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.

Generating Retirement cash flow from your Investments

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Once you stop working your objective shifts from growing your investment portfolio to generating income from it. Many retirees obsess over generating enough retirement cash flow from their investments. They prefer a predictable stream of income to partially replace their previous salary income.

Here are some strategies for getting cash flow from your retirement portfolio:

1.) Income only

This option is popular with retirees who want to maintain the value of their assets. Using this strategy, the retiree subsists on whatever income their bond and stock holdings generate.

Pros: As it doesn’t involve tapping into principal, this approach provides some insurance that a retiree won’t outlive assets. Investors tend to be more relaxed with short-term market volatility while receiving regular payouts.

Cons: Days are long gone where you could buy GICs and bonds yielding a safe 10 or 12%. Retirees in the 1990s were dismayed to see the interest on renewals drop from double-digit to mid-single digit rates, and now you may not get much more than 2%.

More investors are leaning towards dividend-paying stocks. A basket of dividend-paying stocks might generate 3% or 4% without taking on too much risk. Given these current low returns, the securities in a portfolio may have trouble generating a livable yield. Depending on your income requirements, you’ll likely need quite a large amount of invested capital to generate the income you desire.

Related: Why Living Off The Dividends No Longer Appeals To Me

Be careful when hunting for yield. Dividends are not guaranteed. Changes to a company’s dividend policy could occasionally result in payouts being reduced or eliminated altogether.

In reality, most investors will need to dip into their principal anyway to meet unexpected large expenses.

2.) Total return strategy

Here, retirees reinvest all income, dividends and capital gains back into their holdings at their target allocation after taking the amount they need for annual living expenses.

Pros: By rebalancing, it forces the investor to sell appreciated assets on a regular basis while leaving underperforming assets in place, or adding to them.

Cons: If there is a prolonged market downturn, withdrawals can drastically erode capital and reduce future return potential. That argues for holding a comfortable cushion of at least 3 –5 years worth of living expenses in liquid form – cash or cash alternatives. Continue Reading…

U.S. Inflation: A case of high anxiety?

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U.S. CPI vs. U.S. CPI ex-Food & Energy Year-over-Year Change from 1/31/2010 to 1/31/2018

By Kevin Flanagan, WisdomTree Investments

 Special to the Financial Independence Hub

There is no doubt that inflation fear has reared its ugly head early in 2018, impacting the money and bond markets in rather noteworthy fashion. Some key headline-grabbing measures, such as wages and the Consumer Price Index (CPI), have come in above consensus forecasts to start the year, fueling a case of high anxiety for the fixed income arena. Naturally, the million (or should it be billion?) dollar question is: Are these heightened inflation fears warranted?

As we entered the new year, consensus forecasts for inflation were that readings at both the overall and core (ex-food and energy) levels would essentially remain unchanged. Interestingly, economists’ projections have been revised upward of late and now post slightly elevated readings. Indeed, the CPI is now expected to come in at a year-over-year rate of +2.3%, or 0.2 percentage points (pp) higher than the prior projection. The alternate measure, the personal consumption expenditures (PCE) price index, has been changed to a +1.9% increase (also up 0.2 pp), with the core PCE gauge being lifted 0.1 pp to +1.8%. The bottom line is that these revised estimates now all look for some modest increase from 2017 levels.

What about the Federal Reserve (Fed)? For now, all investors have to go by is the policy makers’ December projections. The March FOMC meeting, scheduled for March 21st, will be the Fed’s next chance to make any potential adjustments to their prior forecasts.. The preferred measure is the PCE price index, and the policy makers provide projections for both the overall and core PCE gauges. The Fed’s central tendency estimate is similar to the revised market consensus, with a range of +1.7% to +1.9% for each index. It should be noted that both the economists’ and the Fed’s current PCE projections still fall below the +2.0% target laid out by the policy makers.

Let’s take another look

So, let’s take another look at the aforementioned wages and CPI numbers. Continue Reading…

Lending to Spouse at Prescribed 1% rate ‘Best Before’ April 1

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“Never spend your money before you have it.”
—Thomas Jefferson

I can’t emphasize enough that time is truly of the essence if you benefit from implementing this simple family lending practice. Interest rates are expected to inch up again and will alter the value of this tactic. Hence, I revisit the benefits of one of the few remaining family income splitting strategies.

It is commonly known as the “prescribed rate” loan. The procedure needs these components:

  • One spouse is in a lower tax bracket than the other, or earns little income.
  • The higher tax bracket spouse has cash to lend to the other spouse.

“The benefit of the prescribed loan strategy is a bigger family nest egg.”

Examine your family benefits from this income splitting opportunity. All loan arrangements and documentation must be in place by March 31, 2018 to derive maximum benefit. The key is to charge interest at least at the prescribed rate on cash loaned to a spouse/partner. That prescribed rate is now set at 1% for loan arrangements made by March 31, 2018.

The lower income spouse aims to accumulate a larger nest egg while the family pays less tax. The good news is that loans don’t have to be repaid for a long time, say 10 to 20 years or more.

