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Andrew Dobson
High Net Worth and Investment Planning Specialist Andrew has been providing financial advice for individuals, families, high net worth, ultra high-worth clients, and corporations in his former role as a Senior Financial Planner for BDO Canada and now as a fee-only, advice-only financial planner (CFP) at Objective Financial Planners. He has extensive experience in banking, lending, investment sales, and advanced financial planning. Andrew has an Honours Bachelor’s Degree from the University of Toronto and his industry related education includes the Certified Financial Planner (CFP), Personal Financial Planner (PFP), Chartered Investment Manager (CIM), and Fellow of Canadian Securities Institute (FCSI) designations. He is currently working toward his Trust and Estate Practitioner (TEP) designation. Andrew has volunteered as an item developer and peer reviewer for various courses offered by the Canadian Securities Institute.
Nancy Grouni
Corporate Financial Planning Specialist Nancy had a 20-year career as an investment and insurance advisor with two large wealth management firms, building and presenting client financial plans and investment portfolio reviews, before becoming a fee-only financial planner. She specializes in financial, tax, and estate planning for incorporated business owners and professionals, sole proprietors who are considering incorporation, and retirees with investment holding companies. As a Certified Financial Planner (CFP), Nancy has been interviewed, and contributed to, a variety of publications and financial websites such as the Globe & Mail, Yahoo! Canada Finance, and the Financial Post.
Video Transcript
Financial Planning Insights
Presented by Jason Heath, Advice-Only Financial Planner
Hello everybody! It is great to be back here at the Canadian Financial Summit for another year. Today I’m gonna be talking about conventional advice, challenging that advice, particularly with a focus on investment and retirement planning. But we’re gonna talk about personal finance in general.
Um, just a little bit of background. Uh, I guess, for those who don’t know me, my name is Jason Heath. I’m an advice only financial planner. Uh, used to refer to myself as a fee only financial planner, but I find now there’s many people that are fee only, fee-based. It’s kind of hard to distinguish what’s what advice only meaning that I don’t sell any products, don’t sell mutual funds, don’t sell insurance. Um, I, and my company, we just sell our time with a focus on personal finance and in particular, retirement planning. I’ve been doing this for quite some time.
I remember when I first got started, I was in my twenties and I was very concerned, you know, who is going to listen to this young guy talk about money? Um, I would always wear a jacket. I would always wear a tie. I grew a beard. I wanted to look older. And 20 years later, I’ve just become older, as we are all prone to do.
Um, I do a lot of writing out there in the media in particular for the financial post, for Money Sense and for Canadian Money Saver. Um, I studied economics at York University, thankfully got into, I guess personal economics, personal finance, where I can mix and match money and the personal side of sort of, you know, helping people through money decisions. I’m a certified financial planner. It is the primary financial planning designation that is recognized within Canada and around the world. And I run a company in Markham, Ontario called Objective Financial Partners. Uh, but we work with clients all over Canada and all around the world.
Investments and Returns
Um, I wanna start off talking a little bit about investing and investments. And maybe just as a starting point. Um, I think this is kind of an interesting sense of, you know, expectations that people have about the future. And I think it’s really important also to take a look to the past, to understand, you know, what’s a reasonable rate of return expectation going forward. And this was a recent survey that was done by Natixis in the US. They asked investors all over the world, Canada, in the red rectangle here, you know, what are your long-term return expectations? And the average Canadian investor said that their long-term return expectations for their investment portfolio is about 10.6% on average.
They asked the same question of financial professionals, you know, financial advisors, financial planners, investment advisors, pension fund managers, you know, what’s a reasonable long-term return expectation? You can see, their answer was 6.5%. That represents a 63% expectations gap. But investors are expecting a massive excess return beyond what financial professionals think they should be expecting. Uh, the crazy thing about this particular survey was they asked retirees the same question, retirees had an even higher investment return expectation 11.1%, 70% gap relative to what the professionals think they should expect.
Um, we started with the future. If we looked the past, you know, what are historic rates of return? Um, as of December 31st, 2022, Canadian and US stocks. You can see here the 10, 20 and 30 year investment returns. Uh, these are annualized returns, reinvested dividends, does not take into account any investment fees. Um, but over 30 years, and even over 20 years, you can see sort of eight point a half to 10% is what stock markets have given us. The Toronto Stock Exchange, representing Canadian stocks, S&P 500 US stocks. Uh, the anomaly is this 10 year return for the S&P 516% in Canadian dollars. That’s an annualized rate of return. Um, even despite a poor year in 2022. I think it’s gonna be hard to replicate that over the next 10 years. But historically, you know, eight, nine, even 10% rates of return for stocks.
