Last column we looked at the five ways retirees could enhance their income, as outlined in Fred Vettese’s book, Retirement Income for Life. Today, we’ll drill down on the specific and controversial “third enhancement,” which was partial annuitization at the point of embarking upon retirement (usually at 65).
This strategy is for the vast majority of private-sector workers who lack the traditional Defined Benefit plans that are still prevalent in the public sector. If you envy that kind of guaranteed-for-life pension, there is a compelling argument for annuities, or at least partial annuitization. That of course is why annuities have always been one of the two main choices you are confronted with when you have to wind up your RRSP at the end of your 71st year.
Since few people want to cash out totally and immediately pay tax on the whole chunk, the vast majority of people either convert to a RRIF or to an annuity, although it’s not well understood that you can do both: this does not have to be an all-or-nothing decision.
Indeed, Vettese’s call to partly annuitize 30% of registered holdings at the point you begin retirement is an example of partial annuitization. The other 70% would still be invested in an RRSP or RRIF, perhaps with a second round of annuitization closer to the traditional age of 75 or so. (Keeping in mind Vettese also calls for commencement of the annuity-like CPP benefits at age 70).
Don’t expect your own advisor, especially if he or she is compensated with a percentage of assets under management from your RRSP or RRIF, to agree on this recommendation to annuitize. (As we said in the book review, few of Vettese’s enhancements will be embraced by the average financial advisor). Fee-only financial planner Rona Birenbaum says that’s because asset-based advisors charge 1% or more of your portfolio each and every year whereas an annuity merely pays an advisor a one-time commission up front of 1.5% or 2%, and that’s it.
That may help explain the mystery about why annuities are less popular than you might expect, given their benefits. But if you lack what finance professor and author Moshe Milevsky calls a “real” pension, then annuities are one viable way to go, if only for a portion of your assets. And you’re starting to see the nation’s financial institutions paying a lot more attention to this topic. Late in January, RBC ran a blog that said 62% of Canadians aged 55 to 75 are worried they’ll outlive their retirement savings but only 10% use or plan to use an annuity to ensure they’ll have a viable lifestyle in retirement.
Vettese says only 10% of private-sector workers now have true DB pensions and this will continue to dwindle: 60% of existing DB plans are being closed to new members, so he expects the percentage to fall eventually to just 5 or 6%. That’s a lot of people without true pensions. If you want to see what that world looks like, read the book Nomadland, which depicts the dire state of thousands of North Americans who lost their homes and wealth in the financial crisis and have taken to the roads to live in RVs and do temp work for Amazon. With grey divorce on the rise and the demise of employer DB plans, their only reliable income source is Social Security, or its Canadian equivalent of CPP/OAS.
CPP/OAS and social security are in effect inflation-indexed annuities but were only meant to be one of three pillars of retirement. If you lack pillar two (employer pensions) it’s up to retirees to convert whatever wealth they have in pillar three (registered and non-registered savings), and create their own “personal” pension. Enter registered and non-registered (or prescribed) annuities.
Here I must admit that I personally am considering going this route in the near future even though I know interest rates are finally starting to rise and may rise further in the coming year or two. As Birenbaum explains in a YouTube video, how much you receive from an annuity is very much age-related and the later you start, the higher the mortality credits (which you get from pooling longevity risk with others).
My own advisor, who is NOT compensated by assets, argues in favour of delaying annuitizing for now given my age (64) and a rising rate environment, but retaining flexibility with ladders of two-year GICs maturing at various times; my situation could be revisited when conditions are more advantageous to annuitize.
In her video, Birenbaum tackles the GIC vs annuity issue head on but seems more inclined to come down in favour of annuities. To test out the impact of one GIC laddering strategy, Birenbaum compared cash flow from age 65 to 90 under three scenarios: full annuitization at age 65, half at 65 with the other half in a five-year GIC until annuitization at age 70; and finally, all in a five-year GIC until age 70, then half annuitized at 70 and the other half annuitized at 75. She found virtually no difference in outcome under these three scenarios. “Overlaying the analysis with a present-value calculation would have resulted in the full annuitization at age 65 being the winner.” Chalk one up for Vettese, although she cautions that the comparison doesn’t factor in potential changes in interest rates.
As an exercise, I asked Birenbaum to provide three quotes for a $100,000 registered annuity (joint-and-survivor, with 20-year guarantees) with payments commencing at age 65, 70 and 75. As you might expect, the longer you wait, the higher the payouts but they are not dramatically higher by waiting. At age 65, the annual income ranged from a low of $3,810 from one provider to a high of $5,071. If commencing payments at 70, payouts ranged from $4,133 for the low provider to $5,566 for the high one. And by waiting till age 75, the annual income rose from $5,306 in the low case to $6,447 in the best case. Keep in mind that, as is also the case when deciding to defer CPP or not, going earlier also means you have the use of the money earlier.
The actual process of buying a registered annuity is simpler than you might imagine: you would liquidate $100,000 worth of investments in your RRSP so the cash is available to transfer, then complete an annuity purchase application and fill out and submit a T2033 RRSP transfer form. That form is sent to your RRSP administrator, and they transfer the cash to the insurance company without triggering tax. Once all these preliminary steps have been taken, payments begin the month following the annuity purchase, according to Birenbaum.
Of course, there is some risk in waiting to annuitize, since doing so assumes markets will cooperate long enough for your RRSP or RRIF to grow in the meantime. That risk is one reason Vettese argues for partial annuitization as early as 65, if that’s your chosen retirement age.
But as soon as 65? Doug Dahmer, CEO and founder of Burlington-based Retirement Navigator (a fee for service planner specializing in customizing retirement income), says that’s “a pretty punitive way to create assurances of money lasting as long as you do.” He agrees with Vettese that “dollar cost ravaging” can deplete retirement nest eggs far faster than originally planned. However instead he suggests that “by simply creating or taking advantage of forward knowledge of how much money you need, when you need it and where to source it on a year by year basis you can put pension-like disciplines in place to protect against the variability” described in Vettese’s strategy.
You can learn more about Vettese’s strategy in this YouTube video conducted by Rona Birenbaum.
With 1,100 Canadians reaching the official retirement age of 65 every day, there’s a sea of change occurring in the investment world. The move from wealth accumulation is rapidly moving to its opposite, de-accumulation or “decumulation.”
Decumulation is actuary Fred Vettese’s preferred term over “drawdown” and his new book Retirement Income for Life (Milner & Associates, Toronto, 2018) seems destined to become the bible of any new or near retiree challenged with converting large RRSPs and other savings into reliable income.
The only retirees who may not need this book are the fortunate few and increasingly rare members of traditional Defined Benefit (DB) pensions. As Vettese says – the chief actuary for Morneau Shepell Inc. – decumulation is a much trickier act than accumulation. The book covers some ground previously occupied by Moshe Milevsky’s Pensionize Your Nest Egg or Daryl Diamond’s Retirement Income Blueprint but Vettese takes the topic further.
What I like about Vettese’s book is a 5-part strategy involving what he terms “enhancements.” In a nutshell, it’s all about cutting investment costs with Exchange-traded Funds; delaying receipt of Canada Pension Plan benefits to age 70; annuitizing initially 30% of an RRSP at the onset of Retirement; adjusting spending “dynamically” up or down as markets surge or falter; and – as a last resort – the “nuclear option” of a reverse mortgage.
