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.

Real Life Investment Strategies #2: Debunking Retirement Financial “Rules”

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Should you Plan your Retirement Savings according to the 4% Withdrawal Rate Rule or 70% of Pre-Retirement Income Rule?

Lowrie Financial: Canva Custom Creation

By Steve Lowrie, CFA

Special to Financial Independence Hub

Last month, we kicked off our “Real Life Investment Strategies” series by taking on the geopolitical world. Today, we’re going to tackle an FAQ that hits closer to home.

Whether you’re an accumulator or preparing for retirement, how do you plan for saving AND spending your hard-earned cash in retirement?

My Answer: It depends.

All those popular retirement spending rules you hear about in the popular press or through your favourite financial guru really should be called guidelines. Augmenting blunt estimates with finer-pointed planning may not be as quickly accomplished. But it’s a far more effective way to plan for how much to save as you accumulate wealth, and how much to spend as you withdraw it. In fact, it’s best to consider retirement spending as being a variable process, versus a one-and-done equation.

Which is why it depends.

Let’s bend some Rules: the 4% Withdrawal Rate Rule & the 70% Pre-Retirement Income Rule

I do feel most popular retirement spending rules were made to be broken: or at least bent to fit your specific assumptions, and adjusted over time as you encounter various phases in your retirement lifestyle.

Take the 4% Retirement Rule, for example. The catchphrase has been around since 1994, when William Bengen published his Journal of Financial Planning paper, “Determining Withdrawal Rates Using Historical Data.” In it, Bengen suggested that under certain assumptions, retirees could avoid outliving their money by withdrawing no more than 4% of their wealth in the year they retire, and then adjusting this figure annually for inflation.

The 70% Retirement Rule is another popular retirement spending hack. Here you plan to spend no more than 70% of your pre-retirement income in retirement and save accordingly toward that figure. This is supposed to work because, in theory, retirees spend less in retirement to fulfill their lifestyle wants and needs.

There are many similar shortcuts for guesstimating your retirement numbers. It’s tempting to accept these simplified rules as close enough and assume they’re all you’ll need to proceed. But the thing is, while Bengen’s analysis was rightfully lauded as an innovative new way to think about withdrawal rates in retirement, I don’t think even he meant for the 4% figure to serve as a hard and fast rule for every retiree, under every assumption, throughout their entire retirement (during which your lifestyle is likely to evolve).

The same goes for the 70% rule, and similar retirement rules.

Financial Talking Heads’ Rants on Retirement withdrawal Rate and other Shenanigans

In lieu of rules of thumb, people are also known to follow the shotgun advice of popular financial gurus who spout sweeping generalities as perfect solutions for one and all.

A prime example is Dave Ramsey of The Ramsey Show, who recently assured listeners that an 8% retirement withdrawal rate should “last forever,” as long as you invest as he suggests. He said a 4% spending rate was “asinine,” based on calculations generated by “super nerds,”“goobers,” and “morons who live in their mother’s basement with a calculator.” He then goes on a Wizard of Oz tirade about flying monkeys stealing your ruby slippers. Seriously, you can’t make this stuff up. (Check out 01:19:20 in The Ramsey Show’s “You Can’t Win with Money if You Don’t Know Where Your Money Is”  podcast episode.)

Ramsey’s math is simple, which makes it appealing and easy to understand: “If you’re making 12 [percent] in good mutual funds and the S&P is averaging 11.8, and if inflation for the last 80 years is 4%, if you make 12 and you need to leave 4% in there for average inflation raises, that leaves you eight. So, I’m perfectly comfortable drawing eight. But if you want to be a little bit conservative, seven. But, sure, not five or three.”

In a Rational Reminder rebuttal episode, “Retiring Retirement Income Myths with the Retirement Income Dream Team,” my super-nerd friends (David Blanchett, the Managing Director and Head of Retirement Research for PGIM DC Solutions; Michael Finke, a distinguished professor of wealth management at the American College of Financial Services; and Wade Pfau, Director of Retirement Research at McLean Asset Management) offer what I believe is a considerably more realistic assessment of the market’s risks and expected rewards over time, with no monkey business involved:

Without going too heavily into the math, the two main counter arguments against an 8% withdrawal rate from the Retirement Income Dream Team are:

  • There can be large differences between geometric returns (what you earn in an investment) and arithmetic returns (the simple average). For example, an average 12% return doesn’t mean that a retiree’s portfolio grows by 12% per year. If $1 million invested in stocks falls by 20%, you now have $800,000. If it rises by 25% the next year, you’re back up to $1 million. The average return of -20% and positive 25% is 2.5%. But you still only have a million bucks. Your actual return was zero.
  • A 100% stock portfolio significantly increases the sequence of returns risk. For example, a U.S.-based investor, owning U.S. stocks in the 2000s and following an 8% withdrawal rule would have run out of money in as little as 13 years.
Source:  https://www.thinkadvisor.com/2023/11/13/supernerds-unite-against-dave-ramseys-8-safe-withdrawal-rate-guidance/

I would add from a behaviour side of things, that a 100% stock portfolio, especially during retirement would be virtually impossible to stick with.

When it comes to Retirement Savings, One Size rarely fits all

Besides, don’t you want your retirement numbers to be based on personalized levels of evidence and reason, instead of hope and hype? I know I do, which is why I treat sweeping assumptions and general rules of thumb as starting rather than ending points.

By necessity, generic advice involves making assumptions, often huge ones, that may or may not reflect your own realities. The original 4% Rule, for example, assumed the investor is investing their retirement nest egg in 50% stocks/50% bonds, held entirely in tax-sheltered accounts. It also assumed a 30-year retirement.

Not everyone wants or needs to invest this conservatively. At the other end of the spectrum, Ramsey appears to assume you’re going to put your entire nest egg in the U.S. stock market, mostly large-company growth. He also seems to assume (quite erroneously) that we can rely on this market to deliver an average 12% pre-inflation return forever.

My take: There’s nothing nerdy about wanting to avoid hoarding or squandering your wealth. If your retirement years are short enough, your income remains ample enough, and your market timing is lucky enough, spending 8% annually in retirement might be right for you. For others, even 4% is overly optimistic. Either way, I wouldn’t bank on any given number without first engaging in some serious reality checks, and revisiting your plans as you proceed.

Let’s return to our fictional investors to illustrate how real-life retirement planning, withdrawal rate, and spending works. Continue Reading…

Automating Wealth: How to Systematize your Path to Financial Independence

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Pexels/Tima Miroshnichenko

By Devin Partida

Special to Financial Independence Hub

Financial freedom: everyone knows what it means, but few understand how to achieve it. Those who do understand the role of automation in the process and how it allows them to focus on other vital actions necessary to reach their goals. Automating repetitive manual tasks can streamline financial management and improve decision-making.

Strategies for Automating your Finances

Becoming financially independent requires the right habits. However, consistently following a set pattern for saving, budgeting and other money-related activities can quickly feel repetitive. Automation can take care of the boring stuff, saving time and giving you more control over your financial situation. Here are some ways to go about it.

Automate Bills and Recurring Expenses

Bills you pay regularly — such as rent, mortgage, utilities, credit cards and subscriptions — take a significant part of your budget. These payments can cause stress and anxiety, especially if you have to keep track of them manually. Most banks offer automatic debit arrangements  that deduct monthly payments from your account on or before specified dates, ensuring your expenses are always covered on time.

Use a Budgeting App to Track Spending

Building long-term wealth begins with knowing where your dollars are going and how changing prices affect your budget. If you need help with your finances, a budgeting app will be your best friend.

These platforms can simplify expense tracking and help you identify where to scale back. Several are available, so feel free to explore until you find one best suited to your requirements.

Set up Automatic Transfers to your Savings Account

It’s easy to forget to transfer funds into your savings account, especially if you have many financial obligations. Like your recurring payments, you can also automate your financial conservation efforts. This method can help eliminate  the emotional side of decision-making that often makes saving money difficult.

Set Investments on Autopilot

Investing is a powerful way to grow your finances, but the inherent risks can be off-putting. Consider using a robo-advisor or investment bot to manage your portfolio, make data-driven decisions and minimize the time required to manage your investments.

For example, AI stock-trading programs can analyze historical information and current trends to predict market shifts, cluing you in on when to buy or sell a particular stock. Some systems can even tailor recommendations based on your budget and automatically make investing choices based on set parameters.

How Automation gets you Closer to Financial Independence

Financial freedom starts with defined goals backed by intentional action. Automation plays a massive role in shortening the path to achieving these objectives. Ideally, a well-framed goal only requires 3–5 steps to accomplish: anything more than that will likely complicate the process. Continue Reading…

How to Financially Prepare for Retirement

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Before you know it, it’ll be time to retire. Will you be ready? Learn how to prepare for retirement financially with this guide.

