Victory Lap

Once you achieve Financial Independence, you may choose to leave salaried employment but with decades of vibrant life ahead, it’s too soon to do nothing. The new stage of life between traditional employment and Full Retirement we call Victory Lap, or Victory Lap Retirement (also the title of a new book to be published in August 2016. You can pre-order now at VictoryLapRetirement.com). You may choose to start a business, go back to school or launch an Encore Act or Legacy Career. Perhaps you become a free agent, consultant, freelance writer or to change careers and re-enter the corporate world or government.

Retired Money: Time for retail investors to STANDUP to the financial services industry?

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My latest MoneySense Retired Money column is a review of advisor John De Goey’s new book: STANDUP to the Financial Services Industry. Click on the highlighted headline for the full column: Fight for your right to low fees.

Obviously a retrofitted acronym, STANDUP stands for Scientific Testing and Necessary Disintermediation Underpin Professionalism. STANDUP was an undercurrent in the four editions of De Goey’s previous book, The Professional Financial Advisor. There he argued that while most advisors hold themselves out to be professionals like doctors, lawyers or accountants, the primary function of most advisors is “to sell products.” STANDUP Advisors are the good guys and gals: the “self-aware and knowledgeable advisors” his new book aims to help readers find. His personal website is www.STANDUP.today.

Bad advice they believe is good

Right from the get-go, De Goey is pretty harsh on many members of his profession. Much of what advisors believe is “demonstrably wrong” he declares right on page 2 of his introduction: “People who give advice for a living routinely give bad advice while honestly believing that the advice they are giving is, in fact, good. That’s a huge problem.”

He puts much of the blame on the managers of retail advisors, chiefly the senior members of Canadian mutual fund companies. He hauls out the old Upton Sinclair quote to illustrate the gap between doing what’s good for investors and what’s profitable for the financial industry itself: “It is difficult to get a man to understand something when his salary depends upon his not understanding it.” Continue Reading…

The ABCs of Retirement Compensation Arrangements (RCAs)

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Tax Minimization Strategy for High Income Individuals

By Spencer Tilley, CFP, RFP, CFA

Special to the Financial Independence Hub

There is a common theme among high net worth and high-income earners:  “How can I save on tax?,” and “What are the most tax efficient ways to save for retirement?”

No question that focusing on tax savings is the most crucial component to some of the most successful individuals in the world.

In Canada, RRSPs, TFSAs and pension plans are commonly utilized retirement vehicles, but what happens when you max out your available room? Unfortunately, as a salaried employee, your additional options for tax-efficient retirement savings are limited, or non-existent.

Retirement Compensation Arrangements (RCAs) are one strategy that not many know but may be available to you as a high-income earner.

What is an RCA?

RCAs are a tool for a high-income earner to save additional funds on a tax-deferred basis, over and above the RRSP/pension limits, for their retirement. It is funded by an employer for the employee’s long-term benefit. It was created to help supplement and overcome the income gap in retirement that occurs because of the relatively low annual prescribed RRSP/pension limits.

Basically, RRSP room has not kept pace with wage growth and there is essentially a cap on the amount that can be saved tax-deferred for retirement. RCAs help make up the difference between what can be saved for retirement and what is needed in retirement, on a tax-deferred basis.

Here’s what you need to know:

Today, top personal tax rates are over 50% in 7 out of 10 provinces, with the other 3 provinces clipping north of 47.5%. With these high personal tax rates combined with the recent changes in the Federal Government Small Business Tax regime, RCAs, along with the Individual Pension Plan (covered here), are making a comeback as a strong player in the retirement game for highly compensated executives and can provide a huge tax benefit for those who may qualify to use it.

