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 BDO. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. My posts are blunt, opinionated and even have a twist of humour/sarcasm. You've been warned. Please note the blog posts are time sensitive and subject to changes in legislation or law.

Monday, March 22, 2021

How much do you need to retire in Canada? (Part 4)

In the first three parts of this series, the focus was on the safe-withdrawal rate for retirement. Today, in the final installment of this series, I revisit factors I discussed in my 2014 retirement series that can impact both the funding of your retirement nest egg and your withdrawal rate in retirement. The randomness and unpredictability of these factors can derail even the most detailed retirement plans.

How long am I going to live?

In Canada, depending upon which study you utilize, the average male will now live to approximately 80 years old and the average female to around 84 years old. There is also around a 50% chance that one spouse will live to age 90 if both are alive at 65 years old and a 20% chance one spouse will reach 95, again depending upon which study you review. These numbers are not intended to provide absolute actuarial accuracy but to reflect your planning needs. Bottom line: There is a good chance one spouse will still be alive at 95 years old.

The fact that we don’t know how long we’ll live creates the ultimate dilemma of retirement: do you scrimp in the early years of retirement, when you are likely healthier and full of energy, to ensure you have money to support yourself if you live longer than average?

I have seen far too many people die without spending their nest egg and enjoying their retirement (and as the Michael Kitces studies noted earlier in this series reflect, most people’s nest eggs seem to last longer than expected). I am in the camp that values those early retirement years, without being reckless about saving. Based on the studies, I would consider erring slightly on the side of early-retirement spending.

Interest Rates


We have been in an unprecedentedly low-interest environment for many years, and it’s now been exacerbated by COVID. This has weakened the benefit of GICs, term deposits and similar investments to fund and keep funding retirement. Bonds have been a bit of a buffer, but if rates turn upward, bonds may not provide the backstop they have over the last few years.

There is no consensus answer for this issue. Many investment advisors are suggesting a higher allocation to equities, but this involves far more risk than many people are willing to assume. So, this is a current-day quandary that has no clear answer.

Inflation


In addition to being in a low-interest rate environment, we have also been in a period of low inflation. Post-pandemic, it is unclear if inflation will rear its ugly head again, but a strong recovery could be problematic. An economic environment of low market returns and high inflation can severely impact the funds you accumulate to fund your retirement and the real returns you achieve in retirement.

Sequence of returns risk


Sequence-of-returns risk for purposes of retirement planning refers to the random order in which investment returns occur and the impact of those random returns on people who are in retirement. In plain English, it relates to whether you are the unlucky person that retires into a bear market or the lucky person who retires into a bull market. This is important because if your returns are poor early on, your retirement nest egg will not last as long as someone who had good returns early in retirement.

The sequence of returns phenomenon is illustrated very clearly on page 7 of this report by Moshe Milevsky and by W. Van Harlow of Fidelity Research Institute. In this example, two portfolios have the same return over 21 years but in inverse order. The portfolio with the positive returns initially ends up worth $447,225 in year 13, while the portfolio with the negative returns was depleted in year 13.

If you are looking for solace about retiring at a market peak, read this blog I posted in 2019. There I discuss an article by Norman Rothery on the sustainability of the 4% rule even when you start your retirement in a poor market.

Michael Kitces, whom I referenced in my blog post a couple weeks ago, has also written extensively on the sequence of return phenomenon. As noted in the prior posts in this series, Mr. Kitces has used the worst years in history as his floor for the 4% rule, and the rule held up. Here are a few helpful links on his sequence of returns articles:


Can you solve for the sequence of returns?


Finally, Mr. Kitces and Wade Pfau, whom I noted in Part 2 of the series, both seem to agree that people can reduce the impact of sequence of returns near to or early in retirement by using something called a rising equity glidepath in retirement.

This strategy has you starting retirement with a lower equity component in your portfolio—30%, for example—and increasing it throughout retirement to, say 65% or 70%. The advice is counterintuitive, since consensus advice has always been to reduce equity as we age. But as Mr. Kitces and Mr. Pfau point out here and here (at the 6:12 mark), the glidepath actually reduces losses in your nest egg when you most need it (at the beginning of your retirement) and allows for recovery in later years as your equity increases. You may lessen your child’s inheritance, but you may protect yours.

I am not saying yeah or nay on the glidepath alternative but rather providing you with some alternative thoughts.

Your principal residence


While most of us would love to ignore the value of our home for purposes of our retirement planning, the reality is that for most Canadians, our homes will in small or large part fund our retirements. For some, their home will just backstop any retirement shortfall; for many, their retirement funding includes at least the incremental capital benefit of downsizing their home; and for most, retirement can only be fully funded by selling their home at some point in their retirement.

Parenthetically, the same applies to business owners, who often consider selling the business to support their retirement plans. Business owners do need to add several factors when planning their retirement.

The scary thing about relying upon your home is that its reliability for retirement funding depends on a key variable: its value upon sale (and continued tax-exempt status).

What will my house be worth?