Image courtesy Logiclal Position, licenses from Adobe/ by Khongtham

 

By Dan Coconate

Special to Financial Independence Hub

Retirement is a significant life event that requires thorough financial preparedness. If you’re striving to ensure that your golden years are your best, this guide will take you through the essential steps of securing your financial future. Read on to learn how to prepare for retirement financially.

Understanding Retirement Planning

Retirement planning is more than just a single event; it’s a dynamic process that requires fluidity and adjustment. You must make significant financial decisions with respect to when you intend to retire, how you will live post-retirement, and what you hope to leave behind. The key to successful retirement planning is to start early, understand the landscape of retirement, and make informed investments and savings decisions.

Calculating Retirement Needs

It’s important to calculate just how much you will need in retirement to live comfortably and handle unexpected expenses. This involves a careful consideration of your current income, your essential and discretionary expenses, and the inflation’s impact. One of the most challenging aspects is predicting how these factors will evolve over the years.

Saving and Investment Strategies

Saving for retirement is a marathon, not a sprint, and the most effective way to prepare is through a combination of savings and investments. Retirement accounts like 401(k)s and IRAs offer tax advantages [in the U.S., or Defined Contribution plans and RRSPs in Canada.] Diversification is a crucial strategy to manage risk and increase the likelihood of a healthy return on investment.

Debt Management

Debt is a heavy financial weight, especially in retirement. One of the healthiest steps toward financial freedom during retirement is to clear as much debt as possible. Entering retirement with less or no debt is like starting a new chapter of your life with a clean slate. It’s essential to ask questions with your registered investment advisor about how to clear debt and structure your finances for these goals.

Income Sources in Retirement

Multiple streams of income make the difference between just getting by and living comfortably in retirement. Social security and pensions are a part of this picture, but a personal investment portfolio and other assets can significantly enhance your income. Maximizing these resources to get the most out of them is a testament to solid financial planning and execution. Continue Reading…

Is Now a Bad Time to buy Bonds? Yes, and Here’s Why

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We think Now is a bad time to Buy Bonds … Here’s Why

Recently a friend asked, “Pat, I see that several prominent Canadian investor advisors recently wrote articles that said it’s a bad time to buy bonds right now. Do you agree?”

He was surprised when I told him I haven’t bought any bonds for myself since the 1990s. I haven’t bought any for our Portfolio Management clients in the last couple of decades, except on client request.

In the 1990s, I used to buy “strip bonds” for myself and my clients, as RRSP investments. This was the Golden Age of bond investing. Back then, high-quality bonds yielded almost as much, pre-tax, as the historical returns on stocks. In addition, they were more stable than stocks and provided fixed income that simplified financial planning.

Bonds have tax disadvantages, of course. But you can neutralize those disadvantages by holding your bonds in RRSPs and other registered plans.

The big difference back then was that bond yields and interest rates were much higher than usual. That’s because we were still coming out of (or “cleaning up after,” you might say) the inflationary bulge of the 1970s and 1980s.

In the 1980s, government policies pushed up interest rates and took other measures to hobble inflation, and it worked. But interest rates stayed high for a long time after the government policies broke the back of inflation: kind of like finishing the antibiotic prescription after the infection goes away.

Long-time readers know my general view on the stocks-versus-bonds dilemma. When interest rates are as low as they have been in recent decades, high-quality stocks on the whole are vastly superior to bonds. However, you have to understand the differences between the two. For one thing, stocks are more volatile than bonds. But volatility and safety are two different things.

Volatility refers to sharp price fluctuations, often due to short-term uncertainty and the randomness of short-term market movements. Safety refers to the risk of permanent loss.

Bonds improve portfolio stability but cut investment returns

You might say that what you get from bonds is the opposite of what you get from the stock market.

Inflation near-automatically reduces the purchasing power of bonds. Inflation can also hurt the returns you make in the stock market, of course. However, companies you invest in can take steps to cut the costs of inflation. They can pass on cost increases to their customers. They can introduce new processes and equipment to improve productivity and cut their costs. Continue Reading…

A deadline seniors don’t want to miss: RRSP-to-RRIF conversions

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My latest column looks at a topic of high importance for near-retirees or already retired folk who have reached their early 70s: the requirement to convert an RRSP to a Registered Retirement Income Fund (RRIF) and/or annuitize.. You can find the full column by clicking on the highlighted text here:  How to cope with the RRSP-to-RRIF deadline in your early 70s.

