by Thomas Johnson
I’ve had many clients who struggle with the idea of retiring with a single dime of debt on their balance sheet. There seems to be this inherent, ingrained notion that all debt is bad debt and it’s impossible to retire successfully when you are still on the hook for repayment. While eliminating debt is generally a good thing for your finances, it is still possible to enjoy a comfortable retirement with some controlled debt scenarios, such as:
1. “Good Debt”. I define “good debt” as any debt that is taken on to positively grow your asset base. Loans for investment in securities, business ventures, or real estate are typically good for a number of reasons. If the asset purchased is of an investment nature, the interest costs may be tax deductible, which makes the net cost of the debt lower than at first glance. Debts secured by appreciating assets can also be cleared by selling the asset in a pinch. This makes unexpected cash crunches less damaging to your finances when you have collateral on your side. “Bad debt,” conversely, is debt that is accrued for depreciating assets or regular spending. If you have lots of bad debt as you approach retirement, it may be a sign that your budget needs realignment.
2. Limited Impact on Your Cash Flow. If you still have a mortgage as you near retirement, or a small balance on your vehicle loan, don’t fret! If the cash flow requirements of these debts can make it into your retirement budget without too much sacrifice elsewhere, then you may still be able to retire on schedule. A helpful trick for those that intend to downsize their home in retirement is to restructure that remaining mortgage balance over a longer amortization. This will reduce your monthly outflows for mortgage payments and the balance can be paid off when you eventually sell the house.
3. Unused Credit Facilities. I’m often asked by clients if they should close out their home equity line of credit that they never use. If it’s not costing them fees to maintain and not harming their credit scores, I will encourage them to keep it open! Access to low-cost debt in retirement can be harder than many realize. Lenders can’t collateralize registered investments,
like RRSPs or LIRAs, and have harder times underwriting investment income than employment income. If you have an emergency crop up in your retirement years, access to low-cost debt sources can help fill the hole without ruining your tax or
investment plans. It’s an excellent tool to keep in your retirement toolbelt!
Don’t let debt deter you from your retirement dreams! Structuring your household liabilities, the right way, can have a positive boost to your balance sheet without hindering your lifestyle. Take the time to understand what you owe and, maybe, that loan can co-exist peacefully with the next chapter of your life.
by Thomas Johnson
One of the most common idioms when it comes to investing is “buy low and sell high.” It’s a simple notion that can be dreadfully hard to achieve in our retirement years. After all, your retirement investments are likely one of your main sources of income. If you’re “selling” to fund your retirement every few weeks, or each month, how can a person manage to consistently “sell high?” To attempt to do so might be maddening and to ignore it could be detrimental to your finances.
A really simple, yet effective strategy I employ is called the “Two Bucket Approach” to retirement income planning, and it works like this:
Step 1: You separate three-to-five year’s of retirement income needs into a low-risk portfolio. This is your “income bucket.”
Step 2: You put the remainder of your capital into a risk-appropriate, long-term portfolio. This is your “growth bucket.”
Step 3: You only take withdrawals from your income bucket.
Step 4: Review your growth bucket regularly. In years where it has made a profit, you top up your income bucket. In years where it has a dip, you don’t touch it.
By following this style of process, your routine “sells” are only made from stable holdings. Your infrequent “sells” are carefully managed. By keeping the next three, four or five years’ of income set aside, you can buy yourself time for the growth bucket to work through the natural ebbs and flows of the markets. By keeping the bulk of your investments in the growth bucket, you increase the potential longevity of your money.
It’s a win-win-win style of strategy that can really simplify your portfolio management in your retirement income years and build good investor habits. If you’re concerned about making your money last in retirement or reducing risk, give the Two Bucket Approach a try!
by Thomas Johnson
When you’ve worked, budgeted and saved for 20, 30, 40 or more years, it’s really hard to look at your life savings and think “I should take a gamble with that money!” After all, your retirement nest egg is meant to carry your family, financially, through the next several decades. As a result, safety is top of mind when it comes to how most Manitobans want to manage that money. That’s why it may surprise you when I say, “being too safe with your retirement money could be the riskiest thing you do.”
How could “playing it safe” be potentially risky? The answer to that lies in one single word, “inflation.” The cost of all things we buy tends to increase over time. Utilities, groceries, dinners at restaurants, electronics – you name it – life gets more expensive each year. The Bank of Canada, who controls monetary policy, has a target inflation rate of between 1-3% per year, ideally hitting the mid-way point of 2%.
How then, does inflation affect your retirement? Inflation means that the cost of living your retirement can reasonably be estimated to go up by 2% per year. Compound that out over a 30-year retirement period and a $100 grocery store bill when you’re 60 will cost $181 by the time you turn 90! Put another way, every dollar you own today will be worth $0.55 of purchasing power 30 years in the future, if it never grows. For your retirement nest egg to stay above water – ignoring taxes and withdrawals – it needs to generate a minimum return = inflation.
The long-term pressure of inflation on retirement is the main reason why I’m shocked when I encounter clients who have most (or all) of their retirement savings in ultra-low risk, ultra-low reward investment vehicles. If your retirement funds are in a hypothetical account that earns 1% per year, but inflation is 2% per year, you’ve effectively guaranteed your money is losing 1% instead! Since we don’t see the cost of inflation on our investment statements, it can be easy to trick yourself into thinking you’ve played it safe and come out ahead on the year, only to find yourself woefully short on retirement funds down the road as you need larger withdrawals to keep up with everyday expenses. That’s a substantial risk of inflation eroding your retirement capital!
