Monday, December 25, 2017

Investors Group Podcast About Our Early Retirement

Around the end of August, we were contacted by a journalist requesting to talk to us for a podcast about early retirement that he was working on for Investors Group.  The podcast is the 4th of a six part series about retirement, which also includes topics like "What Happens When You Are Forced To Retire", "Working Past Retirement Age", and "What Will My Retirement Look Like".  In our case, the podcast would focus on why we wanted to retire early, how we achieved it and what we were doing now that we were into our sixth year of early retirement.  It was not easy to schedule a time for the interview, since our retirement days are packed with activities.  At that time, we were just gearing up for the Toronto International Film Festival and were in midst of watching early preview movies en route to a new annual record where we watched over 40 movies this year.  Luckily we were able to squeeze time in for the podcast, which you can listen by following the link below:

Sunday, March 12, 2017

Retirement and Income Tax: Moving Beyond the RRSP

As retirement savings plans go, the difference between the TFSA versus the RRSP epitomizes the concept of "pay me now or pay me later".  Sooner or later, the taxman gets you.  The RRSP  allows you to postpone paying income tax on any contributions made during your working years when your income is presumably higher.  But once you retire, it is time to pay the piper.  At that point, funds withdrawn from the plan are taxed at 100%.   By contrast, you do not get a tax deduction for contributing to the TFSA, but any funds withdrawn from it, including growth in value or income earned via dividends or interest payments, are tax free.

The short term allure of paying less income tax or even getting a refund as a result of making a RRSP contribution masks the long term implications to your tax burden in the retirement years. This made sense when life expectancy post-retirement used to average around 10+ years compared to 40+ years of working.  These days with people striving to retire earlier and commonly living to age 90 or more, it is quite possible and even likely for some people to have as many if not more retirement years compared to working years.  For example, my husband and I retired at 48 after working for 26 years.  We only need to reach age 74 before our retirement years start to outnumber our employment years. With so many potential retirement years ahead of us, it made sense to have a plan that balanced out the tax burden both before and after retirement.  Given this new normal, I believe that it is unwise to have all your retirement savings come solely from an RRSP, pushing off so much of the tax burden to the future.  We chose instead to spread out the allocation of our retirement savings to include the TFSA and even a non-registered account which receives extremely favourable tax treatment for Canadian eligible dividends by means of a generous dividend tax credit.

Let's look at an example of how $50,000 of retirement income is taxed when it comes out of the various types of accounts.  Not all of these cases are realistic options, but they highlight the differences between the tax owed from RRIF income vs. TFSA income vs income from a non-registered account that holds only Canadian eligible dividend paying stock.  I pumped each of these income scenarios into a 2016 tax calculator to determine the estimated tax owed.  Note the significant difference in tax burden for the income from the RRSP/RRIF  (taxed at 100%) as opposed to shifting some of that income to a TFSA (0% on withdrawal) and/or a non-registered account holding dividend-paying stock (reduced average tax rate due to dividend tax credit).  Imagine having to pay this tax differential throughout your retirement years.

The current conventional wisdom dictates that low income earners should choose the TFSA while mid income earners should pick the RRSP as their first savings vehicle of choice, and high income earners that make enough money should max out on both.  While this definitely makes sense if you are only looking at minimizing tax during the working years, there is more to the story when you look beyond that into the retirement years.  I believe that the RRSP is over-used as a retirement savings platform and that a more balanced strategy would be more beneficial in the long term. In 2013, I wrote an article detailing my strategy for contributing to an RRSP vs a TFSA.  I suggested that RRSP contributions should only be made to the point where you no longer have to pay more income tax beyond the amount held at source by your employer.  After that, all extra funds should be allocated to the TFSA or non-registered account in an effort to reduce your tax burden after retirement.

Implementing this plan of diversifying our retirement savings platforms during our working years gave us a good jump that we try to continue even after retirement.  We continue to strive for the goal of moving income sources from registered to non-registered accounts.  A tax strategy detailed in my book Retired at 48, One Couple's Journey to a Pensionless Retirement describes the advantages of collapsing our RRSP into a RRIF immediately after retirement and actively trying to reduce the size of the RRIF each year, or at least prevent it from growing too much.  So far we have tried to accomplish this by withdrawing the dividends generated from the stocks within the RRIF, saving us from drawing down the equivalent amount of this money in our non-registered account and stopping the RRIF from growing by the value of these dividends. But since we did not touch the capital within the RRIF, the value of our RRIF has continued to grow, as the bull run of the TSX over the last 8 years have caused stock prices to continue to rise.  This means we continually need to withdraw more income from our RRIF each year.  And despite that income being generated as Canadian eligible dividends, it is still taxed at 100% when it comes out of the RRIF, since the dividend tax credit does not apply.

