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. 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, July 25, 2016

The Best of The Blunt Bean Counter - How Much Money do I Need to Retire? Heck if I Know or Anyone Else Does! - Part 6

This summer I am posting the "best of" The Blunt Bean Counter blog while I work on my golf game. Today, I am re-posting Part six of my 2014 six part series titled "How Much Money do I Need to Retire? Heck if I Know or Anyone Else Does!" If you have not read this series, the links to each part of the series can be found down the right hand side of my blog, under the retirement section.

The intention of Part 6 of the series was to attempt to provide an actual range of numbers for your nest egg. However, as noted below and throughout the series, there are so many permutations, combinations and unique situations, that you should only view the number below as wide ranging guesstimates and understand this was more of a fun exercise then an attempt to provide a concise retirement number.

Finally, please note that some of the tax numbers and RRIF information is now outdated. If you wish, you can easily skip my personal attempt to arrive at a "number" and go directly to the Comparing Apples to Oranges to Pineapples section and you will not miss much and save reading energy.

How Much Money do I Need to Retire? Heck if I Know or Anyone Else Does! - Part 6


Parts 1-5 of this series highlighted the challenge in determining a definitive retirement number. Nevertheless, against my better judgment, today you will receive some simplistic retirement nest egg calculations; since we all like to know what everyone else thinks their number should be. Who the heck knows, if any of these numbers will be in the ballpark or not.

Before I get to the numbers, you will read about some Canadian income tax idiosyncrasies and the impact income taxes and inflation have on your anticipated retirement withdrawal amount.

Made In Canada Idiosyncrasies


One significant issue for retired Canadians is that your annual minimum Registered Retirement Income Fund (“RRIF”) withdrawal starts at 7.38% and averages approximately 8% of your actual RRIF balance over the first ten years. If your spouse is younger, you can elect to use their age to calculate your minimum RRIF withdrawal amount, which will lower your yearly required withdrawal. In either case, where the majority of your retirement funds are in your RRIF, the required withdrawal may be substantially higher than the 3-4% you plan to withdraw annually from your retirement nest egg (However, as per my example for Mr. and Mrs. Bean below, if you can split pension income with your spouse, the income tax cost of the excess withdrawal may be mitigated).

A discussion of how to manage the drawdown of your RRSP and take into account the minimum RRIF withdrawals is too fact specific and beyond the scope of this series. I may however, post a future blog on this topic.

For higher income Canadians, their Old Age Security may be clawed back as their retirement income increases. For 2014, the clawback starts at $71,592 and your OAS is fully clawed-back at $115,715.

I am The Blunt Bean Counter –So let’s get Tax Centric


As discussed way back in Part 1 of this series, the 4% withdrawal rule ignores income tax. Thus, I will provide you with some examples of how income taxes may impact your selected retirement withdrawal rate. These examples illustrate the tax centric framework I use for one of my own retirement nest egg estimates, which I then compare with other retirement calculators, formulas, etc. proposed by other expert retirement planners.

You will note my model is just a variation on the 4% rule and still ignores investment fees. However, I am going to assume you use low cost ETF’s so that your costs are minimal or if you use an investment advisor, your returns are at least market after accounting for your management fees ( ha ha). I am also going to assume the yearly inflation adjustment under the 4% rule will cover off inflation if not overcompensate for it. Just accept these assumptions for the time being. I know Michael James is flipping with the investment fee assumption.

Sample Data – Mr. and Mrs. Bean


Let’s say Mr. and Mrs. Bean each expect to receive full Old Age Security (approx. $6,500) upon retirement and that Mr. Bean and Mrs. Bean anticipate they will receive $12,000 and $6,000 respectively a year in CPP retirement benefits. Finally, assume Mr. and Mrs. Bean will have equal RRIF’s or make the election to split pension income such that they will each receive $50,000 in RRIF payments in Scenario 1, $40,000 in Scenario 2, $30,000 in Scenario 3, $25,000 in Scenario 4 and $20,000 in Scenario 5.

Using the sample data above, here is the Bean’s income tax situation upon their retirement.

