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.

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…

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…