As the column mentions, this deadline is rapidly approaching for my wife and me.

Here’s how Matthew Ardrey, senior wealth advisor at Toronto-based Tridelta Financial, sees the big picture on RRSP-to-RRIF conversions: “By the year in which one turns 72, the government mandates that the taxpayer convert their RRSP to a RRIF and draw out at least the minimum payment. The minimum payment is calculated by the value of the RRIF on January 1st multiplied by a percentage rate that is tied to the taxpayer’s age. Each year older they get, the higher that percentage becomes.”

Currently, at age 72 (the latest that you can receive the first RRIF payment), the minimum withdrawal is a modest 5.28% of the market value of your RRIF assets. By age 95, this increases to 20% of the market value, says Rona Birenbaum, founder of Caring for Clients.

You need to take the RRSP to RRIF deadline seriously: you must convert by December 31st of the calendar year in which you turn 71. What if you miss it? Then, Birenbaum cautions, 100% of your RRSP becomes taxable income in that year, which will often push you into the highest marginal tax rate. Needless to say, for those with hefty RRSPs, losing almost half of it in a single tax year would be disastrous.

There is of course the option of using your RRSP to purchase an annuity, but Birenbaum observes that most clients opt for the greater flexibility of the RRIF.

Given the normal human inclination to procrastinate, most near-retirees will probably want to keep their RRSPs going until the bitter end and aim for this “latest” deadline for conversion. However, technically, Birenbaum says you can open a RRIF much earlier than is mandated. “There is no earliest age, though it’s rarely beneficial to open a RRIF during your working years.”

Note that when RRIF income is received, it’s taxed as fully taxable income, Ardrey says, “There is no preferential treatment for this income, like there would be for capital gains or Canadian dividends. Though this income is a cornerstone for many Canadians, it can also cause tax complications that were not there

While similar in several respects Birenbaum notes some important differences between RRSPs and RRIFs. Both are tax-sheltered vehicles, can hold the same investments, and withdrawals are fully taxable as income. However, RRSP contributions are tax-deductible, while you can’t contribute to a RRIF (so there are no tax deductions.)

RRSPs don’t have any mandated withdrawals, whereas RRIFs have mandated annual withdrawals, starting in the calendar year after you open the account. With RRSPs, there are no minimum withdrawals, although they are permitted: your only option is to request a one-time lump sum withdrawal (and pay tax on it at various rates depending on the amount you wish to withdraw).

RRIFs have mandated annual minimum withdrawals, which rise steadily over time. Minimums are outlined on this website. Unlike an RRSP, a RRIF lets you automate withdrawals for ease of cash flow management (monthly, quarterly, annually etc.)

Unless the taxpayer requests it, there are no withholding taxes on RRIF minimums. A second complication is that this extra income from the RRIF can also trigger clawbacks of Old Age Security (OAS) benefits. If income exceeds $90,997, OAS payments will be clawed back by $0.15 for every dollar over this amount until they reach zero, Ardrey warns.

Pension splitting and using your spouse’s age

Fortunately, there are ways to minimize these possible tax consequences. If you are one half of couple, you can benefit from a form of pension income splitting: RRIF income can be split with a spouse on their tax returns, providing the taxpayer is over the age of 65. “Even if incomes are in a situation where a RRIF income split would not seem logical, a split of $2,000 can provide a pension tax credit for the spouse. This could also be the difference between being impacted by the OAS clawback or not.”

Another trick is basing your minimum RRIF payment on your spouse’s age. This works when you have a younger spouse/ By doing this, the taxpayer gets their younger partner’s age percentage applied to their RRIF minimum payment.

The full MoneySense columns goes into the mechanics of withholding taxes and what happens upon death.

The Mechanics of Conversion

Birenbaum says you can usually expect your financial institution to reach out to you to remind you before the deadline. There will be paperwork to file at the institution where you’d like to hold the RRIF, although it’s not required that the RRIF be at the same place your RRSP is held. Your existing RRSP investment holdings can be simply transferred to your new RRIF account. The initial paperwork will ask you to set your desired payment schedule (day of month and payment frequency), to choose RRIF minimums based on your age or that of your younger spouse.