Where I think he breaks new ground is in focusing on these five critical topics to which traditional financial advisors often give short shrift. Vettese says many of the ideas are current in academic research but have been slow to make it to the mainstream. In part the slow migration of the concepts from academia to practical use can be attributed to the negative and sometimes vested views of commission-paid financial advisors. The manner in which some financial advisors are paid means Vettese’s four “enhancements” (I’m not counting reverse mortgages here) may not be in the advisors’ financial self interest: that is, some less reputable advisors may be more concerned about their own retirements than that of their clients!
Certainly, mutual fund salespeople may not be inclined to recommend well-heeled clients start buying ETFs at a discount brokerage. Similarly, some asset-based advisors may not love the recommendation to draw down on RRSPs or RRIFs early (in your 60s) in order to maximize CPP benefits by waiting to collect them at age 70. That’s also the case with annuities, which pay advisors a one-time commission of 1.5% or 2%, as opposed to a comparable commission each and every year for advisors charging by assets under management.
In the book, Vettese says he actually “pulled my punches with advisors … The academics have been slamming them pretty hard.”
Of course, a fee-for-service planner or “advice-only” planner not compensated by product sales would not be under any such apparent conflict and they are becoming more common as the low-cost argument becomes more compelling in a low interest-rate environment.
The argument for the “third enhancement” I found particularly compelling: Vettese suggests annuitizing 30% of your registered assets at or near retirement, and then further annuitizing in your 70s. Some of the rationale you can find in a YouTube interview conducted by financial planner Rona Birenbaum. Vettese favors a “joint-and-survivor” annuity that pays the survivor 60 or 75%, and buying term life insurance to make up the difference. He doesn’t recommend buying inflation-indexed annuities, since they tend to be unpopular with both insurance companies and the public: the fact that both CPP and OAS are inflation-indexed should be enough protection, he argues.
While many pundits recommend waiting till your 70s to buy annuities, especially as interest rates are still low but gradually starting to rise, Vettese sees it differently. He says the “math works wonderfully” annuitizing as early as 65, if that’s the age you plan to stop working. It’s true that mortality credits get better the later you wait, Vettese explained in an interview with me, but those worried about overvalued stock markets and a harsh correction in the next few years may not be able to afford to wait. “I’m not predicting that but one day there will be a big correction and bear market and you’re kidding yourself if you don’t plan for it,” Vettese said. Again, this is for people without DB pensions. “I tried 40% and 20% but 30% is the sweet spot at 65.” Then you would add another 20% or 30% in annuities around age 75, he said. “It may make sense to do some at 70, but if you want to keep it simple, do it twice in your life. Most are not doing it at all so once or twice is better than nothing.”
In the meantime, Vettese eats his own cooking: lacking a DB pension and turning 65 this April (like myself), he “bought an annuity last year and plans to buy more.” Because he considers annuities to be a form of fixed income, he sold fixed-income investments to come up with the cash for the (registered) annuity. As per his recommendations in the book, he also will take OAS at 65 (as will I, as my column in 2016 argued) and plans to defer CPP to 70.
Vettese also tackles the perennial topic of how much money you need to accumulate, which is closely related to the replacement ratio. As in his earlier book, The Essential Retirement Guide, Vettese comforts would-be retirees with his assertion that the traditional guideline for middle- and high-income earners of replacing 70% of working income is “too high.”
Vettese, like his retired colleague Malcolm Hamilton, argues 50 or 60% should suffice if you reach retirement with the mortgage and all consumer debt paid off. After all, if the children are launched and employment expenses vanish, you need to generate less income and so pay less income tax, plus of course you no longer have to save for retirement itself! Plus, as you move from your go-go to your slow-go years, spending tends to fall, although it can pick up again towards the end of the “no-go” years as health care costs start to rise.
Vettese provides real examples that illustrate his view. The base case is a real couple he calls Carl and Hanna (not their real names) with $500,000 in combined RRSPs and $50,000 in TFSAs. However, he also includes material for more affluent couples with five times that amount.
The book will be available at Amazon later in February and should be in bookstores early in March. A bonus is that Morneau Shepell also makes available a free retirement income calculator for those already retired on the cusp of retirement. It can be found on its website at morneaushepell.com.
The “tontine” is a centuries old idea that seems poised for revival in time to prevent the tsunami of retiring Canadian baby boomers from outliving their money. Finance professor and author Moshe Milevsky thinks a new form of longevity insurance proposed this week by the CD Howe Institute is “a great idea.”
One of the problems of the decline of Defined Benefit pension plans in the private sector is that the alternatives do not provide the same sort of “mortality credits” that DB plans provide: in effect, those who die early subsidize those with longer lifetimes. RRSPs and TFSAs also lack this feature.
Add in extended longevity and chronically low interest rates and the proverbial warning about seniors eating cat food is again becoming current. About the only place DB plans are thriving is in the public sector, so it’s ironic that the public sector is being asked to come to the rescue of the next generation of impoverished seniors.
Longevity insurance based on pooling senior risk is the key proposal of a program called LIFE, recommended by CD Howe. LIFE stands for Living Income for the Elderly and is the subject of a paper authored by Bonnie-Jeanne MacDonald, titled “Headed for the Poorhouse: How to ensure Seniors don’t run out of cash before they run out of time.” And yes, the press release accompanying the report actually uses the phrase cat food, as in the headline “Pooled Risk Insurance can save seniors from cat food.”
Retirement expert and retired actuary Malcolm Hamilton thinks the reference to cat food and the poor house is “unfortunate and unwise … There is nothing in the paper to suggest that either outcome is commonplace in Canada.” He says the paper is not about senior poverty but about the inability to provide well-designed, affordable products to those who have saved reasonable amounts for retirement and seek an effective way to convert their savings into an income for life.
“This is not an issue for the poor, who rely on government pensions for life,” Hamilton told me via email, “It is not an issue for public servants, who collect large public-sector pensions for as long as they live. It is an issue for middle class private-sector workers who don’t have traditional DB pensions.”
This giant cohort – a big focus of this column – typically have modest amounts saved in DC pension plans, RRSPs and TFSAs and must figure out how to tap these to supplement government pensions (OAS and CPP). Their challenge is how to invest the money, how much and when to withdraw, and whether and when to buy annuities. But they can’t find safe, adequate returns in a world with ultra-low interest rates, so “end up doing the wrong things for the wrong reasons. They take too much risk, or not enough. They earn dismal returns by investing in high fee mutual funds or low interest deposits,” Hamilton says, “They hold on to their houses and hope that, if all else fails, their home equity will cover any shortfalls. Most muddle through somehow … but there must be a better way.”
There is, if Ottawa starts to embrace “tontine thinking” in designing its retirement support programs and tax policies. In the report, MacDonald says “Retirement will span beyond age 85 for more than half of 65-year old Canadians … We need innovative solutions now: ones that add definitive value but place no new pressures on the Canadian public purse.”
Well amen to that, as the program proposed by MacDonald would be completely voluntary, a national program that lets retirees buy into a pooled fund that would provide a stable income beginning at age 85.
Hamilton says Ottawa could play a role but “it won’t be easy. The ‘government led’ plan will have many of the same problems that financial institutions have encountered but the government will be less encumbered by a profit motive. Maybe that will make a difference.”
Here’s how LIFE would work. For those who sign on at age 65, Canadians could invest funds into LIFE according to their discretion. Monthly payouts would start at age 85 and continue as long as you lived.
