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, May 30, 2022

The One-Two Punch of Inflation and a Weak Stock Market

We are currently facing the highest inflation rates in forty years. In April, the inflation rate was 6.8% in Canada and 8.3% in the United States. It is scary to think that these rates pale in comparison to the levels hit in the 1980’s which were as high as almost 14% in Canada and 15% in the United States.

In addition to the current inflationary pressures, the stock markets performance is also the weakest since 2008. How this double whammy affects you is based on your age, working status and income bracket. Today, I will look at two scenarios: those of you still working and those of you retired or close to retirement.

Working Individual

The Effect of Inflation on Your Cost of Living 
The current environment of low interest rates (although they are moving higher quickly), the war on Ukraine and supply chain issues are a rare economic mix. I certainly have no clarity of where inflation is going and I am definitely not qualified to comment. I will just say personally, I am concerned we are stuck with higher than usual inflation for a while until the supply chain is restored to “normal” or the demand side drops.

While not representative of the population in general, a sizable portion of my blog’s readership are high-net-worth (“HNW”) individuals and owners of successful private corporations. If you are part of this economic group, you are undoubtedly feeling the impact of the rise in inflation. However, in general, HNW individuals are typically not as significantly impacted by inflation, as their higher monthly income provides a buffer to absorb higher monthly costs. In addition, many HNW jobs and business goods and services are in demand currently, resulting in higher wages and/or profits. While the above is not the case in all situations, for many high-net-worth people, inflation has a minor impact on their day to day lives.

If you are not a high net worth individual, the rise in inflation can be painful. The high cost of gasoline, groceries, restaurants, clothing, travel, appliances, cars etc. has raised your monthly costs 7% or so, or maybe higher depending upon how you consume or if you are required to drive long distances for work.

So how does one offset inflation costs if their wages are not covering the increase in costs? Essentially, you have to watch your day-to-day spending and consider delaying or cutting-out some discretionary spending. This is also a suitable time to update or create a monthly budget.

You may want to consider the following tips to help you offset your rising costs and expenses:

1. Review your Mortgage Term -As we are seeing, governments are increasing interest rates to offset inflationary pressures. How high and for how long these rate hikes continue are unknown. But interest rates in most cases cause the largest potential impact to family costs in the form of higher mortgage costs. If you have a mortgage advisor or financial planner, you should discuss with them whether you should lock in rates for a longer-term mortgage to provide cost stability. If you do not have a planner, educate yourself as best as possible and speak to people you trust about what tact you may want to take in respect of your mortgage.

2. Reduce and Consolidate Consumer Debt - Consumer debt can become very costly when interest rates rise. You need to consider if you can pay down any of this debt or consolidate into a lower interest rate.

3. Contain Food Costs -This is not a micro-cost savings blog, so I am not going to get into cost saving details, but as we all know, grocery and restaurant costs have increased substantially. You may need to pay more attention to your grocery planning and cut back on your restaurant visits.

4. Drive Smartly -With the explosion in gasoline prices, it may be prudent to cut down some non-essential driving and when driving with your spouse or companion, you may want to use the most gas efficient vehicle rather than the “nicer car”.

5. Cancel Unnecessary Subscriptions and Fees -You may want to review your various subscriptions and fees; as if you are like most people, one or two are not providing much value. This would include gym costs that are often new years resolutions that fade by March.

6. Review Larger Discretionary Costs -You unfortunately may have to consider cutting back or delaying on planned discretionary expenditures such as travel, home improvements, RRSP contributions etc.

Many of your other expenses can be reduced or cut. Again, I suggest you prepare a detailed budget to help identify those expenses.

The Second Punch – The Stock Market Decline

The stock market has taken a large hit in 2022 (the TSX has done better than most), however, the reality is that unless you are near retirement, you should have several more years to make-up any current year losses whether you are a high-net worth individual or not.

While your investment statements will not be pretty, the strong market returns of the last few years have created a buffer. Historically, a long-time horizon until retirement will allow you to recover any current losses and hopefully have some significant future returns.

This may be the appropriate time to review your advisor’s three, five and ten year investment returns to their established benchmarks and review their annual fees, to ensure you returns are reasonable and you are receiving value for your fees. I will not discuss potential re-allocations of your portfolio, as those should be discussed with your investment advisor. Keep in mind short-term fixes often come back to haunt you when things turn around. So, keeping to your plan with a couple tweaks, often is the best course of action, but speak with your advisor who is aware of your personal situation.

Given many people have reported significant capital gains the last few years, you may want to discuss with your advisor (or consider yourself if you are a DIY investor) realizing capital losses on speculative holdings or other stocks that have suffered losses and do not fit your current investment strategy. Any losses realized in 2022 can be carried back against capital gains in 2019, 2020 and 2021.

