subscribe to the RSS Feed

Sunday, April 26, 2015

The Game Changer – Expanded TFSA

Posted by Tim Stobbs on April 22, 2015

With the cat finally out of the bag we now know a few details of the much rumoured expansion of the TFSA contribution limits from yesterday’s Federal budget (page 232 if you want to read the official text). First off it isn’t a actual doubling of the limit rather it is rising up from the current $5500 per person per year to $10,000.  Still that is a huge increase in room, and it takes effect this year.  The only downside of the announcement was the fact that they stripped out the inflation adjustment on the accounts contribution room.  So enjoy that increase because we are likely not going to see another one for a VERY long time.

Of course a change in Federal government leadership might also trigger this to be a single year event with a roll back in the plan down the road.  But for now it is going to happen this year, so let’s look at the potential implications for this in your retirement plan.

To say this is a game changer for some people is a bit of an understatement.  A couple can now put away $20,000 per year in TFSA and never pay a dime of tax on growth in those accounts.  So the holy grail of retirement planning just got a bit easier: the zero income tax retirement. I’m not sure if you realize this is about your life, but your single biggest bill is likely not your mortgage, but rather your tax bill.  Your income tax portion of it can often be a big chunk of change so if you can reduce that in your retirement years you can often speed up your retirement date.

The trick has often been that while the TFSA’s are great ways to invest they don’t often have enough contribution room to make them your sole retirement investment account.  For example, if you made $75,000/year as a family your RRSP limit is 18% of your previous year’s income or $13,500.  So while the old TFSA limit was close at $11,000 for a couple, now it becomes possible to skip the RRSP entirely for most people and pour everything into a TFSA.  (For those with math inclined minds, if your family makes $111,000 per year you can shelter the same amount in your TFSA as your RRSP now).

But what about the RRSP tax refund?  Well while that is a nice thing to get you do still have to pay tax on your growth of your RRSP at the other end when you take the money out.  While a TFSA you can shelter all the growth from getting taxed.  So imagine you have saved well in your life and have a cool $1 million in retirement savings and a paid off house.  Now imagine never having to pay a dime of tax on that and not having it reduce your Old Age Security benefits.  Cool eh?

So to compare you take our $40,000 a year of income from that in an RRSP you would have to pay tax on that money.  The final amount will vary by province but if only one of you take the money out you would lose anywhere from $5800 to $7700 in income tax for 2015.  Leaving you with a net spending amount of $32,300 to $34,200.  Or you could have put it all in a TFSA and got $40,000 to spend.

In our particular case this means I will likely skip putting money in taxable investing accounts and instead just shelter everything in RRSP and TFSA accounts.  While I might need to keep some contributions aside for the last year or two I can then stuff it all in get caught up in no time (ie: likely two years after retirement).

All in all, there is a fair amount of potential in this announcement for your retirement plans.  Of course, you should still do some numbers for your particular case to ensure it would be worth it to you.  So are you making any changes your plan because of this change?  Or you don’t think it will last?

Find the Edge Between Too Much and Enough

Posted by Tim Stobbs on April 14, 2015

Perhaps one of the more frustrating points of planning your early retirement is knowing at what point your target savings amount is enough without going so far over it you end up saving too much.  After all missing the mark of enough is problematic on both sides: too little and you may need to go back to work or downgrade your lifestyle, while too much may result in you working years more than you needed.  So how do you find that thin line of enough?

Unfortunately the answer is you really can’t know exactly if you hit enough in advance of retiring.  It’s only after the fact does the answer become clear.  It sucks, but sorry it is true.  So what do you do about it?

In the end, you take your best educated guess and add just a bit beyond that to provide some degree of cushion and call it good.  The problem is retirement planning tends to have people generate massively over conservative assumptions piled on top of each other landing a bunch of people firmly in the over saving category.  For example, we assume high inflation and low market returns, we add in every possible spending item we can imagine for the next 30 years and we still can doubt if that is enough.

The real issue isn’t your planning process or your assumptions, but rather the fear that exists in your own mind.  You see fear does funny things to people.  We want to try and predict everything and control for it all, but in reality that is pointless.  No one can predict the weather a week from now perfectly, so why on earth would you try to predict the stock market, government policy and inflation for the next 30 years or more…you can’t. So stop trying.

Instead realize humans got to where we are not by being smarter than other life, but rather our ability to adapt to our surroundings.  You need to embrace that in your retirement as well.  Life doesn’t go according to plan during your working life and that won’t change in your retirement.  So what happens know when things don’t work out….we adjust our plans and keep going.

So instead of beating your head against the wall in frustration, might I offer a reasonable idea of what enough could be.  Get a sample of three to five years of your spending and then add in some obvious adjustments for your spending changes in retirement like if you both have cars, but plan to drop down to one car in retirement or perhaps downsize your house.  After that add in 5% to the yearly spending and then make your plan on that.  Why just 5%…its good to have a little cushion to allow you some additional flexibility…so rather than having to reduce spending somewhere else for a minor change to your plan you can absorb a bit of the little shocks with a small cushion in your spending.  Alternatively, you could also just create a lump sum of cash (~2 years living expenses) as a your super-sized emergency fund to do the same thing, then when you end up with extra money you can just top up your fund during the good times.