The thing is, when investors invest their money, most of ’em are in a hundred percent in stocks. Most of ’em have investment fees that they pay. Um, you know, that’s a relatively high rate of return expectation. My governing body, FP Canada suggests 6.5% for US stocks, 6.2% when we’re running long-term financial projections. So, again, I think it’s just important for people to have a reasonable expectation of profit going forward into the future. But, I thought this was kind of interesting, came across it recently.
Dividends
So, sticking on the theme of investments, I’m gonna get controversial here. I’m gonna talk about dividends, dividends, just that everyone understands what they are there. Um, when the after tax profit that a company earns is paid out to a shareholder, the board of directors is who decides if and when there’s going to be a dividend paid. Most big publicly traded companies that are fairly established pay quarterly dividends, and the board of directors, you know, typically they try to increase the dollar amount of those dividends assuming the company is profitable. Um, but effectively what it is, is when a company is unable to reinvest the money into the business, they don’t have an acquisition, they don’t have, you know, something they can buy or do with the money within the company. They pay it out to shareholders. ’cause they might as well.
That’s what tends to happen with businesses once they get to a certain point by comparison, you know, you tend to have companies that are in the growth phase reinvesting or needing to keep that cash in order to reinvest. But, you know, $1 retained and reinvested versus $1 distributed in dividends. You know, you can have two companies that are equally profitable just because one company pays it out as a dividend and one company keeps it and tries to reinvest in growing the value of that company. The company with the higher dividend, paying out more to investors isn’t a better company. It’s not more profitable. It’s not necessarily likely to generate a higher investment return over the long run.
So I think it’s just important to understand, you know, dividends aren’t magical. They’re not free money. It’s just money that’s being paid out to shareholders that’s not being reinvested in the business. Uh, you tend to see certain stocks in certain sectors, you know, banks in Canada, telecom companies, utility companies, that you know, can’t reinvest all of their profit into growing. They may be limited in terms of their ability to grow, and that’s why they tend to pay out higher dividends compared to other sort of growth type companies. Uh, I think it’s important to note that banks, telecoms, utilities, just as an example, these sectors make up less than a quarter of the S&P 500. So for a Canadian investor, if they’re really, really focused on dividend investing, they may end up with a very diversified portfolio compared to what you see if you look south of the border. And, that can be detrimental as well.
Uh, the other interesting thing about dividends, when you take a look to the various tax rates, you know, Ontario is the biggest province in the country. I know we’ve got viewers from all across Canada. Uh, but the tax rates tend to be pretty similar if you look at the top tax rates. And it doesn’t matter whether you go with the top tax rate or sort of a more moderate tax rate, the story tends to be pretty similar. Interest in foreign dividends are taxed at a fairly high, a fairly high rate of tax. Canadian dividends get preferential treatment, and that’s why some investors in taxable investment accounts will focus on Canadian dividends. But capital gains actually have the best outcome. You know, investing in stocks that pay lower dividends and have more of their return come from capital growth and appreciation. Effectively, you end up with a more tax efficient investment portfolio.
And the other thing with capital gains is you can, to a certain extent choose when you trigger those capital gains. So for an investor with a taxable portfolio, I might argue that there’s a benefit to having a bias towards capital gains. Um, anyways, the whole point is dividends. They’re not magical. They’re good, they’re not great. Um, you know, I wouldn’t go out of my way to build a portfolio of dividend stocks if you happen to end up with some great, I think a diversified portfolio, both by sector and geographically is way more important.
Portfolio Returns
Um, I think this is kind of cool. If you look back, this shows rolling periods, one year rolling periods and five year rolling periods. Going back to 1935. Um, US stocks in blue Canadian stocks in red, a balanced portfolio in green bonds. In yellow, you can see the different, one year returns, the highest one year returns here up top, and the worst or the lowest, one year losses down to the bottom. And, as you would expect, you know, if you have a balanced portfolio over a one year period, you would tend to have lower highs and not as bad lows or losses. Uh, diversification and holding bonds in your portfolio tends to make things a little bit less volatile. Um, bonds, you can see here, the worst one year return minus 14%, I think that was probably in 2022. If not, we were pretty close to it.
