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.

You should protect your retirement portfolio assets long before your actual retirement date.

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By Dale Roberts

Special to the Financial Independence Hub

We often think of wealth building and retirement as static dates. We have that accumulation stage when we are building our assets and net worth, and then we have that decumulation stage (retirement or semi retirement) when we are spending our assets. We tend to think of those periods in static terms, with hard stop and start dates. But that could be dangerous thinking thanks to what Dr. Moshe Milevsky of York University describes as the Retirement Risk Zone. That period is typically 5 years before your retirement date and the first 5 years of retirement. That is when the risks are greatest for a retiree.

We need to prepare our investment portfolios well in advance of our planned retirement date. We need to protect our ASSets. And certainly we build wealth in many ways or by many channels. We have our cash and investment portfolios, and we may also have workplace pensions that are building future retirement payments. And of course we have our real estate and perhaps we are also building value and net worth in business ventures. We may have inheritances that we know are likely to come our way. On that front, we don’t want to count those chickens before they hatch.

In this post we’ll discuss protecting the assets that potentially hold the greatest risk: the stocks in your investment portfolios. Of course the funds could be in an RRSP, RRIF, a locked-in plan of sorts, your TFSA or in taxable accounts. And the risk comes from holding those stocks that can be more than volatile at times.

As a refresher, imagine if you had picked January 2008 as your retirement date. In 2007 things are looking rosy and then the Financial Crisis hits and the US stock markets fall by more than 50%. The chart is courtesy of portfoliovisualizer.com

Retirement 2008 start dateYour handsome $350,000 RRSP portfolio gets clipped to fall below $200,000. If a retiree was spending down in typical fashion on the above portfolio they would have seen that $350,000 drop to the $170,000 range. If one entered retirement with an aggressive all-stock stance, they might have their retirement permanently impaired. The Retirement Risk Zone is more about the retirement funding math compared to your tolerance for risk.

Related post: How Retirees Made It Through The Last Two Recessions

When should you prepare your portfolio for retirement?

Again, Dr. Milevsky suggests the risks are great even 5 years before retirement. I’ll give an example using perhaps the most dangerous start date for a retiree over the last 50 years: the year 2000. This was the beginning of a stock market correction that simply would not let up. US stocks were down for 3 successive years in 2000, 2001 and 2002. That has only happened twice in US stock market history, you’ll have to go back to the Great Depression of the 1920s and 1930s to find the other event. Canadian stocks were down for 2 years in a row and did not suffer the same level of meltdown (though it was certainly a troubling bear market).

As you can imagine if a retiree had the year 2000 as a retirement start date and they entered retirement with an all stock portfolio that asset bucket would have been permanently impaired. Of course, I’m assuming that they need to spend from that account type. If you need to spend from that plan or retirement bucket, you need to protect those assets at least 5 years in advance.

Here’s an example of failure in the last years of portfolio accumulation for a retiree. The year is 1998, the stock markets are one the greatest kicks in stock market history and our retiree is smiling from ear to ear with those incredible portfolio gains and a planned 2003 retirement date.

In 1998 our future retiree has $350,000 in her RRSP account, she is still adding $700 monthly, or $8,400 annual. Once again, we’ll use the US stock market for demonstration purposes. Of course you hold a more diversified asset mix.

Retirement 2003 No ProtectionThe retiree has been adding monies on a regular schedule for 5 years and has a negative rate of return. The real rate of return when we factor in inflation is even less favourable. The retiree started 1998 with $350,000, added $42,000 and ended the period with just over $369,000.

In Scenario 2 our retiree moves to a Balanced Growth model in 1998. She is now 70% stocks and 30% bonds (I’ve used 10 year treasuries). She enters 2003 with modest but positive returns for the period, and with a portfolio value of $438,000.

Retirement 2003 with ProtectionAnd of course, to a point, the more conservative a portfolio (more bonds) the better for the test. But hey, that’s all certainly hindsight as we’ve picked the worst possible retirement start date. Right? Not so fast. Even if we look at the 2008 market correction protecting the assets well in advance works much better, and the more conservative the balanced portfolio, the better. You might at least keep your equity allocation in the 30%-40% area.

*And certainly, one can use other assets beyond bonds to manage risks.

We are on the same last few years accumulation strategy with a 2010 retirement start date. In this example we are ‘protecting’ the funds 6 years in advance.

Portfolio 1 is all US 100% equity.

Portfolio 2 is 60% stocks and 40% bonds.

Portfolio 3 is 40% stocks and 60% bonds.

Retirement 2010 start date various allocationsThe only time this strategy will fail, that is deliver opportunity cost, is when we take out a severe market correction and invest only in a period of mostly rising markets (bull markets). Of course as an investor or advisor that is not a risk that you want to take. You do not want to guess that a stock market correction is not in the near future. Stock market corrections historically come along with regularity. We are currently in an abnormal period of an extended (mostly) bull market run.

A more conservative accumulation stage

As we approach the final turn toward the retirement ‘finish line’ we obviously want to increase our portfolio value. Continue Reading…

My biggest retirement planning mistakes

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Looking back, my biggest retirement-planning mistakes had nothing to do with money. Rather, they resulted from not thinking things through and not having a good retirement lifestyle plan in place, for when I did retire.

