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Friday, June 24, 2016

The Retirement Investments

Posted by Tim Stobbs on June 23, 2016

On my last post, Sherry asked for a bit more details on our investments and how that relates to our plan in retirement.  So basically, now that we have built the money up, how exactly does one use it to live on?

To be honest, while I had some vague ideas on this before I only really got to thinking about this in detail this year.  So I can say I’m not firmly decided on all of this, but this is the current plan. Please note, I’m not predicting the exact amount per account but I will give approximates if I can.  Our money at the end of this will be divided into the following groups:

  • Pension and Locked In Funds – the stuff with age limits on when I can actually use it.
  • RRSPs – Which actually don’t have an age limit, they just function like taxable income when you take the money out.
  • TFSAs – Which can be pulled out with no tax implications.
  • Taxable Investments – So your basic investment account where you pay capital gains if you sell something for a profit.

First up is the pension money, which the vast majority can not be accessed until I’m 50.  The good news on that particular account is when I leave work I am allowed unlock my voluntary contributions and move it to an RRSP.  Crudely this is about 1/3 of that accounts value (current value is ~$140,000).  I do intend to do this to allow the most flexibility on that money.  Yet even with that option I will likely have more than $100,000 when I retire that I can’t use for the first 10 years or so.  So the trick for this account is to basically leave it alone and let it grow until I need it more a more traditional retirement later on.  I intend to leave my  remaining pension right where it is for the long term as the fees are low and I’m not required to move the money out of the pension plan.

Next up is the RRSP accounts (current value is ~ $130,000) which I will be trying to reduce the tax on these account withdrawals as much as possible.  So even if we don’t need the money I will likely take out the full amount up to our basic income tax deduction each year (if our work income doesn’t make us use that up first).  Any unused money would then just get shifted over the TFSA accounts. The other side issue with the RRSP accounts is I’m accepting the fact I may be using some of the principle in these accounts to offset the fact I can’t access the pension money. The RRSPs are all index funds which do spin off some income but the vast majority of the money here will come from selling small amounts of the funds annually (or semi-annually – I’m still debating this point as there is the issue of withholding amounts for tax purposes on money taken out of an RRSP).  So the hope is the mainly use the capital gains in these accounts, but as I mentioned I’m okay dipping into the principle until I turn 50.

The TFSA accounts are a different beast all together.  These accounts are invested in individual dividend paying stocks and the plan here is to never touch the principle amount but rather just harvest dividend payments out of the accounts.  Yields here are averaging just over 5% currently on about $130,000 right now (so that will be slightly higher when I retire).  The longer term plan for this account is to grow it as we draw down the other taxable and RRSP accounts when we have contribution room available in the TFSA accounts.  That additional money will likely get used to cover living expenses, its just a matter of when we use the money.

Then the last pool of cash is the taxable investment account.  Currently this is rather small (~$35,000), but since we are maxed on TFSA and RRSP contribution room so it will grow to be around $60 to $70k.  Yet a portion of that will be our emergency cash float which will allow us to not pull money out of investments for up to a year in the event the markets take a major decline.  In the long term it would be nice to move that cash float into the TFSA from the taxable investment account, but given the low tax implications of that we will likely not do that anytime soon or do it slowly over a number of years. Except for the emergency cash float we will use up this money towards the early part of our retirement to ensure we keep any taxable capital gains to a minimum and again if required I would be okay using some of this principle money.

So long story short, we mainly plan to live on capital gains and dividends, but I am okay touching a bit of the principle if required.  I will actively avoid doing that (by having some employment income during the first five years), but as I previously noted I am fine with downsizing the house in the medium term to shore up the investments if required.

Hope that helps.  Let me know if you have any questions.

The Last $100K

Posted by Tim Stobbs on June 8, 2016

So while I know I owe you all a net worth update with all the details I will provide the following little tidbit of net worth news: we just broke $450K in investments at the end of May.  This number may seem a bit odd to be excited over, but I should provide some context to help you understand it.

First off my floor number for leaving work is to have investments of at least $550,000 (plus the already paid off house), so now I’m officially are on saving the last $100,000 to reach my goal.  Being this close to the end of my goal is interesting as I can now actually make a fairly realistic guess of when I will hit that floor value (late 2017 if you must know).  I do intend to actually keep saving (and working) past that number a bit to add some cushion in for a few items like some renovation savings and a pool of cash to use to pay our expenses in the event the stock market falls right after I leave my job.  So rather than fixing the dollar value when I will leave work I’m leaning instead to merely fixing a date in my head in early 2018 and worry less about the exact number of investments when I leave my day job as long as it is past my floor amount.

The second reason that $450,000 in investments is important is that is actually enough money that I am now financially independent on our basics expenses. So when I talk about basic expenses I mean merely bills paid, food on table and nothing else.  No fun money, no vacation, no luxuries, no wine or beer (gasp and sob)! Obviously I have little to no interest in actually leaving paid employment at this particular level, but it does add to the comfort of knowing that if things went really bad suddenly and I was laid off we would be fine for an indefinite period of time.