Um, if you go out over a five year period, the range of returns tends to be much smaller. Uh, these are annualized rate of returns for what it’s worth. So US stocks, the best five year annualized rate of return was 31% annualized. Um, I think one of the key lessons here, you can lose money on bonds over a one year period. Um, you know, you can lose money over a five year period. A stock portfolio, that’s all US stocks, all Canadian stocks, certainly you can lose money as well, and that has happened historically. Um, but a balanced portfolio. Interestingly, the worst five year annualized rate of return for a balanced portfolio over the last 87 or 88 years, was 0.9%, but 1% annualized. So if you have a five year period that you’re investing money for, balanced portfolio is very unlikely to have a negative rate of return.
If you’re investing for one year. You know, certainly if you’re in stocks, you can have a great return, you can have a poor return, even in bonds, you can have a negative rate of returns. You’ve gotta be careful. Um, this is kind of interesting down to the bottom. This is the percentage of periods with positive rates of return. Uh, about 79% of the time US stocks are up about 74% of the time. Canadian stocks are up over a one year period, 86% for a balanced portfolio. But you can see as you go out five years, stocks, bonds, balanced portfolios, you know, a long-term investor tends to make money. And, to the extent you can have exposure to stocks over the long run, you’re more likely to have a larger return from your investment portfolio.
Real Estate
So, real estate, you know, this is very timely. Uh, depending where you live in the province, there are people who have done very well in real estate, those who have done less well. Um, if you look back in the US, real estate information, for residential prices goes all the way back to 1890. And if you took a hundred dollars of residential real estate back in 1890, and you looked at how much that a hundred dollars has grown in real terms, what was the real home price index? And what that means is if you take away inflation, how much has that hundred dollars grown? So between 1890, that hundred dollars has only grown to about $111. Effectively, real estate in the US residential real estate has kept pace with inflation and maybe increased slightly more. That’s kind of what you would expect. ’cause cost of living incomes, you use your income to buy real estate. So, you know, in a normal real estate environment, you’d expect cost of living increases and income increases to line up with home price increases.
Um, on the right hand side of the two charts here, I think this is kind of interesting. If you look at the United States, going back to 1975, you know, what has been the increase in home prices in black incomes in blue, they’ve gone more or less lockstep. I mean, things got a little bit out of whack here in 2007, 2008, sort of leading up to the great financial crisis in the US. Um, home prices dipped pretty significantly there thereafter. But over the last, you know, almost 40 years home prices and incomes in the US have also moved more or less lockstep on the right hand side here, Canada, you can see in blue incomes have gone up at a pretty similar pace to the United States, but what has differed over the last 20 years in particular has been home prices. They’re just completely divorced from income growth for the last 20 years.
Um, and, you know, a lot of people point to population growth and immigration as being a big contributor to home price increases in Canada. And I mean, there are some merits to population growth in certain centers in particular having an impact. But you’ll see in gray population growth in Canada compared to the US has been pretty similar, home prices, income population growth between the two countries. The only outlier is home prices in Canada over the last 20 years. And I just point this out to say, you know, at some point, you know, most things reverts to the mean, and what is it gonna be? Incomes rising significantly in Canada. Is it gonna be home prices declining? Is it gonna be a period of time where home prices go sideways while incomes catch up? I don’t know. Um, but I’m definitely having a lot of conversations these days with people about high interest rates and the worries about the real estate markets.
So just to point out that, you know, real estate has performed very well over the last 20 years, but that doesn’t necessarily mean it well over the next 20. Um, the chart on the left here is kind of cool. What this looks at is the price to rent ratio over the last, you know, 23 years. And, a number of countries you can see. Um, price to rent, maybe just to explain that actually. So if you take the price of a home, an average home, you divide it by the rental income that that home could earn. That’s the price to rent ratio. So price divided by rent. And if price and rent were increasing at the same pace, you would expect these lines here in the chart to go sideways. Um, in Japan, you can see actually the price to rent ratio went down. In other words, prices went down by more than rents. Rents actually stayed steady. Prices went down in Japan. And, you know, 23 years later, the price to rent ratio was pretty similar, similar to what it was in 2000.
Um, a number of other countries the US, Germany, UK prices have risen at a higher rate than rents. Um, New Zealand and Canada are way up here. You can see prices have gone up really significantly relative to rents. And what that suggests is that a rental property may not be as lucrative an investment today as it was 20 years ago. Prices are relatively high, rents are relatively low. Um, and I think Canadian real estate investors, you can’t paint every single property in every single city with the same brush. But, Canadian real estate investors need to be careful because rents are relatively low compared to prices. And even though rents have gone up significantly and caused a lot of problems in, you know, with affordable rents, rents relative to the cost of purchasing a home have not really kept pace.