Commuted-value cash withdrawals would not be permitted during the deferral period or the payout stage. By pooling mortality risk among members, survivors would gain the added return of a “mortality premium,” with long livers benefiting from those who passed away before age 85. Between 65 and 84, each member’s account would be invested in a portfolio described as “relatively aggressive” and grow each year by actual investment experience plus the mortality premium generated within the age 65 to 84 LIFE group that year.
After 85, members’ funds would be moved into a more conservative portfolio, with monthly income commencing that would be fixed across their remaining lifetimes, using conservative investment and mortality expectations. Each year, any surplus in the group’s mortality experience and investment returns would be distributed equally among the 85+ cohort through lump sum “bonus” payments.
So why doesn’t the institute come right out and call this a tontine scheme? Milvesky, a finance professor at the Schulich School of Business and a prolific author of books on personal finance and annuities (notably Pensionize Your Nest Egg), says of the CD Howe report, “Basically, the author is proposing a tontine scheme, but obviously doesn’t want to call it a tontine because of the negative connotations. All longevity-risk sharing schemes can trace themselves back to historical tontines … the author deserves brownie points for bringing a debate to Canada that is taking place globally around these issues (Australia for example).”
Milevsky proposed resurrecting tontines in his 2015 book, King William’s Tontine: Why the Retirement Annuity of the Future Should Resemble its Past. I reviewed it in this Retired Money column almost three years ago. He’s also written academic papers on tontines, which were created in 17th century Europe and occasionally pop up in films like The Wrong Box. At first glance it’s a morbid concept that involves the pooling of investments such that those who die end up subsidizing those who keep living (hence the term mortality credits). But it’s not a lot different than the ideas behind life insurance and indeed DB pensions.
Last August Milevsky’s article Tontine Thinking was published in The Actuary, arguing mortality credits should be re-introduced explicitly in the design of future Retirement Income products. He noted the global decline of DB pensions and the growing concern of policy makers that future retirees will no longer have access to the low-cost efficient longevity-pooling schemes that are the actuarial backbone of DB plans.
The problem of declining DB plans has been exacerbated by the so-called “annuity puzzle,” which describes the reluctance of older consumers to exchange their retirement nest eggs for annuities, “despite their welfare-enhancing properties.” Unfortunately the Defined Contribution (DC) plans that are displacing DB plans “rob” retirees of both mortality credits and the benefits of risk pooling, Milevsky wrote. The question he poses in the paper is whether the centuries-old tontines – “or at least the underlying DNA of a tontine” – can help. “I believe the answer is yes.”
Certainly, LIFE contains this DNA. But can the private sector launch it without any demands from the public purse? “Administratively it might be easier to allow Canadians to buy more CPP income,” Milevsky said in an email, “Why aren’t insurance company annuities good enough? Who is the target audience for this product? Why not change regulations and allow the FinTech and InsurTech ecosystem to take over?”
Warren Baldwin, an almost-retired Wealth Advisor with T.E. Wealth says LIFE is “a nice idea but a traditional annuity is already a form of longevity insurance. The issue with this is it seems somewhat counter-philosophical in that it proposes that seniors of limited means ‘protect’ their future cash flow by putting a lump of funds into a non-liquid pool that gives them no access to funds before age 85. Overall, I think most seniors would give this a very short shrift. The one issue this illustrates is the concept of the longevity premium of a tontine-like structure.”
Adrian Mastracci, portfolio manager of Vancouver-based Lycos Asset Management Inc. says funding the ever demanding retirement years can be fraught with fears and trepidation and any additional options that help retirees from running out of money in their later years are welcome strategies.
I say bravo to C.D. Howe, Milevsky and the other pioneers proposing this transformation. Hopefully, our leaders in Ottawa who profess to care about the beleaguered middle class will listen to this proposal and do their bit to promote it.
You don’t necessarily need new money in order to come up with the cash to maximize your 2017 RRSP contribution.
That should come as welcome news after all the holiday spending. January makes some big demands on cash flow as credit-card bills come due. Add to that the opportunity to top up your TFSA (as detailed last column), and you probably don’t want to be reminded that the annual RRSP deadline is already looming if you wish to minimize taxes for the just-completed 2017.
First, a quick fact check and reminder on deadlines. This year’s deadline is March 1st, which falls on a Thursday. The maximum you can contribute for 2017 is $26,010 (it will be $26,230 for calendar 2018), assuming you earned sufficient income to get that much room, and that you’re not in a good employer pension plan that chops RRSP room down by the amount of the Pension Adjustment (PA) shown on your T-4. Yes, Virginia, tax time is looming, so brace yourself for the annual blitz of T-4 slips, T-3s and T-5s.
OK, now back to some tips on getting at money to make your RRSP contribution and let’s start with seniors. Seniors are most likely to have a good amount of money sitting in “open” or non-registered investment accounts, which means any securities can be “transferred in kind” to your RRSP, thereby generating the required receipt to generate a tax refund come tax filing time in April.
You don’t have to be a senior of course: any Canadian of any age can transfer-in-kind securities from their open accounts to their RRSPs; it’s just that many younger folks may not have a lot of money housed in non-registered accounts. Most tend to maximize the RRSP first and since 2009, the TFSA as well. Older investors, on the other hand, missed out by not having the TFSA option for decades before they were introduced; plus, if they had good corporate pension plans to boot, they may have maxed out on their RRSP room and therefore felt “forced” to put excess savings into non-registered plans.
To be sure, non-registered plans are a poor second to TFSAs, since the above-mentioned T-3 and T-5 slips are all generated by taxable accounts, faithfully reporting to the Canada Revenue Agency just how much taxable dividend, interest and capital gains you received in 2017. Happily, TFSAs (and RRSPs) don’t generate these tax slips.
So just as it makes sense to move as much of your non-registered money into TFSAs, so too can it makes sense to do the same into an RRSP, with the added bonus of a tax refund. Otherwise, the mechanics are similar to our description of TFSA transfers-in-kind.
For starters, even though an RRSP transfer-in-kind may be motivated by tax, keep in mind there can also be a tax hit if the securities you transfer to the RRSP have enjoyed significant capital gains since the original purchase in your non-registered account. Once it moves into your RRSP (or TFSA for that matter), then the transaction is deemed by the CRA to be a “deemed disposition,” which means Ottawa will have its hand out for capital gains tax.
So job one is to scour your non-registered portfolio for securities that do not show significant rises in value since you first purchased then. For example, I recently discovered that my shares in a Canadian dividend ETF were roughly where I had purchased them. That’s sad from the perspective of hoped-for gains that didn’t materialize. But it’s good if you’re looking for a candidate to transfer into an RRSP. If there’s a small gain, then yes, you’ll have a small bit of tax to pay but keep in mind you’ll be generating a larger tax refund and once the security has been transferred into the RRSP, that portion of the investment will no longer generate those T-3 and T-5 slips in future years, at least for as long as they’re held in the RRSP.
But what if you’re such a brilliant investor that all your securities show significant gains? Then you might not want to use the transfer-in-kind strategy but resort instead to using actual new money (cash) or borrow the money with an RRSP top-up or catch-up loan, which we will address in a future column.
However, if you’re like me, you may have some gains here and there but also have suffered the odd loss. If that’s the case, then you may be able to offset the gains with losses, in which case it might still be tax-effective to use the transfer.