Mr. Bean
Scenario 1
Scenario 2
Scenario 3
Scenario 4
Scenario 5
Old age security
$6,500
$6,500
$6,500
$6,500
$6,500
CPP
$12,000
$12,000
$12,000
$12,000
$12,000
RRIF
$50,000
$40,000
$30,000
$25,000
$20,000
Total income
$68,500
$58,500
$48,500
$43,500
$38,500
Tax payable
$14,400
$11,100
$7,700
$5,800
$4,500
Net after-tax amount
$54,100
$47,400
$40,800
$37,700
$34,000
Mrs. Bean
Scenario 1
Scenario 2
Scenario 3
Scenario 4
Scenario 5
Old age security
$6,500
$6,500
$6,500
$6,500
$6,500
CPP
$6,000
$6,000
$6,000
$6,000
$6,000
RRIF
$50,000
$40,000
$30,000
$25,000
$20,000
Total income
$62,500
$52,500
$42,500
$37,500
$32,500
Tax payable
$12,600
$9,100
$5,600
$4,200
$3,000
Net after-tax amount
$49,900
$43,400
$36,900
$33,300
$29,500
Combined after-tax
$104,000
$90,800
$77,700
$71,000
$63,500


The Tax Effect – Ouch


In Scenario 1, Mr. and Mrs. Bean will pay almost as much in personal income tax ($27,000) as they receive in OAS and CPP ($31,000). Consequently, their true cash available for spending is essentially the gross withdrawal from their RRIF’s, likely a huge cash flow surprise for Mr. and Mrs. Bean. In Scenario 2, taxes eat up approximately 2/3 of Mr. and Mrs. Bean’s pension income. For Scenario’s 3-5, the impact of taxes though still significant, starts to decrease as a percentage of pension income and overall income under each of those scenarios.

Playing with Numbers to get a Tax Centric Number


At this point, let’s play with some of these numbers and see if we can come up with a crude ballpark number for the Bean’s retirement nest egg. As I stated on day 1, this framework is clearly limited, is
based on the 4% withdrawal rule and has no academic basis and should not be relied upon as the sole determinant for your own retirement planning. 

Determine Your Spending Requirements


One of the most important inputs into any retirement calculation is your anticipated spending. Mr. Bean, who is an anal accountant, has used Quicken for years to track his spending and can project which of these expenses he will still have in retirement. The amount he needs to add to his projected spending amount for travel is his “retirement wildcard”, but Mr. Bean is comfortable he can estimate this amount and not be materially wrong. Your spending requirement should really be a yearly calculation and should typically account for higher spending in the early years of your retirement and lower spending in the later years, plus account for one-time expenses like a car purchase, helping pay for a child’s wedding or assisting your child buy a house; however, for this crude calculation, I just use a set spending rate.

Reverse Engineering Mr. Bean’s Retirement Needs

 

[Note: For purposes of this example I am assuming all the Bean's funds come from a RRIF to exaggerate the income tax effect; in reality, you will probably have anywhere from 20-40% of your retirement funds in a non-registered account(s). In addition, I do not try and account for the fact the required RRIF withdrawal may be in excess of 4%].

Once Mr. Bean determines his spending requirements, I can work backwards to help him determine his retirement number under my tax-centric formula. For example, if I assume the Bean’s spending requirement is going to be $71,000 a year in retirement and they have $31,000 in pension benefits, the Bean’s will need to make up a $40,000 retirement shortfall before I factor in income taxes. By co-incidence Scenario 5 reflects that exact situation. The Bean’s will each draw $20,000 from their RRIFs and have a combined income before tax of $71,000 ($38,500 + $32,500).

Of course, Scenario 5 reflects that after tax, they will only have $63,500 to spend, which is $7,500 short of their needs. Thus I need to gross-up the $40,000 withdrawal so the Beans can achieve their required retirement objective of $71,000 a year. Luckily I have a tax program that makes this easy to determine (you can do this with your personal tax program if you do your own taxes or use an online calculator) and when I run the numbers, I determine the Bean’s will need to take $50,000 or $25,000 each from their RRIFs (instead of the $40,000 or $20,000 each I required before tax in Scenario 5) to net out to their required $71,000 a year spending requirement. Again by a strange co-incidence, this is essentially Scenario 4 above.