The actual construct of what you decide shouldn’t matter as much as how does that make you feel.  Does that ease the fear in your mind just a bit?  If so, you likely have it right.  You can’t make that fear go away…that take WAY more money than you can EVER save.  Instead, ease the fear and then do some ‘what if’ games.  What if the market drops by 5% the day after you leave work?  What would you do?  What if a major storm happens the same week your car dies?  What would you do?  The idea is to move the fear of the unknown into possible futures where you have some reasonable thought responses to likely events.  The key is to keep things in the realm of reasonable.  The odds of your spouse dying by a lighting strike, your car breaking down, your house burning down, your parents getting sick and losing your keys in the same day is so utter improbable that it isn’t worth planning for it.

In the end, accept the fear you can’t plan for it all, do add a small cushion to your plans and then jump off that cliff called early retirement.  There is no way to learn it until you are doing it.  Also keep in mind you might very well end up earning some money from a hobby or interest down the road, everything that happens to you wont’ be bad.

So what do you use as your cushion for your retirement plan?  How do you know you have enough?

 

Don’t Keep All Your Eggs in One Basket

Posted by Tim Stobbs on April 8, 2015

Well the other day I requested a post ideas and I was asked to provide some thoughts around my couch potato portfolio and specifically this article, which points out the good times for that portfolio won’t last forever.  So while I’ll do that,  I also thought I would expand the focus to discuss my overall portfolio approach.

You see I don’t ever believe in putting all your eggs in one basket (yes, it was Easter and eggs are stuck in my head).  Most people believe that statement applies to just one stock or perhaps one stock index.  I instead expand it to also include any given investment style.

That article I previously linked to pointed out rightfully that the couch potato portfolio is going to have some down years.  Now when you saving up for retirement, this isn’t a particularly big issue other than to slow down the rate of savings for a while.  Yet when you are living in retirement these down years can be outright critical.  After all if your portfolio takes a 20% decline one year and you take out another 4% on top of that you just increased the downside to 24%.  If that continued for a few years you would be in some serious trouble as you likely won’t have enough cash to allow you to recover in the long haul.

So what do you do?  Keep multiple streams of income so you can ease off pulling out money during these major dips in your portfolio.  There are multiple options out there for people to have other income streams including, but not limited to: part time work, workplace pensions, government pensions, investment portfolios, cash savings or rental income.  Another less obvious way to expand that list is to also splice your portfolio into different investment styles to balance their risks.  I’ve previously mentioned my plan include all of those above except rental income (I prefer to keep REITs instead of rentals).

In my case, our actually overall portfolio consists of three different subsets of investments: my workplace pension, my couch potato in our RRSPs and finally dividend investing in our TFSAs.  So while the couch potato has a weakness of pulling out money during a big drop, this doesn’t exist in the dividend investing portfolio since I plan to never touch the principle and only take out the dividend income.  Therefore you might be tempted to believe dividend investing is superior to the couch potato, which isn’t true.  The price you pay for that level of security is often lower returns so you often need a MUCH bigger portfolio value to retire if only used dividends.  For example, if your dividend portfolio only generated 3% instead of using 4% withdrawal rate for a couch potato your portfolio to generate $30K in income goes up from $750,000 to $1,000,000 for dividend only portfolio.  So security is offset with much bigger savings targets.

This is why I think you should actually consider a blend of investment portfolio styles to balance out the risks and positives of each.  So in our case, our target spending is around $30K a year.  We plan to generate that income from various streams.  In the beginning of our retirement, for example, my wife plans to continue working for a few years after I quit which should generate at least $6000/year.  Then I’m aiming to have the dividends in our TFSAs generate another $6000/year.  That leaves $18,000 to come out of our RRSPs.

Yet what happens if the stock market tanks just after I quit my job?  I could reduce our withdrawal from the RRSP up to zero by using other income streams instead.  Perhaps I pick up a part time job or contract work for a few months or we could just using our cash savings to fill the void for a given year. For a year, this isn’t a big deal…the issue becomes if all of your portfolio was just in couch potato you would be a much harder spot.  Since you need to take out the full $30K, it would have a bigger one time impact which depending on the size of the drop you may never recovery from.

The other complication for income streams is your access to given stream will vary through time.  So for example, I can’t collect Old Age Security until I’m 67 and my workplace pension is locked until I turn 50.  We could also downsize our house to bring in a one time shot of capital into the investment accounts.  But once some of those time locked steams kick in I need less of my other streams to cover the remaining.  So over time you can over draw from one stream, if you can make it up from another one later on.  So in theory I could take out too much from the RRSP, but I better be damn sure of my offsetting future income stream to cover the difference.

You are likely just realizing that mapping out all the options do get a bit mind numbing with the amount of possible combinations.  So rather than try to do that I would suggest you merely map out fully your default plan and then be prepared to make adjustments as you go.  Predicting the future isn’t a real option so plan for what you expect and be prepared to adjust as you go.

I should also point out while I’ve mainly have been discussing the negative side of your portfolio that upside is just as important.  So for example, this most recent wave of good returns for the couch potato portfolio (9% for the last six years) when you are retired would be a great time to withdrawal a little extra money to increase your cash savings or perhaps add to your dividend portfolio.  Don’t just blindly spend the extra returns as you are going to need those to cover your down years in the future.

So in summary, don’t put all your eggs in one basket.  Be prepared to have multiple income streams and be willing to balance them off each other in the good and bad times.  The details after that are up to you.  Just remember…there isn’t just one right answer, but rather thousands of ways to do it.  Find out what works for you and go with it.

How you balance your income streams?  Do you keep more than one investment style in your portfolio?