IN THIS ISSUE: “When can I retire? How much money do I need to save? Are my current investments enough?” Questions like these can make preparing for retirement a daunting task. Factors such as your financial objectives and how you take your income are major pieces of your retirement puzzle. In this edition of Tactics, Phil Tippetts-Aylmer explains our retirement planning process and focuses on areas that can help you reach financial independence sooner.
I have a three-year-old and a four-month-old. The four-month-old doesn’t talk much (give her time), but the three-year-old has quite the vocabulary: “why?” and “what for?” are his latest addictions (not to mention “no” – but that’s a topic for another, more famous (Dr.) Phil, so we won’t get into that). He’s also discovered “are we there yet?” and it got me thinking about life, work, and how things seem to come full circle. In looking at the issues and opportunities we face when approaching retirement, it struck me that the question everyone really wants answered is: “are we there yet?”
So in this newsletter, we’ll look at the process, issues, and opportunities that become apparent when approaching retirement, and hopefully give you a clearer picture of where you’re going and how to get there.
At Nicola Wealth, retirement planning is an integral piece of a bigger picture that is the Financial Life Cycle. No matter who or where you are, you can find yourself somewhere in this cycle. We see our role as helping you determine where it is you see yourself in retirement and how you can best get there. Where we can add a greater benefit, is getting you there sooner or making the outcome better than you had initially hoped.
How do we achieve this? By following a regimented process of developing a financial plan and helping you stay the course by sticking to that plan. The financial plan deals with all facets of your financial well being. We examine the structures and systems that you use to manage the day-to-day financial needs of your family now, and with an eye on the future.
The first step is to establish and clarify the facts that are pertinent to your situation. When broken down, the areas of focus are simple, and when put together they create a picture of your financial situation:
Having established where you are (Net Worth), it’s prudent to identify where it is you want to get to in retirement. An area often paid only lip service, this is a key issue to be addressed. Not knowing what the desired end result looks like is akin to starting a journey not knowing the destination… tough to arrive if you don’t know where you’re going. Once you’ve determined how much after-tax income you need to retire, you’ve set your “destination”.
This is not to say that you can’t change your destination once your journey begins. However, without an end in mind, you’ll always be wondering aimlessly. When your asset base can sustain your desired retirement income, you’ve essentially achieved the ability to stop working at any time.
How much do you make and how much do you need? Sounds simple, but clarifying how one takes income is a critical step and often an area where inefficiencies can be found immediately. Making your method of income more efficient means less tax paid; less tax paid means more money saved; more money saved means quicker wealth accumulation. Be more efficient and retire earlier or with more money. Determining how much income you need to consider retirement is a direct result of understanding your Financial Objectives.
This applies to the majority of our clients and walks hand in hand with income structure. Creating a situation to allow for the most efficient income structures has a big impact on the end result. In conjunction with your income structure being set up correctly, it’s likely that the bulk of your savings will occur corporately, inside a tax-efficient environment. These two issues are key components of any plan.
So now that the facts are established, we can begin to look for the strategies that will help you reach your desired financial destination sooner or with a better end result than initially thought possible. The strategies tend to come in the form of smaller, more focused areas of attention that, when integrated together, become the overall plan. These areas of focus include:
This can come in various forms, however the most typical issue for our clients is how to take income (dividends versus salary). This topic was reviewed in detail in a previous edition of Tactics (The Taxman), where the benefits of having an efficient income structure are clearly illustrated. Advantages of efficiency in this area include key factors such as: increased savings, reduced taxes, recouping of refundable taxes and access to a wider array of investment choices. For more details, review The Taxman newsletter and discuss it with your advisor at your next review.
The majority of our clients are incorporated professionals, and planning is reviewed on a case by case basis. For example, where a client’s company will be sold at a future time, planning revolves around securing the use of their capital gains exemption (recently increased to $750,000). Where a business sale is not certain, important financial planning considerations include managing a working life (especially towards retirement) with scaled back hours and production, and recognizing the impact that will have on lifestyle and retirement plans.
Many high net worth individuals have clear philanthropic goals and, as wealth increases, often so does the level of charitable giving. The tax treatment of gifting funds to charities can be advantageous for many clients and utilised to their benefit. We work on developing creative charitable giving strategies to further enhance the tax benefits that clients can receive and, as a result, further enhance the gifts given to charities.
When creating your plan, it is important to understand that retirement should be seen as a choice. It’s the point at which you are choosing to work rather than needing to work. Some of you are there. Some of you find that “there” moves and changes each year. Some of you don’t really know where “there” is. Well, we can help with all of this and it starts with the lifestyle you anticipate having in retirement and the likely level of income that will be required to sustain it.
Retirement issues/topics are many: RRSPs, healthcare, CPP & OAS pensions, pension claw-backs, unfunded pension liabilities, aging population, and on the list goes. In the interest of keeping things bigger picture and relevant, let’s look at two key areas:
- Lifestyle: Putting some thought into the kinds of activities one will do in retirement.
- Money: Retirement income – how much… and for how long?
Lifestyle: The question most frequently met with a blank stare in meetings is, “how much do you think you need to retire on (or with)?” Some clients have a sum total in mind. “$2M” or “$3M” are common answers, but without knowing how much income you need, how can you know how much capital you need? It can appear to be a daunting task to project yourself 20 years from today and determine how much money you’ll be spending, but it’s a lot like the question “How do you you build a castle?”
Answer: “One brick at a time.” Build up to your final answer piece by piece. We start by asking questions like:
- “What would you like to do when you’re no longer tied to work responsibilities?” Typical answers include: travel, paint, read, write, finally buy that boat/car/Winnebago, live 6 months of the year in Hawaii, spend more time with family – all of these are valid goals and can be assessed in terms of cost a little more easily than the overall picture.