Over the last 10 years, house prices have skyrocketed in most Canadian cities. The million-dollar question is whether these increases in value will continue. Interest rates may increase. Government policy may change. And baby boomer sellers may eventually outnumber younger buyers.

What can I do?


Almost all the factors discussed in this post are impossible to plan for. However, you can adapt and compensate in two ways.

Work Longer

While the old retirement ideal was to sit back and sip cocktails in retirement, many now believe in finding part-time work during the victory lap period of life—or even full-time work doing something you enjoy that pays less. People often say it makes them feel more alive and keeps them mentally sharp, while providing the added benefit of not dipping into their capital. Remembering this may provide comfort if you need to work after you retire to account for the factors above.

Reduce your yearly withdrawal rate


Although possibly challenging, if your nest egg takes a hit due to any of the above factors, you can reduce your yearly withdrawal rate from, say, 4% to 3%, by some dollar value, or the future inflation withdrawal rate as suggested earlier in the series. It’s a tough pill to swallow, but you may need to forgo some short-term plans, perhaps travel for a year or two. As we learned this year, we can all adapt far better than we ever thought if we absolutely need to.

Life is hard enough to plan when things are status quo. It really gets challenging when random economic factors impact your life or retirement planning. The best we can do is recognize these factors exist and adapt and adjust when they arrive.

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.

Monday, March 8, 2021

Claiming your home office on your 2020 personal tax return

In 2020, we received a crash course on working from our homes. To the surprise of many of us, we quickly adapted. We redesigned our workspaces and purchased laptops, adapters, monitors (first or second or third screens), and scanners.

As we approach the 2020 personal income tax filing season, we now turn our heads to determine which expenses we can claim on our tax returns for working from our home offices.

The CRA has also had to adapt quickly to the new normal, and it has provided a couple of different ways for employees to claim home office (HO) expenses in 2020. They are discussed in detail in this BDO tax insight. As I see no reason to repeat this excellent summary word for word, I will quickly recap it and add a couple comments that may be of interest.

To be blunt, since I am The Blunt Bean Counter, I’ll share an observation. Those of us who drove our car for work and did a fair amount of driving to clients and customers in 2019 will most likely find that the additional home office expenses we can claim in 2020 do not make up for the lower car expenses you will be able to deduct this year. As a result, you’ll likely have lower overall employment expenses to claim this year.

Below I summarize the various alternatives to claim your 2020 HO expenses.

New Temporary Flat Method


This method will allow a flat $2 per day for 200 days, so $400 in total (see the BDO piece for the criteria). The best thing about this method is you do not need to track expenses or file the T2200 form, which is completed by your employer and allows you to claim expenses you incur to do your job, such as your home office, car, and telephone). Instead, you will file a Form T777S, Statement of Employment Expenses for Working at Home Due to COVID-19.

The flat method is available only for 2020, per the CRA. That said, it could conceivably extend the exception for 2021, depending on how quickly the pandemic subsides and how this impacts remote work.

This method is great for those who struggle to keep records and track their receipts, and have not incurred much in the way of deductible home office expenses in 2020. However, I would suggest that for many Canadians, filing using the flat method will leave a fair amount of expenses on the table.

Detailed Method


The detailed method will allow you as an employee to claim the actual amount of HO expenses related to your work from home in 2020. As noted in the BDO tax alert, the “usual way of claiming home office expenses requires you to determine the proportional size of your workspace compared to total finished areas within your home, and the employment use percentage of your workspace in order to calculate your workspace in home deduction. Though these calculations can be tedious, the CRA has provided examples and a new calculator to assist.”

For 2020, if you will be claiming only HO expenses and no other employment expenses on your 2020 return, and you were not eligible to claim HO expenses prior to COVID, you will need your employer to complete Form T2200S, and you will need to complete the simplified Form T777S on your tax return.

If you will be claiming other employment expenses, such as your car or phone, you will need your employer to complete the standard Form T2200, Declaration of Conditions of Employment, and complete the standard Form T777.

It should be noted that if you are claiming HO expenses (see this CRA summary), you can only claim your property taxes and insurance if you earn commissions from your employment (if you earn commission, your total employment expense deduction can’t exceed your commission income). Thus, the home office claim is often not as large as most people expect.

I am often asked how much the CRA will allow as the percentage use for your home office space. I cannot provide a standard answer. Per the CRA as mentioned in the BDO piece, you are required to undertake a detailed calculation of the actual space you use for your office as a percentage of your home’s finished square footage.

I will tell you this. Over many years of preparing tax returns, the typical HO claim assumes a percentage use of between 5% and 15%most are 5-10%, and very few are greater than 15%. To reiterate, your claim must be based on your actual square footage use.

Business Income


If you earn business income, as opposed to employment income, everything is status quo. There are no changes to the rules or the way you claim your HO expenses. The CRA made these changes to accommodate employees who typically work out of a physical office but could not do so this year.

I would suggest that over the next few weeks you review your situation to determine which of the above methods best suits your particular circumstances. If you are using the detailed method, start accumulating the required receipts so you can ensure you maximize your HO claim.

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.