Next year we will try a new tactic aimed at slowly reducing the actual value of our RRIF by shifting the capital to our non-registered account.  Rather than making our annual legislated minimum RRIF withdrawal in cash (i.e from paid dividends), we will transfer the equivalent value of stock shares "in kind".  The tax on the withdrawal should be the same since we are taxed at 100% of the value regardless of whether we take it in cash or in stock.  The shares that we transfer will start generating dividends in our non-registered account, while our RRIF will decrease both in value and in the amount of new dividends it is capable of producing.  There is no capital gain tax in the transfer, which will be made at the end-of-day fair-market value p ice of the stock on the day of the transaction.  The new adjusted cost base of the shares in the non-registered account will equal the price that it was transferred at.  This strategy works for us as long as we generate sufficient income from our non-registered account and don't need to spend the income from the RRIF.  If this turns out not to be the case, we can achieve the same result of reducing our RRIF capital and dividends by selling stock each year and withdrawing the cash.

In selecting which stock shares to transfer, we decided that we would not pick any of the income trusts that we have in our RRIF.  The reason that we put the income trusts in the registered account in the first place was so that we would not have to keep track of complicated adjusted cost base issues rising from return of capital, which would be the case if these companies were held in our non-registered account.  Next we determined that it would be more advantageous to transfer shares that have grown in value since we purchased them, as opposed to those that have decreased.  Since the new adjusted cost base of the shares will be based on the deemed fair market share price used for the transaction, transfering stock that has increased in value means that if we decide to sell this stock in our non-registered account later on, we would owe less capital gain or would generate a larger capital loss.

We will contact our discount broker to find out what steps we need to take and how much advanced notice we need to give in order to change the instructions for calculating our 2018 RRIF withdrawal.  Presumably we will need to provide exact details in writing as to which and how many shares we want transferred in-kind in order to come close to the minimum withdrawal amount and then make up the rest in cash.  There should still be no extra withholding tax if we only take out the minimum. Hopefully if we follow this new strategy for some number of years, we will accomplish our goal of slowly moving capital and the source of future income from our RRIF to our non-registered account.  Doing so will help keep our tax burden from steadily and dramatically rising as we are forced to withdraw a larger and larger percentage from our RRIF with each passing year, taxed at 100%.

Thursday, January 5, 2017

Year End Review 2016: After Four Full Years of Retirement

This coming May 2017, it will be five full years since my husband Rich and I simultaneously retired at age 48.  They say that time flies when you are having fun and that has certainly been true for us.  We have had a blast in the past 4.5 years (other than during my brief period recovering from health issues) and we have never encountered a dull moment when we felt bored or wondered what we could do next.  In fact, we have been so busy that we need to prioritize our interests.  We have settled into a routine where our fall and winter days are filled with indoor tennis, interest courses at U of T's Innis College, attending live theatre including our annual subscription to Mirvish Productions, trips to the Art Gallery of Ontario and other museums, as well as visiting or entertaining friends and family. We are so busy during this period that we don't have time to travel, which works out fine for us since we are not keen on "sun vacations".  Instead, we have been taking 4-7 weeks of vacation each year during the spring and summer, continuing to take advantage of the financial and cultural perks of home swapping.  Each year I think that we may not find a new swap opportunity, when out of the blue, another great offer arises.  Since retiring, we have traveled via home swap to the South of France, all around Ireland, Amsterdam, Venice and Paris.  This coming spring, we will be doing a two week swap in Antwerp, Belgium with side trips to Bruges, Ghent and Brussels.

So from an emotional and social perspective, we have no regrets regarding our early retirement and cannot conceive of ever wanting to work again.  We are just having too much fun enjoying our freedom and the luxury of time!  Now for a review of how we are doing financially, to ensure that we will not be "forced economically" to go rejoin the workforce in the future.

2015 was a tough year for the TSX, which lost 11% of its value relative to the previous year.  The value of our portfolio after dividend payouts ended the year at just about the same amount as the start of the year, which meant that excluding dividends, our portfolio was down just over 2%.  This was actually a good result for us when compared to the performance of the market as a whole.  More importantly, in spite of the across-the-board hit to stock prices, the total dividends paid from our stocks still increased by 8%.  Since our retirement income strategy (as described in our book Retired at 48 - One Couple's Journey to a Pensionless Retirement) relies primarily on these dividends, in effect, we received a pay raise in 2015 despite the poor year.