So just wanna warn real estate investors to be careful about purchasing residential real estate in Canada. Uh, anyone who is treating their home as an investment, I’d be more inclined to treat it as a place to live and a place that, you know, might keep pace with the cost of living going forward. But, I’d be careful about speculating that real estate price growth, we’ve seen over the last 20 years is gonna happen over the next 20. And, you know, be a big sort of contributor to your financial wealth. Maybe it might, it’s, you know, hard to predict these things, but I would be cautious generally.
RSPs and TFSAs
So RSPs, RSP contributions, I think it’s important if your income is below $50,000, I think twice about contributing to an RSP. So this is your taxable income. If you make an RSP contribution, you might save tax. Um, but in the long run, it might hurt you. You might save less tax today than you will pay back taking those RSP withdrawals in the future. So, just to point out that, you know, I think somebody needs to have an income significantly above $50,000 to really justify RSP contributions. One exception might be if you’ve got a company matching contribution. So if your employer will match your contributions to an RSP I’d take that free money all day long. Um, as long as you don’t have, you know, high interest rate debt or something else really extraordinary.
Um, if you put $10,000 into an RSP and then put your tax refund into A TFSA, most people don’t do that part. But if you did, and then you compared it to putting $10,000 into A TFSA 10 years down the road, if you were to withdraw the RSP pay the income tax, and if your tax bracket was the same, you would have the same combined after tax RSP and TFSA as if you just put the same $10,000 into A TFSA in the first place. So really, the thing that can make you come out ahead and, you know, support RSP contributions over TFSA contributions would be if you’re in a high tax bracket now and a low tax bracket later. So if somebody’s got, you know, well over $50,000 of taxable income, they’re putting money into their RRSP today, there’s a much higher likelihood in the future, they’ll be able to pull money outta their RSP to lower tax rate and have that high tax today, low tax later scenario that can make you better off. If not, if your income’s below $50,000, I think it’d be more inclined to focus on TFSA and non-registered investing.
First Home Savings Account (FHSA)
Um, there’s a new FHSA account, first home savings account available. Uh, I think it’s a great option. Interestingly, parents can gift money for a contribution. If you’ve got an 18 year old child, you can give them money. There’s no tax issues with doing that. Uh, contributions to an FHSA account are tax deductible, and you don’t need to claim the deduction in the year that you make the contribution. You can actually carry it forward to a future year. So you could have somebody that’s at university, they’re not paying much tax or any tax they can contribute to an FHSA and save that tax deduction for the future when they’re working.
FHSA have tax deferred growth, you put money in there, it grows tax deferred, and you can take a tax free withdrawal if you use it within 15 years to buy an eligible home that you’re going to live in. You can put in up to $8,000 per year up to $40,000 in total. And whatever that grows to over up to 15 years, it could be, you know, hundreds of thousands of dollars potentially you can withdraw to use for a first home purchase.
RIFs, LIRAs, and LIFs
Um, this isn’t much a novel concept. Um, you know, some of the other things that we might touch on today. But I did wanna speak a little bit about RIFs and LIRAs and LIFs, because I find there’s a lot of misunderstanding about how these accounts work. So when you contribute to an RSP, it grows over time and it can’t stay tax deferred forever. Eventually, somebody with an RRSP needs to convert their account to a RIF or registered retirement income fund, and there’s withdrawals that you need to take by no later than age 72.
Um, if you have a LIRA account, a LIRA account is a locked in retirement account, it generally comes from a pension plan. Uh, a LIRA is an RSP, but just locked in with restrictions on how much you can take out. There’s maximum withdrawals that you can take every year, but a LIRA gets converted into a LIF when you need withdrawals or when you want to take withdrawals. A life income fund. So an RSP is to a RIF what a LIRA is to a LIF account.
Um, I’m a big fan of income smoothing. If you retire at a relatively young age, taking withdrawals in your fifties and sixties, I feel especially if you’re in a relatively low tax bracket earlier in retirement, you know, using up those low tax brackets can be advantageous, can help you keep your TFSA account maxed out or minimized the withdrawals that you’re taking from your TFSA. And something that I think is a legit consideration for a couple. For example, if you have one spouse who dies at a relatively young age, the survivor is often in a much higher tax bracket because you’ve got all income and retirement on one tax return instead of two and RSPs and LIFs, these tax sheltered accounts the year that you die on the second death. Or if you’re single and you don’t have a spouse to leave your account too, tax payable can be over 50%. So I think there’s an advantage in retirement to trying to draw down these tax sheltered accounts and not paying too much tax on either the first or second death.