Be careful, though. Matthew Ardrey, Wealth Advisor and vice president of Toronto-based TriDelta Financial cautions that with non-registered losses, you have to sell the security and then transfer in the cash. This crystalizes the loss and to avoid the superficial loss rules you should avoid repurchasing the same security in your RRSP within 30 days; nor should you have bought the security 30 days before the sale. Either of those mistakes will cost you.
Mutual fund distributions often occur in December, which can create superficial loss problems if sold in January, Ardrey says. But even then, the superficial losses can be prorated. Ardrey cites the example of Jim, who owns 1,000 in XYZ Mutual Fund and receives a 100-unit distribution on December 31. Now he has 1,100 units: if he sells them for a $5,000 loss on January 3, he could claim a $4,545 loss, calculated as $5,000 minus $5,000 multiplied by 100/1/100. This can also impact someone with a pre-authorized contribution (PAC) plan in place for a fund sold at a loss and contributions continue to the fund in an account they own or are connected to under the superficial-loss rules.
Clearly, the tax rules are tricky here: speak to a tax professional if you’re unsure about how the rules apply to taking superficial losses or transfers-in-kind generally. Indeed, some financial advisors prefer to keep things simple because of this complexity: “I don’t do transfers-in-kind,” says Adrian Mastracci, portfolio manager with Vancouver-based Lycos Asset Management Inc.
All else being equal, Ardrey reminds investors they should strive to keep equities outside the RRSP and fixed income inside. And with fixed income lagging equities on returns in recent years, it may be an opportune time to rebalance portfolios to the target mix by selling some equities and adding fixed income to your RRSP. There are no superficial loss impacts in this situation.
Sadly, here at Retired Money, we don’t make the rules; we just observe them and try to find ways to play within the system to our advantage. Happy new year!
Because the biggest single expense in retirement is usually tax, high-income seniors should strive to use Tax-free Savings Accounts (TFSA) to minimize the tax bite in their later years.
The key is to maximize both contributions and growth no matter how old you are, which means holding proper growth investments (equities) instead of fixed-income instruments that pay a pittance.
“The TFSA is a mis-named vehicle,” says T.E. Wealth’s senior vice president Warren Baldwin, who prefers the term “Tax-free Portfolio Account” or TFPA. Still, it’s fortunate that despite the misnomer, the TFSA can act as a TFPA.
Because the TFSA was introduced only in 2009, most seniors have ten times as much money in RRSPs and RRIFs than TFSAs, says Sandy Aitken, CEO of M-Link Mortgage Corp, developer of TFSA Maximizer. Over 15 years, his product aims to reverse that ratio.
The main issue is when RRSPs convert to RRIFs after age 71 (if not annuitized) and the legislated annual minimum withdrawals that require them to pay income tax at high marginal tax rates.
Why is the TFSA so valuable to seniors? Unlike RRIFs, TFSAs generate no taxable income on withdrawals nor investment income. But TFSAs are equally a boon to the less fortunate: they don’t trigger clawbacks of Old Age Security or the Guaranteed Income Supplement.
Another big difference is that unlike RRSPs and RRIFs you can keep contributing new money into TFSAs after age 71. Even if you live to celebrate your 101st birthday – as my friend Meta recently did – you can continue to pump in $5,500 a year to your TFSA, as Meta has been doing.
In contrast, you can no longer contribute to RRSPs after the year you turn 71 (or after the year the youngest spouse turns 71), and even then this depends on either carrying forward RRSP room or earning new income. As Baldwin notes, most seniors have little or no earned income. Nor can they contribute new money to RRIFs: they’re strictly vehicles that shelter what you’ve got until the next forced annual withdrawal, which escalates over time from 5.28% at 71 to 20% a year once you reach 95.
Baldwin says some retirees should start their RRIFs by age 64 or 65 in order to claim the Pension credit. Plus it may make sense to “grind down” RRSP/RRIF values well before age 71 if you find yourself in lower tax brackets.
It would be nice if you could magically transform your RRSP/RRIF into a TFSA in an instant. In reality, the process will take a decade or more. “TFSAs are an excellent vehicle for those in or near retirement,” says Matthew Ardrey, wealth advisor and vice president of Toronto-based TriDelta Financial. TFSAs “can be a considerable advantage over the RRSP/RRIF.”
Ardrey provides the example of the purchase of a big-ticket item like a $40,000 new car. If all a senior couple have is an RRSP or RRIF, they’ll need to withdraw almost double the purchase price to get the same after-tax amount that taking $40,000 tax-free from their TFSA(s) would furnish. But withdrawing $80,000 from RRSPs may put their income above the threshold for OAS clawbacks. In 2018, this threshold is $75,910, after which the OAS Recovery Tax results in a 15% clawback of OAS income for every dollar over the threshold.
But what if you can’t afford a car? Ardrey points out the TFSA is even more important for GIS recipients than for OAS because every dollar of taxable income reduces GIS by 50 cents. (OAS and GIS income don’t trigger GIS clawbacks nor does the first $3,500 of employment income).
So TFSAs makes sense for all seniors, rich or poor. This is why Ardrey urges every retiree to maximize TFSA contribution every year: to the current limit of $5,500 a year, plus any future inflation adjustments.
To maximize the time value of money, it’s best to contribute early in January 2018 and every subsequent January. On the flip side, Baldwin says TFSA withdrawals should be deferred as late as possible in the calendar year. This minimizes the time before you can re-contribute to the plan.
But once your working years are over, how can seniors come up with the money for TFSA contributions? There are two primary ways. First are those forced RRIF withdrawals. You must pay the tax on withdrawals but don’t have to spend the proceeds. Assuming that minimum RRIF payments and other income sources exceed spending needs, those net (after tax) withdrawals can go into your TFSA.
Secondly, many seniors have a lot of wealth in non-registered investments (RRSP room may have been limited, perhaps because of a high Pension Adjustment created by generous DB pension plans.)
Fortunately, you don’t need “new money” to make TFSA contributions in your golden years. Aim to gradually “convert” your taxable accounts into TFSA accounts, $5,500 a year for each spouse. Ardrey notes one spouse can fund the entire $11,000 a year available for a couple, as there is no attribution on TFSA contributions.
You can make TFSA “transfers-in-kind” from non-registered accounts: easily accomplished by talking to your financial institution. Best case is to have a security priced roughly where you originally bought it: then you could transfer-in-kind $5,500 worth of that stock into your TFSA with minimal tax consequences.
However, odds are you DO have some capital gains in your open account, in which case you’ll have to take a one-time tax hit. But you may be able to mitigate the tax if you can find some capital losses to offset winners. Ardrey says any non-registered investments transferred into the TFSA are considered deemed dispositions: any gains will be realized; so will capital losses but they can’t be used for tax purposes to offset any current or past losses. In order to crystalize losses, the security must be sold on the market (or redeemed if a mutual fund), then the cash proceeds can be contributed. Keep in mind you can’t repurchase the security in the following 30 days, in order to avoid the superficial loss rules.
Ideally, TFSAs should be the last retirement income source seniors should tap. Purely from a tax perspective, you want to draw down on RRIFs and non-registered accounts first, says Doug Dahmer, founder of Burlington-Ont.-based Emeritus Financial Strategies. Ardrey says after being forced to withdraw your RRIF minimums, you should review your tax situation to see where you should take your next dollar of income.