How it works:

The employer contributes 100% of the amount, of which 50% is sent to the CRA, held in a non-interest bearing, refundable tax account and 50% is deposited to your RCA Investment account, held with a custodian where it can be invested on a tax-deferred basis. Withdrawals are taxed as regular income. Giving the CRA 50% of your money today may seem like a bad deal, but let’s examine the benefits a little closer:

The Benefits    

Employee benefits (assuming top marginal tax rate):

  • In 7 out of 10 provinces, you would otherwise be paying the CRA 51.3%-53.53%, upfront and permanently. You are already ahead of the game in these provinces
  • In the other 3 provinces, you would pay 47.5%-49.8% to the CRA, so at most a 2.5% disadvantage. But …
  • The real advantage lies in your ability to withdraw the funds over time and at your discretion, rather than receive them personally all at once, thus (hopefully) reducing your income in any given year enough to drop you into a lower tax bracket and ultimately pay less tax
  • Contribution limits are not based on RRSP room and can exceed pension contribution limits by significant amounts
  • 50% is contributed to the RCA investment account and invested for your retirement.
  • When you withdraw funds in retirement, 50% of your withdrawal is added back to the RCA investment account via a refund from the CRA refundable tax account (the 50% that went to the CRA at the beginning)
  • Funds are the employee’s in the end, whether the company is around or not

Employer benefits:

  • 100% of the employer contributions are tax-deductible for the business
  • Key employee retention

The Downside/Risks

  • An actuary needs to be hired to implement and keep track of everything incurring an annual cost for administration” approximately $1,000/year
  • 50% of the contribution is sent to the CRA in the form of a refundable tax
    • Money in the CRA account is held in a non-interest bearing account
  • Investment risk is taken on by you and not your employer (unless the RCA is funding for a defined benefit supplemental pension guaranteed by your employer)
  • Employment income needs to be high over the last 15 years to qualify
  • This is only for those who have maximized their pension benefits and cannot achieve 70% of their current income as retirement income with existing retirement plans
  • A company cannot ‘bonus down’ to keep income lower than the small business limit

Who this is best suited for:

High-income earners: groups of managers or executives, successful business owners, or other highly compensated individuals where income is tied to special employment incentives, such as a professional athlete.

Let’s review a simplified example:

Assume you have earned a $1,000,000 incentive paid above your usual salary of $314,928/year in Alberta, which you have received for the last 10-15 years. If you were to pre-plan with your employer and utilize an RCA, the benefit could be upwards of approximately $200,000 using the RCA strategy vs straight T4 income: that’s like an extra $10,000/year for 20 years of your retirement!

Some technical details:

If this $1,000,000 incentive were paid as T4 income, in Alberta you would pay $480,000 (48%) tax and you would keep $520,000 (52%). Continue Reading…

5 pro tips staying on budget when using Credit Cards abroad

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By Maria Weyman, creditcardGenius

Special to the Financial Independence Hub

When organizing a trip, it makes sense to plan ahead for some extra spending to make the most of the experience.

Even the most frugal penny pinchers will want some extra cash to throw around while on vacation for maximum relaxation and culture absorption.

But, if you’re using your trusty credit card to earn some rewards on those purchases along the way, there may be something you’ve overlooked – foreign transaction fees – the peskiest of all credit-card fees coming in hot to totally ruin your budget.

How foreign exchange fees work

Foreign transaction fees will show up on your credit-card statement when you make a purchase with your Canadian credit card in a currency that isn’t Canadian dollars, either when travelling abroad or shopping online. You’re charged this fee in order to convert your funds to the required currency.

There are often 2 parts to this fee:

  • what gets charged by the credit card issuer (Visa, Mastercard, American Express), and
  • what gets charged by the issuing bank (BMO, TD, etc.)

So, not only are you losing out on the currency exchange (depending on the currency), but you’re also charged an additional fee on top of that.

The average cost of foreign exchange fees

In Canada, most foreign exchange fees are 2.5% of your total purchase, but can range from 2% all the way up to 3.5% : yikes.

Let’s crunch some numbers with some examples.

Say you’re road tripping to the U.S. and use your Canadian credit card to buy a $5 USD latte from Starbucks.

At the time of writing, 1 USD is equal to 1.34 CAD.

( $5 * 1.34 ) * 2.5%

$6.70 * 2.5% = $0.17

Ok, not unreasonable. But, the more you spend, the more it adds up…

Say you travel to Ireland and use your credit card to pay for hotel stays, dining, shopping, and sight-seeing for a week, totalling $5,000 in purchases.

At the time of writing, 1 Euro is equal to 1.51 CAD.