Mr. Bean is short a few beans.
Since the Bean’s will need approximately $50,000 before inflation for each year of retirement (in addition to their CPP and OAS), I can now utilize the 4% withdrawal rule to estimate the amount of money they will need to retire. The magic number is $1,250,000 ($50,000/.04), which if you believe the 4% rule, will allow the Bean’s to withdraw $50,000 plus inflation for approximately 30 years or $71,000 after-tax including their pension income. If the Bean’s want to provide a measure of safety and use a 3% withdrawal rate, they would require a nest egg of $1,666,666 ($50,000/.03). Mr. Bean however told me to stick with the 4%, since as an accountant; he has led a stressed life and does not anticipate making it past 85 anyways.

The above calculation results in an inflated magic number as it assumes 100% in registered funds. In reality, the number would be based on a draw-down between your registered and non-registered accounts.

When I told Mr. Bean these results, he was thoroughly depressed. However, with my warped sense of humour, I went on to tell him if he was to retire in ten years and he required $50,000 in non-indexed RRIF withdrawals (CPP and OAS are indexed for inflation) he would actually require approximately $61,000 in yearly withdrawals if inflation averaged 2%. That would push him closer to Scenario 2 above. That would mean he would require almost $80,000 in RRIF payments and using a 4% withdrawal rate he would need to have $2,000,000 at retirement, a staggering number. Personally, I think you cannot look at a 2% inflation rate and just inflate your spending expectation. I would suggest wage increases may partially offset these increases and presumably the extra 10 years of investment returns and new deposits would make it possible to get to $2M in 10 years even if they don’t have $1.25M now. In any event, it is a sobering calculation.

Comparing Apples to Oranges to Pineapples


When I started this series, I was foolish enough to think that I could utilize the Bean's income and spending parameters to provide you with comparable nest egg numbers using various retirement expert's formulas. However, as I discussed in Part 5, there are multiple variables and assumptions that affect each calculation which makes an apples to apples comparison impossible. This will be vividly demonstrated as I walk through the various comparisons below.

Yet, I thought it would still be interesting to see how various retirement experts and their formulas, equations etc. compare when given the same retirement spending level and the same pension numbers. It is enlightening, if not slightly amusing, to see how the retirement variables are applied and the significant variances in the final nest egg determination.

What a Financial Planner Says


William Bengen, the man behind the 4% rule, says that “Where the client has any degree of complexity to their retirement situation at all, I find I must have financial planning software to incorporate all these factors….The financial planning software is essential to blending all these elements and coming up with a withdrawal rate and the use of Monte Carlo, and so forth—I just find that essential”.

So I took Mr. Bengen’s advice and had a financial planner run some numbers on his software for me, based on the above $50,000 RRIF requirement and $31,000 of pension income. In the end our comparison was not apples to apples. His software forced him to make various assumptions I could not include in my crude calculation and he wanted to use a 3.5% real rate of return. He also decided he wanted to allocate the non-registered and registered accounts equally amongst other assumptions I could not make with my limited tax centric model. So what did his software reflect as the required nest egg? His number was $1,335,000.

In this Globe and Mail article from last week, the financial planner comes up with a retirement nest egg of $1,240,000 with a couple retiring at 65 and planning to spend $75,000 a year, with a life expectancy of 95 who receive two-thirds the maximum CPP/OAS payments ($25,000 a year) and who achieve an annual return of 5 per cent, in an environment of 2-per-cent inflation.

Jim Otar’s Retirement Asset Multiplier


I next turned to Jim Otar, a financial planner and mechanical engineer (what is with engineers and retirement?). Jim is the author of Unveiling the Retirement Myth. Jim considers there to be three basic risks for retirement financing:

1. Longevity risk
2. Market risk
3  Inflation risk.

He uses an asset multiplier to factor in these risks. Jim does an awesome job of using “plain English” in this article “Do we have enough to retire?”.

You may not believe this, but I had done all my calculations above before I found Jim’s article. Honestly, it is just a fluke he used $70,000 as his required retirement spending (versus my $71k) and $32,000 for his pension income (versus my $31k). When I use Jim’s multiplier of 28 x my $40,000 pre-tax shortfall, I come to required retirement assets of $1,120,000. I am not sure how, or if Jim even factors in income taxes, into his multiplier.