“As long as there is inescapable tax tied up in your investment portfolios you want to pay these taxes while you alive,” Dahmer says. It’s probable you’ll be in a lower marginal tax bracket while still alive, so can income-split. If you wait until one spouse dies, the survivor’s combined holdings will push them into a much higher tax bracket: Dahmer terms this a “tax trap.”
Tax brackets matter. Baldwin says if you have embedded capital gains and some room in the lower or middle marginal tax brackets, it may make sense to draw on the RRSP/RRIF first since they will be eventually 100% taxable when eventually forced to withdraw; by contrast, capital gains are only 50% taxable, or not at all if donated to charity.
Dahmer’s clients call their TFSAs their “Never Never Fund.” While available for emergencies, they should be the last source of funds to be tapped. This flies in the face of the banks’ depiction of TFSAs as “save to spend” accounts holding low-yielding daily-interest savings accounts. By contrast, Dahmer says TFSA time horizons should be aimed at those likely to inherit the money, which means healthy exposure to equities.
TFSAs can also serve as highly cost-efficient form of estate planning to supplement the use of Whole Life or Universal Life insurance policies. And remember that while both spouses are alive, they should designate each other the TFSA’s successor holder. This way, the survivor can transfer the value of the TFSA at death, plus any growth after death, into the survivor’s TFSA with no tax implications.
If funding is short, you should always top up the TFSA of the spouse who is likely to die first because the survivor can top up later, Dahmer says. “Downsizing your house is also a wonderful time to top up your TFSA.”
Many fixed-income investors are acquainted with the concept of “laddering,” whether it be ladders of guaranteed investment certificates (GICs), or bonds with different maturities. Maturity dates are staggered over (typically) one to five years, so each year some money comes due and can be reinvested at prevailing interest rates. This minimizes the likelihood of investing the whole amount at what may turn out to be rock-bottom interest rates, only to watch helplessly as rates steadily rise over time. Buyer’s remorse results: “Why didn’t I wait to invest?”
The same applies when it comes time for retirees or near-retirees to annuitize. At the end of the year you turn 71 you must decide whether to convert your RRSP into a RRIF, cash out and pay tax (few do this), or thirdly to annuitize.
Mind you, as Warren Baldwin, a senior vice president with T.E. Wealth points out, the analogy is not perfect, since GICs mature and annuities do not. Even so, annuity returns are also affected by low interest rates today. This interest-rate risk may explain why annuities are relatively unpopular, despite providing longevity insurance that guarantees you won’t outlive your money.
Fortunately, annuitization isn’t an all-or-nothing decision. You can convert some of your RRSP to a RRIF and some to a registered annuity. You can take a leaf from the GIC laddering concept and buy annuities gradually over five, ten or even more years. Patrick McKeough, publisher of the TSINetwork.ca agrees laddering annuities can reduce the potential downside: “You could buy one annuity a year for the next five years. That way, your returns will increase if interest rates rise, as is likely.”
Finance professor and author Moshe Milevsky agrees with taking “a staggering or laddering or dollar-cost averaging approach” to buying life annuities, “both for financial reasons and more importantly for psychological reasons.” This lets retirees “get used to their pension” before fully committing to what is an irreversible decision.
Warren MacKenzie, head of financial planning for Toronto-based Optimize Wealth Management, says retirees are generally happier when the income necessary for basic necessities is guaranteed. “For retirees one of the most important things is to have financial peace of mind,” MacKenzie says, “Even if an investment portfolio invested in large-cap bank stocks could deliver a higher cash flow (as has occurred in the past), the investor should choose the annuity if this will deliver greater financial peace of mind.”
If you plan to take the annuity route, “a laddering approach makes perfect sense,” MacKenzie says. But instead of staggering their purchase over just a five-year period, someone in their 60s might consider staggering them over a 10- or 15-year period,” he says. Once you have annuitized enough to guarantee a basic income, you should feel more comfortable investing the rest of your capital in the traditional manner (in a RRIF), with a higher weighting to equities.
Not sure how much to annuitize? Consider first how much annuity-like retirement income you already have, or expect to have: such as an employer-sponsored Defined Benefit pension or CPP and OAS. Some investors may have a high component of annuity-like income without realizing it, says Adrian Mastracci, portfolio manager with Vancouver-based Lycos Asset Management Inc. Many families may already have five or six such sources of annuity-like income. He likes the flexibility of a RRIF to handle large expenditures in later years: where he does like annuities is for big-spending clients who might otherwise be tempted to break into capital.
Lack of liquidity and flexibility is one reason Warren Baldwin isn’t a big fan of annuities. This can be mitigated by adding a guarantee period or a joint-and-survivor beneficiary but these reduce annuity income. In a market swoon, Baldwin prefers more fixed-income liquidity. With a GIC or bond maturing every year, an investor has a lump sum of cash if a major expense arises.
Baldwin also views the lack of estate value of annuities negatively. However, Toronto-based financial planner Rona Birenbaum says annuity buyers can solve this by purchasing a permanent life insurance policy representing all or some of the capital amount used to purchase the annuity. The estate/beneficiary is paid by the insurance when the annuity stops at death. Investor health matters. Substandard health may result in life insurance premiums too high for the strategy to make sense overall.
Most annuities purchased in Canada are immediate: income payments begin immediately after purchase. Birenbaum says deferred annuities are less popular. With these, there is an initial accumulation phase with no payout and a later withdrawal phase where payments commence. The permanence of this purchase before the income is needed and the lack of liquidity makes it a less attractive annuity option, she says.
So how much monthly cash flow could you expect for each $100,000 of capital? The older you are before you start receiving income from annuities, the higher the payout. But the effective annuity rate is also based on factors like current interest rates, mortality rates and optional extra features like inflation indexing, guarantee periods or joint-and-survivor benefits. “The more bells and whistles, the lower the monthly income,” says Birenbaum, who is the founder of the financial planning firm, Caring for Clients.
Investors also need to be cognizant of differing tax treatment of annuities. Payouts from registered annuities (held in RRIFs, for example) are fully taxed, while non-registered “prescribed” annuities are relatively more attractive on an after-tax basis. That’s because only a portion of the monthly payment is taxable. In the examples below supplied by Birenbaum, we look at various options for 70-year olds wishing to annuitize $100,000 in single-life, prescribed non-registered and also registered annuities.
Birenbaum says a 70-year old male purchasing $100,000 in a single life, prescribed non-registered annuity with no guarantee or indexing would get $598.61 a month, of which only $92.96 is taxable, according to an RBC quote. A registered annuity with the same terms would pay $624.26 via BMO.
Add in a 10-year guarantee for the same retiree and the payout is $581.34, of which $107.65 is taxable (Sun Life). A registered annuity with the same terms would pay $600.84 at Equitable Life. If you add both the guarantee and inflation indexing at 2%, the payout falls to $487.42 a month. At Equitable, the registered annuity with those terms would pay out $497.25 a month.
Because women have longer life expectancies, payouts for females are slightly lower. For a 70-year old female, for $100,000 in the bare bones single life prescribed non-registered annuity would pay out $535.16 per month at Desjardins, only $16.84 of it taxable. For registered funds, BMO pays $549.92.
With a 10-year guarantee the payout would fall to $531.86, $88.05 of it taxable. The registered version at Equitable would pay $547.63. With inflation indexing at 2%, the payout would be $433.06 per month, fully taxable at Sun Life. The registered version at Equitable would pay $445.23.