( $5,000 * 1.51 ) * 2.5%

$7,550 * 2.5% = $188.75

$188.75 is not as easily overlooked as $0.17 more for a coffee …

And though it may not seem like much, $200 is still a significant amount of money to figuratively throw in the trash bin if you’re travelling on a budget.

How to save money and avoid FX fees

With that being said, is there any way to escape the dreaded 2.5%?

Here are our top tips on saving money next time you’re adventuring overseas or shopping in a foreign currency: Continue Reading…

The hard truth about the FIRE movement [Financial Independence, Retire Early]

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By Maria Weyman, creditcardGenius

Special to the Financial Independence Hub

Retirement, whether near or far, is a pretty big milestone in a person’s life.

We start saving for it as early as possible and put as much towards it as we can in order to be better prepared.

Whether we want to spend it travelling, immersing ourselves in our favourite hobbies, or spending some quality time with loved ones, most of us look forward to our retirement but don’t see it happening in the near future.

The average age of retirement in Canada is 64 years old, but the popularized FIRE movement – which stands for “Financial Independence, Retire Early” – is the lifestyle concept that proposes an alternative scenario.

By living as frugally as possible and saving every bit possible while maximizing income and revenue, FIRE-devotees plan on retiring much earlier than the Canadian average.

Although we all want to retire early, and being financially independent enough to retire at a young age is possible, it might not be attainable for everyone.

We can all dream, but it’s important to look at the concept without those rose-colored, heart-shaped glasses we all get when thinking about early retirement. Realistically, the FIRE movement can be quite extreme.

Reasonable income

Living from paycheque to paycheque is still the sad reality for many Canadians, some not even being able to set aside money for normal retirement. Living as frugally as possible is just a means of survival rather than a means to a bigger end.

Stagnant wages and the ever-increasing cost of living has made it harder than ever to be financially stable, let alone financially independent, especially for lower or middle-income brackets.

Not to mention getting higher-income jobs in the first place requires many years of education and consequently entails large amounts of student loans, which in itself can take decades to pay off.

Investment risks

Even if you have an income that allows some wiggle room, saving alone probably isn’t enough. To be successful in the FIRE movement requires some savvy investing.

And since we’re taking away the option of long-term, stable, compounded interest savings, the timeframe is much shorter.

But with higher rewards usually come higher risks.

It’s up to you to decide if the risk is worth the potential payout.

Retirement timeframe

Another glitch in the FIRE movement lifestyle is retirement timeframe: how long you’ll actually be retired for.

Savings breakdown

Let’s crunch some numbers just to get a general idea. The most complicated part of this calculation is compounding interest. Thankfully, we can summarize the effects of compound interest using a multiplier.

Let’s say you’re 23 years old and you plan on retiring early at 40 years old. The average life expectancy in Canada is 82 years old, meaning your retirement fund will have to be sufficient enough to carry on for over 42 years.

Compound interest allows our savings to “go further” than they otherwise would. If we are looking at a compound interest of 3.5% (moderate yield rate) we can calculate how much further savings would go for a period of 42 years:

Savings Multiplier = (1 + Annual Interest Rate)^42 = 1.035^42
Savings Multiplier = 4.241

Where the “^” indicates an exponential power (that is 2^3 =  2x2x2). This means that over a period of 42 years, your savings will essentially be multiplied by a factor of 4.2, which shows you how powerful a force compounding interest really is.

While it’s nice that our savings can grow exponentially with compound interest, taking money out of our savings results in losses that grow with compound interest. As such, if we take money out of our savings at the beginning of that 42 year period, that money is also multiplied by a factor of 4.241. Taking the money out one month after would have a slightly lower multiplier and so on. By summing the total effect of each monthly withdrawal we can also obtain a monthly expense multiplier. The first step is to find the monthly interest rate. This can be obtained as follows:

Monthly Interest Rate = (1+Annual Interest Rate)^(1/12) – 1 = (1+0.035)^(1/12) – 1
Monthly Interest Rate = 0.28708987%

Note that calculating a power x^(1/12) is a 12th root and will require a scientific calculator. After obtaining the monthly interest rate, you need to do a recursive sum representing the multipliers for all monthly withdrawals: Continue Reading…

Ten questions on Annuities – answered here!