Pension Income Splitting
Um, pension income. Splitting pension income, and I think this is important once somebody is age 65, if they take an RRSP withdrawal, it goes on their tax return. And that’s said, if they convert their RSP to a RIF or their LIRA to a LIF, those withdrawals are considered eligible pension income and they’re eligible for pension income Splitting. Pension income splitting is where you can move up to 50% of your withdrawals over onto your spouse’s tax return. When you’re preparing your tax filing. It gives you the opportunity to do some retroactive tax planning, which can minimize your combined income tax.
Um, at age 65 RIF and LIF withdrawals also qualify for the pension income amount. The pension income amount is a withdrawal of, depends on the province, but generally $2,000 that you can take out tax free or close to it from a RIF or LIF if you don’t have any other eligible pension income. So if you’ve got a defined benefit pension plan that pays you a monthly payments, that will already give you this $2,000 tax free amount. Um, but for people who just have RSPs and LIRAs converting those accounts, if it makes sense at age 65, could give them $2,000 that can come out tax free.
Um, and annuities, you know, getting more popular these days, but you can use money in your RSPs and LIRAs to buy an annuity, which is where you take a lump sum of money, take it to an insurance company, and based on your life expectancy, they’ll make a monthly payment to you for the rest of your life. Um, it’s a real simple way to basically buy a pension with your registered retirement savings. And, again, I think higher interest rates in particular, which causes the monthly annuity payments to be higher, will make annuities more popular on a go forward basis.
Canada Pension Plan (CPP)
So will CPP be there when you need it? You know, I hear a lot of misinformation about CPP. CPP, Canada Pension Plan, the social security in the US, which is sort of the equivalent of the Canadian CPP, they recently warned that without significant intervention over the next 10 years or so, they may need to decrease benefits by 20%. And I think some of those concerns about Social security translate here to Canada. And just that everyone’s clear, CPP, the government doesn’t control CPP, they don’t have access to CPP. Uh, it’s managed, the money that that is used to pay those pensions, it’s managed by the Canada Pension Plan Investment Board, the CPPIB.
Uh, and every three years, the chief actuary tries to figure out based on population, immigration, life expectancies, contribution rates, all of these various things, you know, is the CPP gonna be around. And the most recent tri-annual report suggested the CPP should be viable for the next 75 years. So I think CPP is something you can count on being there. It’s not going anywhere. There’s even enhancements that are have been introduced over the last four years since 2019, with an additional enhancement coming in 2024.
So, you know, one thing that I find with CPP and I talk about this a lot, you know, it’s important to understand how the pension works. You can start it as early as age 60. You can defer it as late as age 70. If you’re entitled to the maximum pension, in 2023, under 65 this year, you would receive about $15,700. The average CPP recipient only gets about $9,700, mainly because they don’t have the 39 years of maximum contributions that are required either because they, you know, were below the contribution limit, or they had years where they weren’t working or they were going to school retirement before 65 is, is, you know, potentially something that can impact your 39 years of maximum contributions.
And if you start your CPP early, there’s a 7.2% annual discount in your pension. If you take it before age 65, if you defer it after age 65, there’s an 8.4% annual increase in the pension calculation. And if you look at when the, you know, so-called break even is if you added up all the cumulative payments that you would receive if you started at age 60 versus age 70. Um, you know, the break even is typically between age 75 and 80. And what I mean by that, if you looked at starting at age 60 versus 61, 61 versus 62, and you looked at all the various break even ages where your total payments would cross over and you’d benefit if you lived past that age, that break even occurs between 75 and 80. However, if somebody starts CPP at age 60, they get the money in their hands earlier, they can invest the money or they can leave other money invested.
And if we were to use a 3% discount rate, you know, effectively assuming that somebody could invest the money at a 3% after tax rate of return, you know, the break even gets pushed back to 77 to age 82, you’d have to live past age 82, for example, to be better off after adjusting for, you know, the benefit of receiving some of that money earlier. A lot of people would say 3% problem, that’s a low rate of return, even at a 5% discount rate. You know, if you live past age 84, if you live well into your mid eighties, you’re probably gonna be better off deferring your CPP.
And, you know, I think it’s important to look at life expectancy, not only your individual life expectancy. I mean, that’s probably the most important consideration. But the average Canadian in 2022, died at age 83. Um, although we’re gonna come back to that life expectancy concept, I wanna talk a little bit more about that. But, all this to say that I think a lot of people would benefit from deferring their CPP to age 70. It’s controversial topic. A lot of people say, I paid into the CPP, I wanna get my pension. I don’t wanna wait. Um, but you know, one of the best ways to come out ahead is if you’re in good health considering deferring your CPP if you’re able to do so. In 2022, about a third of people started their CPP at age 60, but a third at age 65, almost nobody deferred to age 70.