Because of that, it took me a couple of years to figure things out and get things right after retiring. Unfortunately, I will never get that time back. If I could do things differently, here are some of the mistakes that I would avoid making:

Mistake #1

Deciding to turtle, play safe and hang on for another 7 years

The opportunity cost of staying in a career that you no longer like just so you can max out your pension is high, especially if you have already achieved financial independence. You end up losing precious time and become sour. But there is something about that pension statement with the pre-determined retirement date that keeps us coming back for more. I can’t tell you how much time I spent running the numbers over and over again trying to figure out the right combination that would allow me to move on to something better.

Few people quit a marathon at mile 25 and most people late in their careers will choose to hang in there until the bitter end. But they need to ask themselves: Is it really worth it?

Why continue to waste valuable time putting off something that you are truly passionate about?

Although switching to part-time work means taking a pay cut, finding great work increases the odds of you working longer. Instead of retiring at age 62 feeling tired and worn out, you are thriving and excited by the work you do. By finally making the choice to leave and start your Victory Lap (VL), you no longer go to bed at night dreading the next morning’s work, trying to hang on until another weekend. Making a little less for a little longer while dramatically increasing your daily personal fulfillment is a total win.

Mistake #2

Not knowing my values and what would make me happy in retirement

I’ve learned that a great retirement is not about how much money I have; rather, it’s about an attitude, a way of living, filled with searching and discovery. To have a great retirement, you need to have a good sense of who you are, what you are, what you value and what will make you happy.

Unfortunately, because we are so busy taking care of our families and just trying to survive, we lose touch with our values.

In order to be happy in retirement, you need to get a good feel for who you are. This can be done through self-analysis to identify your abilities, values, drivers and interests. After going through this process, you will know what you are good at, and what you want/need to do with the rest of your life.

Mistake #3

Not starting work on my side gig before I left my corporate job

Working on what I planned on doing in my VL would have been a far better use of my time, instead of wasting it de-stressing in front of the TV for hours at night. 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…

Maxed out RRSP and TFSA? Non-registered investments vs. HISAs or GICs

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By Julia Faletski

(Sponsor Content)

So, you’ve maxed out your registered retirement savings plan (RRSP) and tax-free savings account (TFSA). Maybe you’re a diligent saver. Or you’ve just sold a home or a business. Maybe you’ve inherited wealth. Whatever the reason, you’ve got additional money to invest. And if you were thinking about putting it into a high-interest savings account (HISA) or GIC, think again. There are better ways to grow your money.

Earn more with Non-Registered Investments

Any investment that generates positive returns will bring you closer to your financial goals. And while GICs and HISAs do generate small but guaranteed returns, historically you’re much better off generating growth in an investment than letting it sit in a slow-to-grow savings account.

The chart1below compares the growth and performance of a non-registered investment, GIC and HISA overtime. While HISAs and GICs promise consistent returns, you can see that the non-registered investment account comes out significantly ahead.

How are non-registered investments, HISAs & GICs taxed?

The most common types of investment income include: dividends, interest and capital gains. And while the income earned from investments is always subject to tax, not all forms of investment income is taxed the same way. Some investment income attracts less tax. 

Investment income from HISAs and GICs is considered interest and the taxes owed are based on your marginal tax rate (which varies by income and province). This is noteworthy because this type of tax is the most expensive.

Non-registered investments have a unique advantage in that they can earn a blend of different types of income as a result of what’s held within the account (the most common includes dividend income and capital gains). This is an advantage because the gains earned are taxed at different rates, opening up an opportunity to reduce the taxes paid on the income earned. Continue Reading…

Retirement #2 priority but four in ten Americans don’t see it happening

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Retirement is a close second to home ownership, according to a LendEDU survey of American saving priorities

While having enough money saved for Retirement is narrowly behind buying a home, more than a third of Americans don’t expect they’ll ever be able to retire, according to a survey released Tuesday from LendEDU.com.

Retirement saving was cited by 19% of 1,000 respondents, versus 20% prioritizing “buying my own house or apartment.” Paying off credit-card debt was cited by 14% and building an emergency fund by 10%.

While there was only a minor lack of confidence about paying off credit cards and building an emergency fund, 17% don’t believe they’ll ever become homeowners and but almost four in ten Americas (39%) don’t believe they’ll ever be able retire.

Of those doubting their ability to retire, 52% were over age 54, 30% were between 45 and 54, and 15% were 35 to 44.

As for emergency savings, 33% said a major bill resulting from an injury would destroy their savings and therefore their long-term financial goals; another 14% cited some form of debt that could quickly get out of hand. However, 28% felt “relatively secure” and did not believe their financial goals could be derailed.

Secondary priorities

After home ownership and retirement, the most cited financial priorities were some form of getting out of debt: 14% cited paying off credit-card debt, 7% paying off student-loan debt, and 4% cited paying off other forms of debt apart from credit cards or student loans. 6% answered “Building my credit score,” 5% wanted enough saved to move out of their parents’ homes and rent a home or apartment, 4% said “Buying a car,” and 3% wanted to start a business.

1% wanted to invest in real estate, another 1% wanted to buy a second home and yet another 1% wanted to buy a second or third car. 3% want to “create a retirement account” and 2% want to “invest in the market outside my retirement account.”

Money a bigger priority than Love?

Of the 37% who were not currently in a long-term relationship, 72% were more focused on their financial targets, versus a minority 23% who prioritized finding a romantic partner. (The rest preferred not to say). The survey sees this as a “glass half full” finding: “It is good that Americans are quite serious when it comes to realizing their personal finance goals. But, on the glass empty side, sometimes one’s finances can’t buy happiness, or in this case love, and it is always important to understand what is truly important in life.” Continue Reading…