My sample case highlights the income splitting strategy (figures annualized):

  • The higher tax bracket spouse lends $200,000 to the other at the 1% prescribed rate.
  • The recipient spouse invests the cash, say at 4% ($8,000) and reports the investment income.
  • The recipient must pay 1% annual interest ($2,000) to the lender spouse.
  • The lender spouse is taxed on the 1% interest, while the recipient deducts it.
  • The recipient is taxed on the net income generated ($8,000-$2,000).
  • This results in annual income of $6,000 shifted to the lower income spouse.
  • A promissory note is evidence for the loan.
  • A separate investment account is preferred for the recipient.
  • These loans are best made for investment reasons, such as buying dividend stocks.
  • A new 1% loan can also deal with an existing higher rate prescribed loan.
  • Multiple prescribed loans can be made at 1% while the rate does not change.
  • Business owners can investigate the viability of prescribed loans to shareholders.

Prescribed Rate Loan – Sampler

Here is a simplified method to think of such loans:

Cash Borrowed at 1% rate:  $200,000
Assumed Investment Income (4%): $8,000
Less: Prescribed Loan Interest (1%): $2,000
Taxable Income for Borrower Spouse: $6,000
Taxable Interest for Lender Spouse: $2,000

The benefit of the prescribed loan strategy is a bigger family nest egg. Your mission is to shift investment income into the hands of the lowest taxed spouse.

Need for speed

Today’s prescribed rate, which is set quarterly, is as low as it can be. However, it is most likely to rise at the next setting later this month. The prevailing expectation is a jump to 2% from the current 1% rate on April 01, 2018. Such an increase reduces the net value of the loan arrangement. Further, we may not enjoy a 1% rate for a long time, perhaps never again. Continue Reading…

Choose investments carefully when building dividend portfolios for long-term gains

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A dividend portfolio should focus on high-quality stocks with a proven record of paying dividends

High-growth dividend stocks offer investors a measure of security. Dividends, after all, are much more stable than earnings projections. More important, dividends are impossible to fake: either the company has the cash to pay them or it doesn’t.

It’s important to make sound moves while building a dividend portfolio. That’s why we recommend looking for dividend stocks that have a strong position in their market and have a history of building revenue and cash flow.

The best stocks for your dividend portfolio dominate their markets

When we suggest dividend stocks for a portfolio we look for dividend stocks that have industry prominence, if not dominance. Our reasoning, besides brand recognition, is that major companies can influence legislation, industry trends, etc. to suit themselves. Minor firms can’t do that.

How to avoid sabotaging your dividend portfolio

You may decide to vary how much money you invest every year, depending on your view of the market outlook. But nobody can consistently guess right about the market outlook. Trying to do so is likely to cost you money about half the time.

If you invest more money in years when you’re confident about the economy or market, you may wind up buying more shares when prices are high. If you cut back on your investing in years when the outlook is uncertain, you’ll buy fewer shares when stock prices are low.

Investors may go so far as to try to improve their returns by taking money out of the stock market when they feel risk is high. They often get this urge after a few weeks or months of bad financial news or unsettling political developments. By then, however, the market may have already dropped enough to offset any negative developments.

Often, these temporary sellers wind up buying their way back into the market when the news has improved and stock prices have gone above the price where they sold.

Some brokers encourage this costly practice. From time to time, they may advise clients to “take some money off the table,” setting up a false analogy between investing and gambling. That’s in a broker’s interest. Continue Reading…

Budget 2018 aftermath: Holding passive investments inside Private Corporations

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By Brad Smith and Tea Pupica-Terzic 

Special to the Financial Independence Hub

The 2018 Federal Budget confirms that the Government will move forward with the implementation of the December 13, 2017 proposals regarding the splitting of income by private company owners and their family members. The Budget, however, proposes two additional key measures regarding the taxation of passive investment income earned by a Private Corporation, a topic that was aggressively targeted by the July 2017 consultation paper on tax planning strategies involving private corporations.

The first measure focuses on limiting the access to the small business tax rate to private corporations earning a significant amount of passive income.[1]  Currently, the small business deduction limit allows for $500,000 of active business income to be taxed at a preferential small business tax rate. This $500,000 limit begins to be ground down once the taxable capital of an associated group of companies reaches $10,000,000; it is completely eliminated once the taxable capital of the group is $15,000,000.

Budget introduced new reduction mechanism on passive investment income

The Budget’s proposal introduces a new reduction mechanism, which will work in tandem with the aforementioned existing business limit reduction, based on the passive investment income earned by a private corporation and its associated group. Specifically, once a corporation and its associated members earn $50,000 of passive investment income in a given year, the small business deduction limit begins to be ground down, on a straight line basis, until the passive investment income reaches $150,000. At this point, the small business deduction limit would be ground down to nil. The new reduction will apply to taxation years that begin after 2018.

The second measure aims at correcting an unintended tax advantage currently enjoyed by some private corporations when paying out eligible dividends to their shareholders in situations where the refundable tax pool (aka refundable dividend tax on hand “RDTOH”) was generated from investment income that would need to be paid out as a non-eligible dividend. The Budget is creating a new account, called the eligible RDTOH account, which will include the tax paid on eligible portfolio dividends.

Otherwise, tax paid on investment income or on non-eligible portfolio investments will be included in the non-eligible RDTOH account. The ordering rule will dictate that a private corporation, in payment of non-eligible dividends, will first have to access the refundable tax in the non-eligible RDTOH pool before it can tap into the eligible RDTOH pool.  A payment of eligible dividends will only entitle the corporation to dividend refund to the extent of its eligible RDTOH pool. These new measures will also come into play after 2018.[2] Continue Reading…