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I tell ya…I get no respect.

That could be an old, popular Rodney Dangerfield tagline or it could be how annuities feel from time to time:  disrespected, unloved, and generally misunderstood.

Thankfully, I have someone here to help demystify annuities: to see if these products could be right for you or someone you know at some point.

Alexandra Macqueen is a fee-for-service financial planner, author and faculty member at the Schulich School of Business.  She has also been kind enough to share her expertise on my site, why you should consider pensionizing your nest egg at some point, along with countless other personal finance and investing sites.

Here are ten questions and ten answers about annuities – in plain language – in the hopes of helping you learn more and become better educated about what these financial products actually do.

1.) Alexandra, thanks for this!  Let’s get down to basics: what is an annuity?  

At the most basic level, an annuity is a contract under which you (the annuitant) provide a sum of money to an annuity issuer — a life insurance company — who, in exchange, provides you with monthly income for as long as you are alive, no matter how long that is.

Annuities come in many different “flavours” (indexed? deferred? joint? variable? prescribed?), but all of them incorporate this basic exchange: a sum provided to an insurance company for cash flow in your bank account over time.

2.) Why should older Canadians consider annuities? Who are they designed for?

While I would in no way argue that every Canadian should consider an annuity no matter their financial situation, the reasons that a retiree might consider incorporating an annuity into part of their retirement income strategies include:

  • If you are worried about living a long time, potentially outliving the funds from your portfolio, and want to ensure you have some cash flow that cannot “expire.”
  • If you are reluctant to leave all of your assets exposed to some form of investment market risk and would prefer to have income that’s protected from market-based fluctuations.
  • Depending on factors primarily including the age at which you purchase the annuities and the source of funds used for the purchase, if you are interested in cash flow that has a higher yield than products with similar guarantees (think Guaranteed Investment Certificates or GICs), while producing lower taxable income to preserve income-tested retirement benefits (think GIS)

3.) OK, so great benefits. Why do annuities get no respect? Do you think it’s because Canadians have a huge bias: they just think advisors or planners are (as a reader actually wrote on my site) just “circling the sky” on these products?

In my view Mark, there are many potential reasons why annuities “get no love.”

Think about the asset management industry today, compared to a few decades ago: we now have relatively abundant, cheap, and transparent DIY choices that allow individual investors to take their financial management directly into their own hands.

(Mark:  I’ve written about some of these choices here:

The best all-in-one Exchange Traded Funds (ETFs) to own.

Get help to train your investing brain with a low-cost robo advisor.)

In comparison, the annuity purchase cannot be a “self-serve” choice but must involve an advisor who holds a life insurance license. The product, too, is priced to take into account interest rates at the time of purchase, actuarial factors predicting how long someone might live, and how much the company wants to attract or forego that particular kind of annuity sale at the time you’re looking to buy.

None of these elements are transparently visible to the purchaser, or even the salesperson. In other words: although the concept is simple — the exchange of cash for income — the details are not.

Other factors include the reluctance of purchasers to hand over assets to the annuity issuer, the fact that many people really underestimate just how long they might live in retirement, and the belief that a portfolio invested in markets can “beat” the implied return of the annuity while potentially leaving estate value.

4.) So you touched on transparency: a bigger issue now and rightly so. What are the typical commissions paid to advisors for annuities they sell?  Is it a one-time commission (vs. a mutual fund that typically charges for every year the asset is owned)?

Commissions on annuities are paid once (at the time of purchase), with no ongoing trailers or commissions paid to the advisor: which may explain why these products are perhaps less popular than they might be.

Typically, the commission is “tiered” based on the size of the annuity purchase, and might be, for example, 2 or 3 percent on the initial $100,000 deposit, and scaling downwards as the deposit amount goes up.

Certainly, there are other insurance products, and other asset management transactions, that pay higher commissions than an annuity purchase.

5.) Are there certain annuities that more popular than others?  Which ones?  Why?

Without a doubt the most popular annuities in Canada are group annuities sold to fulfill pension plan obligations. Many people will have some portion of their retirement income provided from an annuity even if they never go out and buy an annuity directly. The size of the individual annuity market pales in comparison to the group annuity market. Continue Reading…