Old Age Security (OAS)
Um, OAS old age security pension, it’s kind of CPP, you can start it earlier or later. Um, little bit different from CPP, though. You can’t start it as early as age 60. It’s only between 65 and 70. And, right now, the maximum old age security is about $8,400. Uh, if somebody has lived in Canada for 40 years after the age of 18, if you’ve lived in Canada for most or all of your adult life, this $8,400 pension is awaiting you at age 65. Um, there was a couple of years ago, a 10% increase that was introduced. So once you make it to age 75, there’s a 10% bump in your old age security pension, which is kind of nice.
Um, there’s a 7.2% annual increase if you wait after age 65 and defer as late as age 70. By comparison, CPP is 8.4%. So if somebody’s kind of on the fence, you know, do I defer my pensions or not? Um, CPP is more lucrative to defer. You could always hedge your bets, start old age security earlier. CPP later break even is kind of similar. You know, in your mid eighties, if you expect to live to a hundred, I’d strongly consider deferring your CPP and old age security.
Um, and there is this concept of old age security clawback. This OAS recovery tax. If you 2023 income exceeds about $87,000, which is fairly high income in retirement, then you lose part of your old age security, 15 cents on the dollar for every dollar. Your net income on your tax return exceeds this 86,900 $12 figure.
Life Expectancy
So I mentioned life expectancy, and the average Canadian dying in 2022 at age 83. I find it’s really important for considering retirement planning to look at, you know, the whole concept of life expectancy. And, again, when you hear that life expectancy is age 83, what that really means, generally anyways, is that that’s the age at which the average person died. So in 2022, the average death in Canada occurred for an 83 year old individual. However, that’s skewed down by people who die at a relatively young age once you make it to an older age in the first place, 65, for example. Lots of numbers in this chart. But if you focus on the red boxes, a 65 year old man has a 50% chance of living to age 89. And, a female has a 50% chance of living to age 91. That’s a lot longer than that age 83 life expectancy, right? Once you make it to age 65 in the first place.
And, a couple, a male and a female, who are a couple, have a 50% chance of one of them living to age 94. So oftentimes when we’re engaging in retirement planning with clients, we’re running numbers and projections out to age 95. And I think that, you know, considering the average 65 year old will live to age 90, you know, 89 for men, 91 for a woman, you know, going back to these breakevens, you know, mid eighties, would be your breakeven age. If you live past that, you’re better off deferring your old age security at age 70. I would argue that most retirees should be deferring their CPP and old age security, even though, you know, only a handful on a percentage basis do.
Retirement Expenses
Um, I find this is a really helpful concept for anyone who’s thinking about and approaching retirement. Um, just, you know, some rough numbers, simple numbers. If you’ve got a hundred thousand dollars salary, depending where you live and your tax deductions, you might have about $75,000 after tax income. And a lot of people, I find, think, geez, well, going into retirement, I need to have a hundred grand of income that I can spend $75,000. But I think it’s really important to look at some of the extraordinary items and really figure out what your retirement expenses might actually be. So if we, you know, stick with a sort of a notional person who has a thousand dollars per month mortgage payment, not, probably not in Toronto or Vancouver or a lot of places these days, but simple numbers, again, a thousand dollars mortgage payment, a thousand dollars that they’re putting into retirement savings, that’s 24 grand per year of their $75,000.
It’s really temporary. You know, if your mortgage is gone and you’re no longer saving for retirement, by the time you retire, you know that $24,000 of expenses disappears in your living expenses might only be $51,000. That might be your permanent expenses that you need to plan to cover in retirement. And to cover $51,000 a year in living expenses, you might only need $60,000 of pension and RSP RIF income. You know, you might only have eight, nine, $10,000 of tax at that level of income. Again, depending on tax deductions, tax credits, province or territory that you live in. Um, and if your, you know, quote unquote, income is coming from non-taxable sources, non-registered investments, TFSA withdrawals, you might need less than $60,000 in order to cover $51,000 of expenses.
So I think it’s really important to start with determining what your expenses are that you’re going to be incurring in retirement, backing out the temporary or extraordinary stuff. And then obviously, you know, look at the duration of how long you’re gonna need to fund those expenses for somebody retiring at, at, you know, 50 is gonna need a lot more money than somebody retiring at 70.