While I do educate clients on the inherent risk of overly conservative retirement plans, I want to make it clear I don’t advocate an extreme risk profile for retirees either. While investment returns are not guaranteed, I do think there is a smart, manageable middle ground to be achieved, based on your personal investment profile and comfort with risk. A place where some well-diversified risk can be introduced to help (potentially) achieve reasonable rewards that may to outpace inflation over the long-term. By carefully managing when, where and how this portfolio risk is achieved, you can have confidence that your nest egg will remain intact for decades to come!
by Thomas Johnson
I’m routinely asked by clients whether they should be using Registered Retirement Savings Plans (RRSPs) or Tax-Free Savings Accounts (TFSAs) for their retirement savings. Unfortunately, there isn’t a “one size fits all” answer to that question. The right answer is dependent on several factors in the individual’s situation.
The complexity is due to the opposing tax nature of RRSPs and TFSAs. RRSPs earn you a tax deduction when you make the contribution, grow tax deferred, and redemptions are fully taxable as income. TFSAs have no tax break for contributing, grow tax free, and redemptions have no tax consequences whatsoever. With those traits in mind, let’s look at why you may choose one over the other when it comes to retirement.
• Your taxable income today will be much higher than in retirement years. If you can project that your income in retirement will be in a much lower tax bracket than it is today, RRSPs may offer you significant advantages. For example, a person who invests $1,000 into an RRSP at a 40% tax bracket will save $400 in income tax. If they withdraw that $1,000 at a 25% tax bracket it will cost $250 in income tax, netting you a $150 profit!
• You’re planning around pension income. If your employer provides you with a reasonable pension plan, you may consider TFSAs your investment vehicle of choice. Since TFSA redemptions aren’t subject to income tax, they are an ideal choice for lump sum withdrawals for big expenses (vacations, vehicles, gifts, etc.). Your pension will help with the routine expenses while your TFSA will be there for the one-offs.
• You need the tax break today. If you find saving for retirement a challenge, the immediate tax relief of an RRSP can make the process easier to handle. Setting aside regular amounts and receiving tax refund each year can make all the difference in balancing a household budget.
• You have other goals that may interfere with retirement. Let’s face it, we are all balancing multiple goals and priorities with our money. Retirement might be your #1 goal, but hot on its heels could be helping with a child’s education costs, a second property, a business opportunity or a much needed holiday! If you feel there is a high likelihood that your retirement funds could be diverted away from retirement, a TFSA will offer far fewer tax consequences for non-retirement withdrawals.
The decision to save between a TFSA or a RRSP is a big one. There are immediate and long-term repercussions, so don’t take it lightly. Consider how you will use the funds down the road and commit to a plan! Your retirement will thank you.
by Thomas Johnson
One of the hardest aspects of retirement planning is managing cash flows. In your working years, you’ve likely had relatively consistent pay cheques every few weeks. You’ve had years of practice in lining up your expenses and saving for big purchases and rainy days. When you retire however, you may find some growing pains in adapting to new income streams.
Your pension payment day may be different than your CPP payment day, which may be different than your RRIF payment day! Add in the tax complexity of some retirement accounts and all of a sudden, a lump sum expense, like a vacation, vehicle purchase or home renovation may just catch you off guard. Here are a few pointers on how you can plan to make retirement
expenses a little more seamless:
1. Avoid lump sums from registered accounts. When you make unplanned withdrawals from a registered account, like an RRSP, you can wind up doing a lot of damage to your retirement plans. This is due to the tax nature of these accounts. If you need, say, $10,000 in your bank account, you’ll need to redeem $12,500 from an RRSP to get there. RRSPs have withholding tax applied based on the dollar value redeemed (in this case 20%), necessitating larger up-front withdrawals than some other account types. This erodes the capital you have working in your favour and can quickly add up in a harmful way.
2. Build up tax-advantaged savings. Having a big pool of money in tax-advantaged accounts, like a Tax Free Savings Account (TFSA), is a great tool for managing retirement cash flows. When you redeem from a TFSA, there is no withholding tax nor income tax triggered. This tax treatment makes these accounts ideal for accessing in emergencies or planned expenditures.
3. Keep access to low-cost debt sources. Having no debt in retirement is great, but if it comes down to paying 20% or 30% in tax to CRA or 3% interest on a home equity line of credit, I’ll take the interest cost any day! Leave open unused home equity lines of credit (if the fees are low or non-existent) or open one up before you retire. If you’ve already retired, you may find it harder to pass a lender’s underwriting standards than in your working years.
4. Budget in some wiggle room. Don’t plan for your retirement income taps to just barely cover your monthly cost of living. Everyone encounters home repairs, holiday shopping and surprise expenses that creep up out of the blue. Be sure to add in some buffer so you don’t feel like you’re living “pay cheque-to-pay cheque” in your golden years!
By planning ahead for the expected and unexpected costs of life, you can help ensure your retirement budget is in good hands. No one wants to be worried about scrimping and saving for the next big thing when you’re on a fixed income, so the time to plan is while you’re still working!
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