These are all at the interest rates prevailing late in 2017: the Bank of Canada stayed pat on December 6th but is expected to hike rates two or three times over 2018. If you partly annuitize now and add more a year from now you can expect still higher payouts: remember the laddering strategy with which we began this article!
The last time we looked at the question of when to commence receipt of the Canada Pension Plan (CPP), we made the case for delaying as long as possible – ideally until 70 – while drawing down RRSP assets in your 60s when you’re in a lower tax bracket. (The piece is here.)
That’s a valid strategy for many but it does make a few assumptions, including that you have a large enough RRSP to withdraw from, have good alternative sources of income in the meantime, and that you’re not confident that the markets will deliver good returns if you were in a position to invest your CPP were it taken earlier.
But the biggest assumption is that you’ll live to enjoy those higher payouts once they commence. If your life expectancy is for some reason lower than average, all bets are off and you may be better off taking CPP between 60 and 65.
Jason Heath, of Toronto-based fee-only planners Objective Financial Partners, leans to advising clients to defer CPP/OAS to 70 for those whose life expectancy is average or longer than average. But he concedes that few do so, in part because Service Canada reaches out to people as their 65th birthday approaches.
In practice, very few Canadians wait until 70. In fact, taking it as soon as it’s on offer at age 60 is the single most popular option: according to the federal government’s 2016 data, of the 312,251 who began collecting CPP that year, 126,954 did so right at age 60, with the second most popular start date being age 65, when 93,460 started to collect. A paltry 4,844 waited until 70. To put that into context, in 2015 there were 13.98 million citizens still contributing to CPP. All told, as of 2016, there were 5.6 million CPP beneficiaries.
Ah but the critical phrase there is “personal health.” Personally, during my wealth accumulation years, I blithely assumed my genes and mostly positive diet and exercise regime meant I could expect to live well into my 90s or beyond. However, I am discovering that as your 60s progress, things can change, either for you or your spouse. I certainly believe you should get regular medical checkups every year at this age, with special attention to blood pressure and heart health.
Sun Life has a useful life expectancy calculator you can access here. It told me I can expect to live to age 86 (the year 2039), which conforms to a common rule of thumb that you can expect to live somewhere between the ages your parents passed away. And my wife, who is a year younger, can expect to live till age 87.
Toronto-based financial planner Ed Rempel says 15% of 60-79 year-olds have cardiac issues and 13% of 65-year-olds have dementia. “I’m sure there is some overlap. People with either would be 1 in 4 or 5.” So odds are almost even that at least one member of a couple will eventually have significant health issues.
That said, the biggest success of modern medicine has been to prolong lives. The average life expectancy of a 60-year-old is now up to 23 years (age 83). For couples, the average life expectancy of whichever one lives the longest is 32 years (age 92).
To plan for a 60-year-old couple, a 32-year time horizon still leaves a 50% chance of running out of money while one member of the couple is still alive. For Rempel, how you invest is an important part of the equation: “In general, equity investors should take it (CPP) early, while balanced and bond investors should not.”
For example, if an equity investor retires at age 60, taking CPP early means taking out that much less from investments. Allowing them to grow with typical equity returns should increase their future income more than delaying CPP would. “If they are still working and in a reasonably high tax bracket, then equity investors likely should delay as well, unless they can contribute the entire amount to their RRSP,” Rempel says.
Daryl Diamond, president of Winnipeg-based Diamond Retirement Planning Ltd., says the CPP start date is the most common question he is asked. But it’s NOT simply a case of getting less if you start early and more if you wait, says Diamond, who is also the author of Your Retirement Income Blueprint.
Sure, the timing decision is easy if you know for certain you’ll live to your 90s or, conversely, are fated to pass away in your 60s. This is where Service Canada’s “notional crossover” ages are often cited, which is the age beyond which it pays to have delayed CPP. Die before the crossover age and Ottawa “wins” the bet on your longevity. These range from 73.9 if CPP is taken at 60, to 77.9 if deferred till 64, and remains at 76.9 between ages 66 and 70, according to Diamond.
Even so, these should not be viewed as definitive numbers, he cautions. In part, that’s because the timing decision also impacts taxation and how other income streams will be affected: CPP and OAS both generate fully taxable income and once begun, you can’t control the amount of income those programs generate.
There is no one-size-fits-all answer but Diamond says for someone who is retired or already retired, his bias is to take advantage of CPP/OAS as they become available (i.e. 60 and 65, respectively). He likes to employ CPP and OAS as “the first layers” of retirement income, precisely because they are less tax efficient and less flexible.
Bear in mind that, like most pensions and annuities, CPP and OAS are income streams that “run out” or reduce upon the passing of a spouse, unlike personal assets that have both a survivor and estate benefits.
One thing the “delay CPP” crowd often forgets is the tricky issue of Survivor Benefits. We looked at this earlier this year but Diamond says that while you can receive both a CPP retirement pension and a survivor benefit, the sum of the two cannot exceed the maximum CPP retirement pension payable at age 65. So if both spouses wait until 65 or beyond and are at the maximum payout, there would be no CPP survivor benefit for the one who outlives the other. And OAS has no survivor benefit nor an estate value (CPP has a $2,500 death benefit).
Speaking personally, I have no regrets about my decision thus far to defer CPP until at least 65, which for me occurs in April of 2018. As I have written before here, I will then take OAS but as of this juncture, will probably defer CPP for another year or two, but probably before age 70.
As Diamond reminds us, retirement planning would be so much easier if you just knew the precise date of your departure from this planet.
If you were told there was a way to boost your income in retirement by 50% it would no doubt get your attention. It certainly got my attention, in a paper in a recent issue of the Journal of Retirement. The paper was co-authored by one of MoneySense’s panelists for the annual ETF All Stars panelists: Mark Yamada, president and CEO of Toronto-based PUR Investing Inc. The co-author is his colleague Ioulia Tretiakova, the firm’s director of quantitative strategies.
You might find the paper is bit too complex but this column aims to explain it in layman’s terms. While the strategy might be hard to replicate, it may at least get you thinking about your nest egg in a different way and lead to some good discussion with your advisor. It’s a new way to look at whether you should target income generation or maximizing returns when you maintain your nest egg in retirement. The paper is called “Autonomous Portfolio: A Decumulation Investment Strategy That Will Get You There.”
Let’s start with the term “decumulation,” which is short for de-accumulation and hence the polar opposite of accumulation, as in “wealth accumulation.” As this column has often noted, while most of us spend our first several decades accumulating wealth, one of the ultimate objectives of all that saving and investing is to start drawing an income for when your working days are over. (See for example The Decumulation Institute, which we’ve referred to in columns past).
Yamada and Tretiakova observe what many aging Baby Boomers are coming to terms with: that the combination of rising life expectancy, minuscule interest rates and declining availability of employer-sponsored Defined Benefit pension plans is making boomer retirement an anxious proposition. And since 10,000 Baby Boomers retire every day in the United States, and roughly 1,000 a day in Canada, the level of collective anxiety is rapidly growing.
As we noted recently, there are good arguments for retirees to maintain significant positions in the stock market, but of course that entails taking on higher risk. Adding to the anxiety is the fear that a stock market crash may occur when it’s least welcome, resulting in what various retirement experts call “retirement ruin.” In fact, I’ve seen various articles in recent years that raise the spectre of all these Boomers moving into decumulation and thereby contribute to a market decline.