Retirement Spending Smile
I think this is kind of a cool concept as well, just talking about retirement spending. A lot of times, you know, we assume that if somebody spends a hundred thousand dollars a year, that’s what they’re gonna spend forever. Um, ignoring inflation, of course, this is real spending of a hundred thousand dollars. So ignoring the impact of inflation that would otherwise push that spending up.
Um, David Blanchett did, wrote an interesting piece in the Journal of Financial Planning back in 2014, where he coined the term the retirement spending smile. And the concept anyways is that most retirees, particularly the ones you get into your seventies, will spend less on stuff. You might go from, you know, say you’ve got two cars as a couple, you might go down to one. Um, you know, you might not be buying the same clothes once you’re no longer working, you might not be traveling as much. You might not be doing, you know, sports or other activities you tended to do. So spending often declines in one’s seventies or eighties.
Um, and if somebody lives long enough, depending on their health expenses might go up for other reasons. It might be because you’re no longer cutting your grass on your own or traveling on your snow. Um, you might have medical costs, healthcare costs, long-term care costs that if your health is not good, causes your spending to spike later on. Some people see a decline in their spending that, you know, never really spikes depending how long they live and how healthily, let’s say they live. But, this is, you know, sort of a more common retirement spending scenario that we tend to see.
The 4% Rule
I thought this was kind of neat. I came across this recently, a lot of people are familiar with the concept, but the 4% rule, quick summary, the rule is suggestive of the ability for somebody to take 4% from their portfolio. Um, and if you envision a hundred thousand dollars portfolio, just use a simple number. The 4% rule states that you could probably take 4% out in the first year. So $4,000 out of a hundred thousand dollars investment portfolio, and every year, increase that $4,000 by the rate of inflation. So it’s 4% of the portfolio value in the first year in index to inflation, the dollar amount thereafter. And over a 30 year period, probably not run out of money. And that’s based on, you know, taking a look at historical rates of return and projections.
Um, in real life, I find the 4% rule, it’s interesting, but people’s lives don’t, you know, work in a straight fashion. You’ve got extraordinary expenses coming out of your portfolio. You’ve got pensions that are layering in starting at different points. You’ve got, you know, inheritances and downsizes, and it’s, you know, a little more complicated than the simple 4% role concept.
Um, but I thought this was kind of interesting nonetheless, just to sort of prove a point. This is from Michael Kitces, and he looked at a period from 1871 to 1988. I know the data is a little dated, to speak, but you know, that’s 117, 118 year period for a 60 40 balanced portfolio, 60% in stocks, 40% in bonds, and looked at all the different 30 year periods. That’s what all these crazy lines represent. And if somebody started with a million dollars after 30 years, there’s a ton of different outcomes over this 118 year period. Some of them good, some of them bad. The bottom 10% of outcomes, this is what everyone’s worried about. Like, what’s, what happens if there’s a really bad sequence of returns? I retire, you know, going into a bear market and my portfolio does horrible, the bottom 10% of outcomes, you know, some of them are, are, you know, draw the million dollars down quite significantly.
Um, but if you look at the top 10% of outcomes, it’s kind of crazy. You see, there’s a, you know, a couple that showing $9 million portfolio, a million dollars turns in $9 million, even withdrawing 4% per year. This 4% rule that you shouldn’t take out more than 4% per year. Um, but if you look at all these historical years and 30 year periods, there’s an equally likely outcome, 10% that you will end up with, you know, call it $6 million or more, six times your starting principle, as to draw your principle down fairly significantly. And the 50 50th percentile, you know, basically the average outcome is that taking out 4% in the first year and increasing the dollar withdrawal to inflation every year thereafter, almost three times as much starting principle is what the average 30 year period would’ve led to.
And I guess the point of all this is a lot of times, you know, using rules this is, you know, questionable in the first place. But if you are conservative that you look at the worst case scenario, you’ve got an equal chance of having six times your money compared to, you know, aggressively drawing down your investment portfolio. And this 50th percentile, I think is, is, you know, there’s research and there’s studies and information to show that most retirees don’t spend down their portfolios. In fact, you know, they tend to grow over time because they’re hesitant to spend.
And when I think about the concept of risk in retirement, I feel there are different risks. There’s obviously the risk of running outta money. That’s something everyone worries about. But I think there’s also the risk of not spending your money, you know, the risk of not enjoying your retirement savings, the risk of working too long, you know, to make sure you’ve got this big nest egg and not being able to spend it because of a health issue or because of a death or a disability, or, you know, any variety of other things. So in recent years, I’ve frankly have started to worry just as much about saving too much as not saving enough.