Moshe Milevsky’s Equation


In Chapter 1 of Mr. Milevsky’s book , “The 7 Most Important equations”, he has a chart showing how much money you need for a 30 year retirement based on a real (after inflation) spending amount. Now to be fair to Mr. Milevsky, he says his first equation does not address taxes and you should use his final all-encompassing equation in Chapter 7. However, that chapter is about sustainable spending and I can easily grab a number from his Chapter 1 chart, so I will use the numbers in this chart and take some liberties with my calculations. If I gross my required spending up to $50,000 to account for  taxes as I did in my tax centric model and use a 3% real return rate that Mr. Milevsky says in his book is reasonable in today's economic environment, his equation would reflect a retirement nest egg of  approximately $990,000.
However, I have read where Mr. Milevsky has stated that in general you need 20-30 times your anticipated spending in retirement, so I think $990,000 would be at the low end of what he would suggest, so I will take the liberty of saying he would probably be more comfortable using a number closer to $1,100,000 for comparison purposes.

 

Michael James


I asked Michael to use his calculator that I discussed in Part 3, to determine the Bean’s required nest egg. He assumed an allocation of 15% in bonds, 15% fully safe and 70% in stocks. He also assumed a 4% real return for stocks and a 2% real return for the bonds. He also assumed a very efficient ETF portfolio with fees of only 0.2%:

Michael determined if the Bean’s want to live indefinitely, they will need a nest egg of approximately $1,680,000. If they plan to live to the age of 95, they will need approximately $1,070,000. If they plan to live to 90 they will need around $960,000 or so.

If Michael used a 2% Management Expense Ratio (“MER) instead of his ultra low cost MER of 0.2%, his figures jump to $3,250,000 if you plan to live indefinitely, $1,270,000 for age 95 and $1,090,000 for age 90.

Summary of $71,000 Spending Requirement


If the Bean’s require $71,000 to spend in retirement after-tax (including $31,000 in pension income), the various calculations would suggest that they should be shooting for a nest egg at the low end of $1,100,000 to $1,350,000 at the high end.

As noted above, I have taken liberties with some of the calculations and the variables would change for your specific assumptions and facts. Like I say in my title, who the heck really knows what you need to retire; all these numbers may be consistently wrong, but the above at least provides a starting point of some sort, even if simplistic.

What if the Bean’s have a $104,000 after-tax Spending Requirement?


Since my chart for the Bean's includes a scenario (#1) where they have a requirement for a $104,000 in after-tax spending ($131,000 in pre-tax income), let's see what the various formulas would reflect as their nest egg requirement for that level of spending.

Blunt Bean Counter – $2,500,000 ($100,000 RRIF/.04%=$2,500,000 for a 100% registered account).

Jim Otar –$2,044,000 (as the $104,000 is an after-tax spending amount and Jim uses a pre-tax spending shortfall, I have estimated that spending shortfall to be approximately $73,000)

Financial Planner –$2,250,000 using the same variables as noted in the prior example.

Moshe Milevsky –$1,978,000 at 3% real return, $2,100,000 at 2.5% return (as per his chart in Chapter 1 for a $100,000 after-tax shortfall).

Michael James – if you want to live indefinitely you will need approximately $3,370,000, if you live to age 95 the magic number drops to around $2,150,000 and at 90, it's $1,920,000 and finally, at 85 it's approximately $1,650,000.

If Michael used a 2% MER instead of his ultra low cost MER of 0.2%, his figures jump to $6,510,0000 if you plan to live indefinitely, $2,530,000 for age 95 and $2,190,000 for age 90.)

Summary of $104,000 Spending Requirement


If the Bean’s require $104,000 to spend in retirement after-tax (including $31,000 in pension income), the various calculations would suggest that they should be shooting for a nest egg at the low end off $2,000,000 to $2,500,000 at the high end.

Canadians Know Best


A recent BMO Harris Private Banking survey said that Canadians with investable assets of $1million or more say they need on average $2.3 million to live out their ideal retirement lifestyle. Based on the above, it looks like they are in the ballpark.

Final Caveat


Throughout this series, I’ve shared with you my research and analysis and provided you with as much information as possible so that you can try and determine (or at least consider) the assets you need to accumulate for your own retirement nest egg. There is not one definitive number. Keep in mind, one size does not fit all. My retirement funding includes the sale of my partnership interest; yours may include the sale of a business or a severance payment for taking early retirement. The point being, we all have unique situations.

Conclusion – This Series is Finally Over!!