Little wonder that one study cited by the authors (Allianz 2010) found 61% of those aged between 45 and 75 were more afraid of running out of money than of dying! Sure, you can decide to work a little longer, which lets you save more and cuts down the years you’ll need to withdraw an income, but there’s a limit to how long you can work (or find willing employers or clients). Ultimately, health and time are not on your side.
Enter the authors’ Decumulation Investment Strategy, which is designed to let retirees better manage both retirement income and the probability of ruin. The goal is to boost income; it assumes a retiree currently withdrawing 4% of their nest egg can use the strategy to be able to spend 6% without increasing the chance of running out of money before dying.
The authors start by making a novel analogy to self-driving cars, of all things. Autonomous vehicles are all about protecting passengers from surrounding hazards and navigating to a pre-determined destination. But as the paper notes, it’s ironic that “protection and navigation are two things the investment industry does not do particularly well.”
The industry has developed different kinds of diversified Target Date Funds (TDF) and managed accounts that actively rebalance to as aggressive an asset mix as possible: typically 60% stocks to 40% bonds. However, the paper argues that if portfolios were autos, “this would be akin to driving with the pedal to the metal” at all times without regard to terrain, weather or traffic conditions.
Worse, the investment industry relies on historical risk and return data to project future returns, somewhat like navigating a car by peering through its rear-view mirror.
Here is how the authors figure they can get the extra 50% in income. The aim is to keep portfolio risk constant by reducing it when market volatility rises and to increase portfolio risk when volatility falls (hence their term of DCR, which stands for Dynamic Constant Risk).
Their maximum weight for equities is 60% because they assume those over 65 won’t be comfortable with more stocks than that. But within that constraint, equity allocation is raised when the investor is behind the goal (the probability of ruin is higher), and, conversely, allocation to equities falls when the investor is on target.
Another key mechanism in their strategy involves variable spending rules that link “spending” (income generated by the portfolio) to the performance of the portfolio. So, they boost income generation when markets are doing well, and cut it when markets underperform. They look at several “safe” withdrawal strategies, including a modified take on William Bengen’s famous 4% rule (The 4% rule attempted to calculate the maximum amount you can withdraw of your nest egg each year without outliving your money. See earlier Retired Money column on this), as well as variants on this approach from the Yale Endowment Fund, Zolt and Guyton.
The DCR strategy offers the highest withdrawal rates of all these strategies, including a fixed 60% stocks allocation. Combined with a so-called “hybrid” spending (income generation) rule, it provides the best result, an average of 51% more income than a Target Date Fund approach. What’s more, it provides an average of 40% more income than a conservative 60/40 diversified fund over the same “range of ruin” probabilities, and delivers spending that does not decline even when the market does.
To be sure, it’s a complex paper and replicating this strategy at home yourself won’t be easy. I have spared readers the math but as Yamada reminds us, managing retirement money is such a challenge because there are so many variables and unknowns, like how long you’ll live and how long you’ll be healthy. Add to that the complexity of financial markets and the challenge is apparent. Investors can only control certain things and accept the reality that much is beyond their control.
Even if you don’t fully replicate the strategy, it’s food for thought when it comes to how you approach retirement planning. The authors’ approach of aiming to keep portfolios travelling towards income goals rather than maximizing returns is a bit of a paradigm shift compared to traditional practice, as is rebalancing to constant risk rather than cleaving to a predetermined asset mix.
For a link to the paper in the Journal of Retirement, click here.
Like Stelco and Nortel before it, thousands of pensioners of Sears Canada are experiencing firsthand what happens to corporate Defined Benefit pension plans when a business fails.
In October, Ontario’s Superintendent of Financial Services (FSCO) appointed Morneau Shepell to administer Sears Canada’s underfunded pension plan, a first step to winding the plan down in the wave of store liquidations that are now under way.
According to veteran Sears Canada spokesperson Vincent Power, the Sears DB pension is only 81% funded as of June 2017, although changes in interest rates and markets could alter the final figure. If it stands, it means DB plan members would get a 19% benefits haircut, although Ontario residents would have some restitution under the province’s Pension Benefits Guarantee Fund (PBGF), which we looked at in detail a couple of columns back. The PBGF guarantees the first $1,000 a month of pension, a figure slated to rise to $1,500 but which has not yet been legislated. Residents of other provinces do not enjoy this compensation, and roughly half of Sears employees were outside Ontario.
The full story of how Sears Canada imploded is beyond the scope of this column but I refer readers to an excellent summary in the Globe & Mail here. Our focus today is on the implications for Sears pensioners.
Sears Canada was founded in 1953 as a joint venture between Sears Roebuck in the U.S. and Robert Simpson (as in Simpson Sears). It has had various incarnations of DB pensions (it also has a Defined Contribution component) but the most recent DB component ceased to exist as of Jan. 1, 2008, Power said. As of the end of 2016, there were 16,921 members in the DB component of the Sears pension plan: 13,121 of which were retirees and 3,025 active or disabled members.
Sears differs from Nortel in that a Canadian subsidiary of a U.S. company is involved and it appears Chicago-based Sears Holdings Corp milked the Canadian unit to the detriment of Canadian pensioners (not to mention the many employees thrown on the unemployment lines without severance.)
Pension advocates fear other domestic subsidiaries of foreign giants may take a cue from the fate of Sears Canada. The retailer filed for protection from creditors in June and lawyers for Sears’ retirees had been asking FSCO and Sears Canada to wind down the pension plan since 2014.
Retired actuary Malcolm Hamilton says the wind-down will be a lengthy process, as there are many calculations to perform, reports to file and permissions to be granted. “Any claim that the pension fund has as an unsecured creditor of Sears cannot be fully evaluated until that process plays out [so] the percentage of the wind-up benefits that the fund will be able to pay will not be known for some time. Once the dust settles, the PBGF will cover any reduction in the first $1,000 of monthly pension for members who were employed in Ontario.”
The Sears situation is similar to what happened to pensioners at Nortel Networks years ago, says pension administrator Sean Cooper. When companies file for bankruptcy, pensioners are left in limbo: they are considered unsecured creditors, Cooper says, falling in priority below secured creditors like the banks.
But Sears is hardly unique: 30% of similar defined pension plans in Ontario are also underfunded, which shows the importance of keeping an eye on the funding status of your pension plan. “Your pension could be halted if the company goes bankrupt. This can be especially devastating if you’re on a fixed income,” Cooper says.
Bill Jones, director of the Canadian Federation of Pensioners, says Sears is another example of a broken, or partially broken, pension promise. He points to the billions of dollars Sears Canada has been sending to majority shareholder Edward Lampert, chairman of Sears Holdings Corp., while failing to put money in the pension fund against the deficit. As a result, “all the people who are Sears pensioners or are going to become pensioners if they’re active employees and have an entitlement to part of a pension will lose on the order of 19%, and they’ve also lost all their health and dental benefits.”
If you’ve not yet begun to start receiving the Sears pension, an option is to take the so-called Commuted Value of the pension, rolling a lump sum payment over into your RRSP so you have complete control of the assets. In that case, you’d give up the monthly income stream for life that the pension would have provided in the future.
But if you’re already receiving a pension, this is usually not an option.
“My advice to pensioners is to hang in,” says Mike Campbell, also a director for the Canadian Federation of Pensioners and vice president of the Nortel Retiree and former employees Protection Canada. Except for young pensioners in their 50s who have low life expectancy, Campbell says the way commutations are calculated, it’s punitive to take out the commuted value. “I wouldn’t recommend it.”