Tax and Probate
Um, just to finish off here, I wanna talk a little bit about tax and probate. Um, capital assets, non-registered investments, you know, real estate, private company shares, RSPs, TFSAs, all of the typical assets that people own generally on the first death, pass on a tax deferred basis to your spouse by default. So, when you’re married or common law on the first death, there’s generally little to no tax that becomes payable. You really have to worry more about tax on the second death, or if you’re single on your own death, you can’t just give assets interestingly to your spouse during your lifetime and pay less tax.
A lot of times people will add their spouse’s name to a joint account, or they want to give money to the lower income spouse to invest, and that doesn’t work during your lifetime. There’s this concept of spousal attribution where if a high income spouse gives money to a low income spouse, it gets taxed back to the high income spouse. Um, you can have a joint account, interestingly, often suggest that if you’ve got a spouse that has an investment account that they’ve been paying tax on and they’ve owned over the years, it’s not a bad idea to add for estate planning purposes. The other spouse jointly on the account just makes it a lot easier to deal with administratively. It makes it a lot more seamless upon death. Um, and you can have a joint account, and it doesn’t need to be taxed equally. So if it’s always been taxed in one spouse’s name, you can add the other spouse’s name and continue to report a hundred percent of the income to the original spouse if you’re inclined.
Um, there’s generally no probate fees or estate administration tax, you know, depending on the province that you live, when assets are held jointly with a spouse. So again, common estate planning is to own assets jointly with your spouse, assuming that you want those assets to go to your spouse upon your death. Um, interestingly, children holding assets jointly with parents. I mean, this is a common estate strategy that we see employed where, you know, children are joint on bank accounts or investment accounts or real estate. Um, but there has been case law, particularly this Pecore case, a number of years back, that generally the default presumption is that children that are joint on an asset are holding that asset in trust for their parents unless it’s otherwise documented.
So, if you want a gift to go to a child or an asset to go to a child on your death, you typically need to make sure that you document it often with a gift letter. Um, and if you’re not documenting it, if you’re not reporting, you know, investment income on investment portfolio equally, for example, on a bank account or investment account that you own jointly with a child, generally the child is assumed to be holding the asset in trust for the parent. And there’s tax rules that, you know, may not have been as much of an issue before this year that might require a trust tax return to be filed or a UHT an underused housing tax return to be filed in the case of a jointly held piece of real estate.
So, you know, this is sort of more complex tax and estate planning, but I guess the main takeaway is that if you want to add your children to assets jointly, or if a child, you know, is encouraging their parent to do it, get tax advice, get estate advice, you know, generally in the absence of, you know, any sort of gift letter or documentation, you know, assets held jointly when a parent dies, have to be distributed based on what’s in the will, those assets may actually end up being subject to probate if the parent is, you know, considered to be the true owner of those assets. So that’s another thing. Sometimes this can backfire from the perspective of avoiding or reducing probate.
Um, there’s also risks, you know, for parents who are considering adding their kids jointly onto their assets, there’s a family law risk. You know, if a child goes through a divorce, you know, and their divorcing spouse says, well, you know, half of that account or half of that piece of real estate actually belongs to, you know, my spouse, the child of the parent who actually owns it, you know, could put assets at risk, likewise with creditors, you know, if a child got sued, and for parents, you know, I always flag the risk of elder abuse, you know, even if it’s not significant or severe, you know, if you’re gonna add your child jointly onto assets, I mean, it’s giving them access to those assets, which may or may not be something that you want.
So, lots of stuff, lots of stuff that we talked about and touched on today. Um, you know, ranging from pensions to tax, to RSPs to stocks and real estate. Um, you know, I think these are all important things to consider as part of your overall financial planning. One of the big challenges that I find with financial planning is there’s a lot of interdisciplinary stuff. So somebody might be getting investment advice or tax advice or estate advice, but they all kind of work together. And, either on your own or with professionals that you’re working with, it’s really important to ask questions to try to understand how the different pieces of the puzzle fit together. And, you know, these are the sorts of things that I to make sure I flag for people and talk about that people try to apply them to their own personal finances.
Um, thanks much for tuning in. This is my personal, or at least professional information and my great team at Objective Financial. Again, we work with clients at our office in Markham, north of Toronto. Um, but frankly, these days the majority of our clients are outside of the greater Toronto area and in different provinces and territories and even other parts of the world. Uh, feel free to reach out if you have any questions, and thanks much to the Canadian Financial Summit and to all of the viewers for tuning in.