After going through the analysis I provided to you, I've determined that I am much further away from my retirement goal than I had anticipated and I will still be working for several more years. I now wish I had a company pension. The largest surprise of this exercise to me is that I may give consideration to purchasing an annuity with some portion of my retirement funds, to ensure I have a constant minimum cash flow. Depressing as this exercise was, it brought some clarity to my retirement planning. I also realized that I have no idea whose Monte Carlo simulator will hit the jackpot and that historical data can be interpreted in so many ways it leaves your head spinning.

I do know a multitude of factors beyond my control may impact my expected withdrawal rate (see Part 5 for the laundry list) and thus as a result, I will have to:

1. Be flexible in my spending requirements and may need to be open to working part-time in retirement

2. Review, revise and refine my retirement plan on a consistent basis to account for financial and life events and any changes in my behaviour
In conclusion, I hope my quest or journey for freedom 55,65,75, helps guide your retirement planning.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Monday, July 18, 2016

The Best of The Blunt Bean Counter- Inheriting Money - Are you a Loving Child, a Waiter or a Hoverer

This summer I am posting the "best of" The Blunt Bean Counter blog while I work on my golf game. Today, I am re-posting a June, 2014 blog post on how people act when they become aware they will inherit money from their parents or grandparents.

This topic is a bit controversial and the post became the basis for an article by Adam Mayers of the Toronto Star on inheritances, titled Inheritances are about love, money and greed.

Inheriting Money - Are you a Loving Child, a Waiter or a Hoverer


In February 2012, I wrote a blog post titled “Is it Morbid or Realistic to Plan for an Inheritance?”. I knew this was a touchy subject and would elicit various reactions from my readers. In the post, I stated that to “ignore the existence of a significant future inheritance that would impact your personal financial situation may be nonsensical” from a financial and retirement planning perspective.

Whether you believe you should plan for an inheritance or not, is your own personal decision. Today I want to deal with the behaviors and actions of those who stand to inherit money from their parents. Over the last 25 years, I have dealt with the tax, financial and psychological issues surrounding numerous client estates. I have observed the actions of those who will be the recipients of an inheritance and have found their behavior anywhere from fascinating to sickening.

I have found people who will inherit money fall into 4 groups:

1. The Loving Child

2. The Pragmatic Loving Child

3. The Waiters

4. The Hoverers

The Loving Child


For this group, their parents come first and money is secondary. Typically, these children are very close to their parents throughout their life and call and see them on a consistent basis, often weekly, or even daily. They have always helped their parents with their medical needs or in some cases with their financial needs, without giving it a second thought; because, their parents are well, their parents. This group would tell you they would give back any inheritance, if it allowed them another day to be with their parents and would consider it blasphemy to plan for an inheritance.

The Pragmatic Loving Child


This group is a subset of #1. These children love their parents and just want their parents to enjoy their lives, even if it means that they spend the children's inheritance. Children in this group may consider the reality that they will likely receive an inheritance. Even so, they do not want to take it into account in their planning and it is only at the insistence of an accountant or financial planner that they would even consider such.

The Waiters


I am not sure who coined this term, but I have seen it used many times. Waiters are described as children waiting for their parents to die, so that they can benefit from their parents assets. Waiters are considered to have a warped sense of entitlement to their parent’s money. I have observed several waiters over the years, some who went into debt to live a lifestyle based on an assumed inheritance. In my limited sample size, the children have always received their inheritance. However, one day I would love to see the face of a waiter when a lawyer informs them their parent decided to leave everything to charity instead of them.

The Hoverers


Hoverers are an even lower species than the waiters. These children often pay little or no attention to their parents their whole life, but when their parents get sick or older, they start hovering around. Many years ago one of my clients was very sick and was expected to pass away any day. I received a call from one of his children. I assumed the call was going to be the bad news that my client had passed away and the child was going to provide me the details of the funeral. The call was indeed to tell me their parent had passed away, but they were not calling to tell me about the funeral arrangements; their question to me was when they could start accessing their inheritance. I just felt sick to my stomach.

Don’t ask me why I decided to write about this topic. I guess as I have stated many times in my blog, I am just fascinated by how money affects people’s behavior. Thankfully, most people fall into the first two groups. If you are a Waiter or Hoverer, consider taking a good look at yourself in the mirror.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.