Of course, some of you may be doing the math on that $550k value above and think I’m bloody well off my rocker for considering leaving work with only that much saved, but I should point out a few important facts:

  • Our plan is based on a spending up to a max of 4.5% of our principle each year (not the usual 4%).  I’ve investigate the risks of pulling out slightly more money I am comfortable accepting them.
  • My wife fully intends to keep working at her daycare, which provides about $6000/year income to the house for the next five years.
  • I fully intend to earn some money myself by working part time at a fun job earning on average $6000/year for the next five years (after an initial 6 month detox period of no work right after I quit).
  • We will be getting an increase in our child tax benefits which will finish funding our boys RESP accounts for us.
  • We are comfortable downsizing in the medium term (5 to 10 years out) and shifting up to $75,000 from the house equity to investments in the event our investments do worse than planned.

Overall I’m happy with plan and the potential risks.  I’m working out the exact details in a spreadsheet model the is broken down by the month from now until 2023. I’ve also setup myself a list of homework assignments to complete before I leave work to determine any issues I have misjudged like reviewing our spending data from the last four years, checking out extended health insurance options, planning my potential weekly schedule ( answering that question of what do I want to do all day) and more.  I’ll provide a post on that in the future.

So I expect there will be questions on all this, so please leave them in the comments I will attempt to address the in a series of posts coming up.

It’s About Risk Management, Not Elimination

Posted by Tim Stobbs on April 25, 2016

Perhaps one of the more confusing things out there for people planning their retirement is what to do about risk.  What happens when you live longer than you planned? What if you kids needs help paying for a wedding?  What if your investments have a lower return than expected?  What if inflation is higher than you planned?  The potential problems are basically endless if you want to keep thinking about it.

As a result most people tend to be conservative when they start their planning for retirement trying to account for those risks.  They include a lower than expected investment return, inflated spending estimates and even high inflation values.  Yet this line of thinking can get out of control and people end up leaving the world of risk management behind and try to eliminate all the risks.  Why? Because they are frighten that something will go wrong.

Yet that really isn’t a healthy approach to the problem.  The main issue is life never goes according to plan.  Think about your last weekend, did everything happen just the way you wanted it to?  Likely not, now take that problem and magnify it over 40 years or more.  Ah, you likely see the full scope of the problem now.  Focusing on eliminating all risks creates a situation where your odds of retiring earlier keep dropping as you work longer trying to cover every remote possible thing that could go wrong in your retirement plan.  You are so focused on the next risk, you end up over saving for your retirement and thus have now increased another risk of not getting enough time to enjoy your own retirement.

On the other hand, I’m not suggesting you go in with nothing done about risk, that would also be foolhardy.  Instead I suggest you shift gears from removing or eliminating risk to just managing it.  When you manage risk you do try to be defensive on some items and account for them in your planning.  While others may in fact be too remote of a possibility or too minor of a problem to bother managing at all.  In those cases, you accept the risk and do nothing.  This might seem odd, but in fact in business this happens all the time.  For example, you can accept a contract with the default wording for a small purchase and accept that if something goes wrong you will just deal with the issue and perhaps be out some money.

For example here are a few items in my retirement plan and what we are doing about managing the risk:

  • The End of the World – Frankly if that happens my plan likely won’t matter so I’m just going to accept that risk and not even bother trying to plan for it.  If society ends, you likely have other issues to worry about – like getting food rather than tax issues with RRSP withdrawals.
  • The End of the Stock Market (aka 80% decline in stock values) – The odds on this occuring for EVERY stock is beyond remote and similar to the above.  So again, I’ll accept the risk on this one.
  • The Stock Market declines 10 to 20% – Alright, this is a reasonable possibility in a given year.  So the plan here would be to cut back on spending where possible, keep of float of cash for a year’s worth of expenses to avoid selling in a major downturn and if need be I can do some part time work to cushion the blow to our finances even further.
  • My spouse dies early and I no longer receive their Old Age Security (or vice versa) – Again, with an accident this is possible, which is why I only included 50% of our total estimated Old Age Security payment in  our plan.  That way if things go well we have some extra money, if not, this won’t put us in the poor house either.
  • Our car breaks down and needs to be replaced, the house roof is damaged in a storm and the fridge dies (all in the same year) – While individually these aren’t a big deal in a given year the compounding effect of having all of these at once may drain the extra cash to very low levels.  So a few options exist like using a line of credit to borrow some of the money to spread the payments out over a few years.  Yes this costs some interest, but it allows us to keep some cash reserves in case something else occurred. Also there is insurance to cover the car and the house if the event true accidents occur for the cost of the deductible.
  • We need major dental work after retirement – In theory I could get some insurance to smooth this cost out or have the option to just self insure (ie: don’t pay any premiums and accept the risk).  In our case, we have fairly good teeth overall and I don’t see much risk here.  So I’m going to just ignore this one and self insure.

The idea of course is to put your mind at ease by going through some of the more obvious problems and determined ideas in advance on how to solve them.  Then of course you can also accept the odds on the more exotic situations and do nothing.  Just keep a few management tools in your back pocket like: one year of spending saved in cash, appropriate insurance coverage, the option of picking up some part-time work when you are younger, selling stuff you don’t use anymore, the potential solutions are like the problems: endless.  Just make sure you have several of them ready to go in case you need a few.