By contrast, 2016 was a tremendous year for the TSX, resulting in a gain of over 22% from the previous year.  Our portfolio matched this performance almost exactly, up 24.5% including dividends and 21.66% after removing our dividends for income.  Just as we were not too concerned with the decline in value of our stocks in 2015, we are not overly excited in what might be a transient increase in 2016.  As always, our focus is on the dividends which once again increased by 8% relative to the previous year.  There are signs of concern though since for the first time since we started investing in equities, two of our stocks (Husky Energy/HSE.T and HNZ Group/HSZ.T) actually eliminated their dividend causing their share prices to plummet, while two other stocks (Enbridge Income Fund/ENF.T and Corus Entertainment/CJR.B) failed to raise their dividend for the first time in over 5 years.  Is this a harbinger for a slow-down in the rate of dividend growth in Canadian stocks for the coming year(s?).  That would fall in line with the forecasts from multiple US market sources throughout 2016 regarding dividend growth slow-down in US stocks due to a corresponding slow-down in earnings.  Luckily our dividends have risen 34% since our retirement in 2012, so we are far enough ahead of the game to be able to withstand even an extended period of slower growth.  It is interesting to note that the dividends did better in the bad TSX growth year in 2015 than the good one in 2016.  Perhaps there is a time delay in reaction to the previous year's results?

While we withdraw just about all of the dividends from our non-registered account to use as income, we only withdraw the legislated minimum from our RRIFs.  Until we reach age 71, the minimum is calculated by the formula (1 / 90-age in current year) * Balance of RRIF on Dec 31 of previous year.  The government's intent is for the dollar amount of the minimum RRIF withdrawal to increase each year to provide an income amount that accounts for inflation.   This did not happen in 2016, since our 2015 ending RRIF values were actually lower than the previous year.  As a result, my RRIF minimum in 2016 was $28 less than 2015!   This situation has reversed itself with the huge stock value gains of 2016, resulting in my 2017 RRIF minimum increasing by 14% over the previous year.

For the most part, our discretionary expenses (entertainment, travel, dining) came in around the same levels as last year.  On the other hand, mandatory expenses climbed higher than the rate of inflation with electricity costs rising 23%, condo fees up 4%, and groceries up 9%.  But all that was a drop in the bucket compared to the huge, one-time unexpected expense that we learned about last year—this was the need to replace defective Kitec pipes in our condo.  While we had over 6 months warning to save up some money, the $13,000+ final bill still put a dent in our long-term emergency kitty fund.  We will need to slowly rebuild this kitty in 2017 and hope that no new major unexpected expenses arise this year.  So far since our retirement, we have been able to live off of our annual dividends plus our emergency cash funds without requiring to dip into our capital.  Having a healthy emergency kitty helps us prolong this goal.

All along, we have been monitoring the distributed value of our equities portfolio in terms of market capitalization and diversification of business sectors as a means of reducing risk.  Our goal was to not have too large a percentage of our holdings in any one sector, or in small-cap companies.  With this year's annual review, we have started keeping track of the same distributions in terms our dividends.  We wanted to make sure that our dividends are not stacked towards one sector such as oil and gas, where the industry as a whole might go through a rough patch, increasing the potential of companies lowering or stopping their dividend payouts.  We are fairly satisfied with the results of this exercise as we saw that most of our dividends come from large and mid cap companies and are reasonably spread out across the sectors.  Our percentage of small-cap holdings have shrunk over the past year, as several former small-cap companies have grown to the point where they are now categorized as mid-cap.

For this year's review, I finally hunkered down and did the calculations to determine the answer to a question that I have been wondering about since we retired.  It relates to when to start taking our CPP payments.  The government has put a heavy penalty of 6% per year for taking CPP earlier than age 65.  But the calculation of my annual CPP retirement benefit is also impacted by the number of years where I did not max out on CPP contributions, between age 18 and the year I start taking CPP.  Obviously once I retired at age 48, I stopped making any CPP contributions since I no longer generated any earned income.  So what would hurt me more, my growing number of years of zero CPP contribution or the penalty for taking CPP early?  If I took my CPP at age 60, I would save myself 5 additional zero years, but would this be worth it to offset the penalty of starting CPP early?

It is a long, convoluted calculation to determine what my CPP retirement benefits would be if I started taking them at age 60 vs 65 vs 70.  I followed the instructions of this Retire Happy Blog which walked me through the steps, creating a new spreadsheet (I love spreadsheets!) to guide me.  I'm not sure I have all the details exactly correct, but I completed enough of the the exercise to answer my question.   Although I would definitely receive less than the maximum possible CPP benefits due to my 17 extra years of retiring early and not contributing, I was still better off waiting until age 65 or later to take CPP, assuming I don't need the money earlier.  The impact of my elevated number of years of zero CPP contributions became inconsequential relative to the massive penalty of taking CPP early.  This is what I always suspected the results would be, but it was definitely interesting to definitively prove it.

Comparing our 2016 year end total against our original retirement plan, we continue to trend significantly ahead of plan and are well positioned to live out our retirement years without running out of money.  Thank goodness, since I have no intention of ever going back to work.  That would be no fun at all!

2015 Year End Review
2014 Year End Review
2013 Year End Review
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