.” This sounds good, but anyone using Google maps knows the fastest route to a destination is not necessarily the shortest. UPS routes deliveries to avoid turns against oncoming traffic to reduce accidents and delays waiting for gaps. Their drivers make 90% right hand turns and experience shorter delivery times, lower fuel consumption and operate smaller fleets. What if investment portfolios could similarly be routed more efficiently to correct destinations?

Autonomous portfolios

The self-driving automobile that protects passengers from immediate risks and routes itself to a predetermined destination provides a template for an autonomous portfolio.

Getting to a destination is a different strategy than going as fast as possible all the time. For starters, brakes and steering are needed not just an accelerator pedal. Maximizing returns, the investment industry’s primary approach, is about going fast. If your strategic asset mix is 65% stocks and 35% bonds, your advisor will periodically rebalance to this mix. If stocks go down, she will buy more stocks. This sounds like the right thing to do, and it is, if your investing time horizon is long enough to make back accelerating loses over the next market cycle; your portfolio is throwing money at a falling market after all. For an aging population in general and retiring baby boomers in particular, this is an increasingly risky and unpalatable proposition.

How we can do it

To protect portfolios we keep risks as constant as possible. When volatility rises, some risky assets, like stocks, are sold and less risky ones, like bonds, are added. When volatility falls, we add riskier assets. The critical effect is avoiding big losses. Statistically this is like card counting in the casino game of blackjack. When volatility is higher than average, the deck is stacked against the player. This means we expose portfolios primarily to markets that are favorable. It’s an unfair advantage but it’s legal! Continue Reading…

CPP Reality Check

Repeat after me: The Canada Pension Plan will be there for me when I retire.

In fact, CPP is sustainable over the next 75 years according to the most recent report issued by Canada’s Chief Actuary. This projection assumes a modest 3.9 per cent annual real rate of return over that time.

The plan is operated at arms length from governments by the CPP Investment Board (CPPIB), whose sole mandate is to maximize long-term investment returns in the best interests of CPP contributors and beneficiaries.

Despite this assurance, I still see numerous comments on blogs and social media dismissing CPP as something doomed to fail.

“The feds are robbing the CPP fund to pay for infrastructure and massive debt loads.”

“I’m fairly certain there won’t be a CPP fund in 25 years when I’m ready to retire.”

“My retirement projections don’t include CPP, just in case . . . “

The media exacerbates the problem by reporting on the CPPIB’s quarterly earnings, which, most recently, slumped to 0.7 per cent thanks to a strong loonie dragging down its foreign investments. But to the CPPIB and its long-term investing mandate, a quarter isn’t measured in three months: it’s more like 25 years.

Don’t ignore CPP in your retirement projections

It’s a mistake to ignore CPP benefits in your retirement planning projections. While it won’t save your retirement, CPP is paying out on average $653 per month for new beneficiaries as of July, 2017. The maximum monthly payment amount [if taken at age 65] is $1,114.17.

Continue Reading…