- “Do you plan to travel?” Destination, duration, frequency, class (1st class or on a budget), to what age, etc. Do both halves of a couple have the same aspirations? It is not that difficult to come up with an idea of how much you would need to meet those goals for a period of time.
- “What fixed costs will you have?” Typical answers include: taxes, debt servicing, property maintenance, education costs, food and drink, clothing, new cars every so often, etc.
- “What other expenses are you likely to have to deal with?” This covers a multitude of issues: entertainment, healthcare, gifting money (charitable/family), miscellaneous, etc.
Breaking down these costs should be manageable (healthcare excepted, as these costs will be different in retirement years). Calculate the gross total (including a buffer percentage) and you have a rough idea of what kind of expenses you’ll face in retirement.
Clearly this is not an exact science, but bear two things in mind as you think about this:
- In going through this exercise you will be far more aware of your likely needs and costs than you were before, and
- If the actual expense figure you experience in retirement is different from that estimated via this process, the difference is more likely to be of the small, manageable variety rather than the big scary variety.
Money: Armed with an awareness of what your retirement lifestyle is going to cost you, the issue of how much capital you need comes to the fore. Via our retirement income spreadsheet, we can quickly estimate one’s savings requirement to achieve their desired retirement income. It allows us to plot a chart from where a client is today, in financial terms, to where they wish to be at a retirement age. The spreadsheet then gives us an indication of what level of regular cash/savings we need to reach the goal.
More than just the selection of investments, portfolio management encompasses the task of growing your investable asset base to desired levels and ensuring that it provides the maximum tax-efficient income for you and your family in retirement. This includes organizing asset categories into suitable account types to achieve tax-efficient returns. Holding interest-bearing assets in registered accounts and dividend/capital gain-generating assets in corporate or non-registered accounts creates a tax-efficient environment for portfolios to grow.
We build portfolios from the asset allocation out. In gathering the facts, we build an impression of your investor profile and match up asset allocation percentages based on your goals and risk aversion. Once we’ve narrowed this down, we’ll then concentrate on security and manager selection. Our fee-based approach allows us to objectively select the best managers and best vehicles for our clients allowing them the greatest chance of achieving their set investment goals with the least volatility.
The efficient structuring of income (as previously outlined) means that the bulk of our clients’ savings will be corporate and not in RRSP accounts. This results in an accumulation of funds inside corporate savings accounts; the company becomes the main retirement savings vehicle.
Why should incorporated professionals deviate from the typical course of saving in an RRSP? The answer lies in being a small business owner. In most instances our clients’ businesses qualify as a “small business” paying tax at 17.6% on the first $400,000 of active net income. In this case, money placed into a personally held RRSP is taken from an environment where it is being taxed at only 17.6%.
The result is that 17.6% is the most tax that can be saved by a small business owner in making an RRSP deposit. When the funds come out of an RRSP or RRIF as income, they are taxed at the marginal rate, which is more likely to be higher than this small business rate.
In taking dividends as income (rather than salary – see The Taxman) further benefits come from the fact that the company’s income can be split between shareholders (commonly spouses and Family Trust beneficiaries – i.e., other family members) which will reduce income taxation. In paying out dividends the company will also qualify to recoup Refundable Dividend Tax on Hand (RDTOH), which, when combined with a tax efficient corporate investment portfolio, could drop the overall tax rate on corporate investments to as low as 10%.
It’s also important to note that one has access to a wider array of investments in the non-registered corporate environment as compared to an RRSP. Consequently, we believe that saving corporately is a very attractive option for our incorporated clients.
This point is illustrated graphically by another of our (now famous) spreadsheets. We are restricted by space here and can’t show details of the spreadsheet, but our calculations show compelling evidence to suggest that corporate investing can achieve a very efficient tax outcome. Let us show you how this applies to you in your next review meeting.
Insured annuity – Previous newsletters have dealt with the topic of insured annuities in far more detail than we will be able to offer here (see Have Your Cake & Eat It Too, also available online). Suffice it to say that the implementation of an insured annuity can be a critical investment decision to make pre-retirement. Yes, I said investment decision.
For the sake of simplicity, let’s say an advisor told you there was a product that offered guaranteed return of principal and an after-tax income close to double that of a regular GIC. In some cases (where the use of registered funds is applied) it could alternatively eliminate all taxation on that registered asset upon the owner’s death. You’d probably think that was a pretty good deal and want to learn more. Well it’s called an Insured Annuity, it is a good deal, and you definitely should learn more.
A critical phase in the life cycle, this concept has been reviewed in other newsletters (see our newsletter The Road to Hell) and it demands more time and space than we have here. That said, this is a piece in the overall puzzle and must be integrated into the overall plan.
Those of you who have no desire to leave an estate and who would like nothing more than to have the cashing of your last cheque coincide with your last breath, take note of this. Our experience is that individuals are not comfortable with a constant decline in their asset base, thus eroding their wealth to sustain their retirement lifestyle.
The more likely scenario is that there will be a residual estate. Effective retirement planning and the use of income-focused portfolios (including an Insured Annuity) mean that leaving an estate is a foregone conclusion.
Sorry, chances are you’re going to die wealthy! Bummer!
The planning process should be a focus on various areas of your current and future financial life. When we integrate the pieces we’ve discussed into an overall financial plan and put it all together, we should have you well on your way to reaching financial independence earlier and with less bumps along the way.
“Are we there yet?” Yes we are! At least until the next trip.
Usually by the time I turn around to let my son know that we have arrived, he’s fast asleep. Hopefully you were a bit more enthused by this latest edition of Tactics and by the prospect of reaching your retirement destination safe and sound.