My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned.

Monday, September 17, 2012

What "You May Be Worth Someday" Statements

I recently had to complete an updated net worth statement for my firm’s partnership banker. After completing the statement, my net worth seemed higher than I expected. However, as I reviewed the statement, I realized that this document would be more accurately considered, at least in my case, as a “what you may be worth someday statement".

I say this because if I removed my house from the net worth statement (I intend to live in my house as long as I am physically able) and discounted my partnership interest to account for the multiple variables that could affect that value, either up or down, my net worth statement looked a lot leaner. If I made these adjustments, my net worth statement would reflect how I view my current net worth and provide me a better visual of my retirement building net worth.

This revelation made me smirk. You see, a common complaint I hear from my clients is that they are “worth way more on paper or dead and not worth much in tangible today value”. I smirked a second time when I realized my wife had to sign off on the form. I constantly drive her nuts when I tell her that we have to pay far more attention to our retirement funding and now she was going to see a standard net worth statement that was misleading in my mind.

So why do I consider net worth statements misleading? If you are an employee and you do not own your own business, the statements are misleading because the majority of your net worth is most likely real estate based. Real estate value generally comes in three forms; your principal residence value, cottage value and investment property or vacant land value.

Let’s break down these components. While there is no denying the value of your principal residence, the reality is many people wish to continue living in their principal residence until they are either unable to physically do so, or it becomes a financial requirement to sell or reverse mortgage their home. Thus, I consider a house a net worth backstop and the only value you can currently attribute is the incremental value you would recognize if you were to either downsize your home, sell your home and rent or reverse mortgage your home. In fact, as I reflect further, you probably need another variation of a net worth statement, a "retirement net worth statement" to account for the difference in net worth between your current home and the cost of your downsized home or debt related to any reverse mortgage. 

In regard to investment properties, the value is a fairly hard number; since the property or land is not required for shelter. However, the value of the second property or vacant land can only be maximized if you do not have to liquidate on an urgent basis and you sell when market conditions are strong. Thus, the current value attributed to an investment property could be significantly overstated depending upon the current economic climate and the demand for the investment property; however, it should definitely form part of your net worth statement.

Cottage properties are a bit of a hybrid. Cottages may be similar to a house in that you intend to use your cottage until you are physically unable, or they may be like an investment property, you wish to sell upon retirement. Finally, some people intend to sell their cottages to their children for "hard cash".

If you have a business, your net worth and retirement are often both dependent upon the value you realize for your business. The vagaries of realizing that value are why I consider a net worth statement misleading. If you have a service business such as mine, there is less risk initially in starting the business since if it does not take off, you take your clients and work for another professional firm. However, once the business is established, its value is subject to market conditions such as supply and demand (the accounting profession is top heavy in age), technological advancement of the practice  and its condition when you are ready to sell or, in my firm’s case, transition to the next generation of partners. I have had many a client sell their business sooner rather than later because they were concerned that when they were ready to sell their business, the business or economy may have taken a turn for the worse and they would not realize what they required for retirement. Sometimes these clients have sold at a substantial discount for “a bird in hand”. What I will realize on my share of my firms partnership interest will be determined by such things as the economy, tax laws (say a flat tax is enacted) and our succession plan.

Finally, net worth statements have the same flaw as many retirement plans; they do not account for the impact of income taxes. If I reduced the value of my RRSP by 46% and reduced the value of my partnership interest for the inherent income taxes, again my net worth statement would look significantly different.

So what is the takeaway from this post? First, don’t get mesmerized by a real estate inflated net worth statement. Second, you should probably assume a discounted value for your business, and finally, remember; your future tax liability has not been accounted for on your net worth statement.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.