In any case, Hamilton doubts the pension fund would be allowed to pay out commuted values while the process is ongoing. Those allowed to commute their pensions will eventually be able to do so, subject to any reductions imposed by the wind-up process and any guarantee provided by the PBGF, once they have the choice. The decision to commute or not would be the same as for any other commutation, he added, and most should consult their financial advisors.
Joe Nunes, president of Actuarial Solutions Inc., says one of many factors in that decision is how well the plan is funded and how the employer approaches it when it’s underfunded. Normally, once you have started a pension, you have to stay in the plan and the option of commuting is lost, Nunes says. Some employers give you the choice upon termination of employment, while others provide the choice at the time you start retirement, but there’s no legal requirement either way, Nunes says.
Sears retiree Ken Eady, representative for retired Sears employees, is particularly concerned about those who may have smaller pensions. For them, a 19% haircut and the loss of health and dental benefits will be onerous. Over the past five years the group was repeatedly told by the company that it was abiding by the law; asked whether they considered they had a fiduciary responsibility to the pension plan the company responded “we believe we are,” Eady says.
“Clearly the pension promise has been broken by the company. I don’t like asset-stripping: what matters is that shareholders had a big payday while leaving the pension plan underfunded. The plan is short $260 million, even after $3.5 billion was paid out to shareholders.”
Eady adds: “They sold the assets, took the capital and did not make any meaningful investment in the business, including the pension plan. They let the company drift into a very bad spot and stripped it of many revenue-generating assets. If they had invested in the company, built a new online sales platform or other revenue-generating enterprises, Sears would still be operating and we wouldn’t be talking about this.”
He’s also concerned that other Canadian units of foreign companies will look at the Sears Canada situation and emulate the hedge-fund asset-stripping strategy to the detriment of many more Canadian employees and retirees. Many more cases like Sears and there would be huge pressure on the PBGF and by extension the cash-strapped Ontario government.
What’s the single biggest fear retirees face? Undoubtedly it’s the prospect of outliving their money. And as this column has pointed out before, retiring in this second decade of the 21st century poses challenges for just about any healthy person who lacks an inflation-indexed employer-sponsored Defined Benefit (DB) pension plan. We’re living longer and interest rates are still mired near historic lows after nine long years.
Any financial advisor will tell you the solution to this dilemma is to stop reaching for minuscule “guaranteed” investment returns from instruments like GICs or bonds, and instead embrace the higher risks—but potentially higher returns—of the stock market. Historically, equities have generated on average a 10% annual return, which means you should be able to double your capital in a matter of seven or eight years.
It’s in this challenging environment that I recently read two recently published books that tackle these themes head on. The first is Falling Short, by Charles Ellis, better known as the author of the bestselling Winning the Loser’s Game.
Survive the retirement crisis
Falling Short is Ellis’s diagnosis of and prescription for surviving what he calls “the coming retirement crisis.” He starts by positing what many on-the-cusp-of-retiring baby boomers already suspect: that the “golden age” of retirement enjoyed 30 years ago is mostly a thing of the past. Employers are jettisoning DB pensions in favour of Defined Contribution (DC) plans that put investment risk squarely on the shoulders of workers, and (at least in Ellis’s native United States) curtailing retirement health benefits to boot.
The average retirement age for American men is now 64 (my age) and 62 for women. Based on current life expectancies in the U.S. that means the average man will spend 21 years in retirement and woman 23 years. Even counting home equity—which has come under fire as a last-resort retirement plan—most of us won’t have enough for two or three decades of retirement, Ellis warns.
Sadly, there are only three options: accept that we are going to be poor in retirement, save more while working, or work longer, which of course means fewer years of retirement. “Those our only options,” Ellis writes (his emphasis).
While it may be a bitter pill to swallow, Ellis’s solution to the retirement crisis is a combination of working longer and saving more, not unlike my own book flagged in the author bio below. Even then, Ellis suggests retirement may be less lavish than we might hope, and suggests tapping home equity to make ends meet in certain situations.
Rethinking the retirement age
One of Ellis’s key prescriptions for Americans is to recognize that while U.S. social security does permit early retirement as early as 62, albeit with reduced benefits, the real retirement age is becoming age 70, which is when Social Security payouts are much more substantial. The same dynamic is at work in Canada: this column has more than once described the strategy of deferring Canada Pension Plan (CPP) benefits and possibly Old Age Security (OAS) from the usual age of 65 to 70. The result in Canada are benefits that are 42% and 36% higher respectively. Ellis counsels governments to “vigorously promote age 70 as the new 65.”
There is another possible route, which is to make what money you have managed to put aside work harder. But that means embracing both the risk and return potential of stocks. Here a useful book has just been published called Slash Your Retirement.
The author is Chris Cook, founder of Beacon Capital Management Inc., based in Dayton, Ohio. Right in his introduction, Cook reprises Ellis’s major themes: longer life spans, low interest rates and extreme market volatility means that without a major shift in your approach to investing, “You very likely could run out of money in your lifetime.”
Cook has coined a term he calls the New ROI, which stands for Reliability of Income. In a nutshell Cook argues that in this low-yield, rising-costs environment, investors can’t afford to avoid equities and the higher growth potential they offer.
How much equities? As with Ellis, the prescription may be unpalatable to many older or risk-averse investors. Even for investors between the ages of 65 and 71, Cook suggests stock allocations of well over 50%, and in some cases as much as 94% to 97%.
If your objective is to adhere to the 4% rule (See my Retired Money column on the 4% rule), then Cook suggests starting with 94% of your portfolio in stocks before dialling it back slightly ever year until you have no equity exposure by age 83. If you want 4.5% annual income from a portfolio, then he suggests starting with 97% stocks at age 71 before eventually dropping your equity exposure at age 86. And if you want 5% per annum, it’s 98% stocks at age 75. (The chart below illustrates his recommended stock allocation for these three scenearios.)
Aggressive? I’d say so and admittedly such a high level of stock exposure may not be for everyone. While he claims not to be a proponent of market timing, Cook advocates staying fully invested in the market until there a 10% correction in the S&P 500 index. If that happens, you retreat to cash (since half the time 10% corrections turn into 20%-plus bear markets). You don’t re-enter until markets have recovered 15%.
His preferred investments for Americans is to invest equally in eleven U.S. sectors of the economy using ETFs: everything from consumer staples to tech, energy, utilities, financials and so on.
I’d be remiss if I didn’t offer a word of caution. While Cook’s approach is intended to guard against catastrophic losses, there is an element buying higher and selling lower at play, which contradicts conventional wisdom.
Question the old rules of thumb
Certainly this approach involves having a trusted financial advisor and a disciplined approach to investing. You can quibble about the high levels of stock exposure and no doubt it will be a slightly different scenario for Canadians, but the gist of Cook’s approach is to at least consider the effect of far greater stock exposure than old rules of thumb (notably that fixed income should equal your age) have hitherto suggested.
In short, readers who agree with these authors should probably keep working until 70, delaying the receipt of CPP/OAS or Social Security until that age. With the extra years of working, they should save as much as they can and invest aggressively in equity ETFs or reasonably priced mutual funds. Don’t count on your home to bail you out, but know that a reverse mortgage or HELOC is a last resort. And pray that stock markets don’t crash during your golden years.
Jonathan Chevreau is founder of the Financial Independence Hub and co-author of Victory Lap Retirement. He can be reached at email@example.com