The Effect of Inflation and Poor Markets on Retirees or Those People Close to Retirement

I have written a couple times on how much money you need to retire. In 2014, I wrote an extensive six-part series titled How Much Money do I Need to Retire? Heck if I Know or Anyone Else Does! (the links to this series are under Retirement on the far-right hand side of the blog).

I updated this series between January and March 2021, including a discussion on the factors 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.

Two of the most impactful factors on retirement planning are inflation and sequence of returns. As both these factors have reared their ugly heads at the same time, this one-two combo can really throw a wrench into the accumulation of your future nest egg if you are close to retirement. Furthermore, they can impact the retirement savings and withdrawal rates of those already retired.

Inflation Can Dramatically Impact Your Retirement

Many financial plans I have seen over the last few years have been using a 2% inflation rate. However, a 2% inflation rate is at least in the short-term 4-5% too low. If inflation holds, many retirees will need to reduce costs and may have to make larger than anticipated withdrawals from their retirement funds.

The following excerpt taken from Investopedia, quantifies an example of the damage inflation can do to an American receiving social security. “In terms of the actual amount of money that inflation can cost retirees, the numbers are startling. LIMRA Secure Retirement Institute constructed a model demonstrating the effect inflation could have on the average Social Security benefit over a period of 20 years. According to its research, a 1% inflation rate could swallow up $34,406 of retirees’ benefits. If the inflation rate were to increase to 3%, the shortfall would total more than $117,000”.

Hopefully, the spike in the inflation rate is a short-term blip and government policies cause the rate of inflation to settle down to more recent levels. If not, there is no magical panacea. Retirees will be forced to review spending and possibly cut-back on items that are not necessary or substitute cheaper alternatives.

Stock Market Declines and Sequence of Returns

As discussed above, for non-retirees, a drop in the market historically provides short-term pain only, as the investors portfolio has a long-time frame to recover and grow. However, for retirees (and possibly near-retirees) that is not the case and they are subject to what is known as Sequence-of-Returns Risk. For purposes of retirement planning, this 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(ish) market in 2022 or the lucky person who retired into the bull market five years ago. 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.

For full transparency, most of the discussion below comes from prior blogs I have written on the subject of sequence of returns.

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 read the article, you will note the authors also discuss the affect of inflation.

Can you solve for the sequence of returns?

Michael Kitces and Wade Pfau two of the most renowned retirement specialists 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.

I am not qualified to condone or dismiss the equity glidepath. I am just pointing out some alternative thinking by two retirement specialists.

Retirement planning is difficult at the best of times, it can get downright ugly when inflation and poor markets occur simultaneously. Let’s hope, these are just short-term blips, but they are a wake-up call to the random risks we always have in saving for retirement and more acutely, for those already in retirement.

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. Please note the blog post is time sensitive and subject to changes in legislation or law.

Monday, May 9, 2022

Talking with Your Parents about Planning, Documenting and Meeting on Their Estate

Let’s be honest, talking with your parents about estate matters can be a very uncomfortable discussion. In my experience, this process sadly starts in many cases, when a parent becomes sick or has a terminal illness. This is very unfortunate and not the best time to start estate planning.

This parental discussion has a fair bit to unpack, as there are three component pieces. The planning component, which some parents do not undertake. The documenting element, which is often not done or incomplete. Finally, there is the family meeting which occurs infrequently. I will discuss each of these factors separately below.

How to Start the Planning Conversation

Many parents (I will use the plural parents throughout this blog post, but the discussion will apply equally to the "singular" parent) plan their estate without prompting. Others think it will magically plan itself or they just procrastinate as they do not want to contemplate their ultimate demise. In many cases, parents do not think it is their children's business to even discuss their estate planning. 
So how does a child/children raise the estate planning issue without causing their parents to think they are greedy, nosy or rubbing their hands in anticipation of an inheritance? Here are some suggestions I have gleamed from various articles and from my personal experience.

1. This may seem crude, but use another person’s poor planning as a way to start the discussion. Your parents may provide the opening when discussing “the mess their friend Mrs. Smith left her estate in”. Alternatively, you may bring up a bad situation one of your friend’s parents had or use an article in a newspaper or publication that discusses a messy situation caused by poor estate planning.

2. Set-up a scheduled time to meet with your parents and siblings to discuss their wishes for the estate, so that you and your siblings can support their desires. This meeting will hopefully make your parents feel that they are not being ambushed and feel there is a family consensus. Let your parents know specific dollar amounts do not have to be disclosed, which can sometimes be an impediment.

3. Directly ask if your parents are working with a planner. This may lead to an opening and request for a referral, or they may get their back-up. If the latter, don’t pressure them. It is very important to be patient and empathetic. Try again at a later time, maybe when one of the opportunities in #1 present themselves.

4. Flip the situation around and say you are working on your own planning and your advisor has asked is there anything your parents can share with you so that it can be built into your planning. Alternatively, where your parents may not be financially secure, the siblings can say they want to ensure they can help, but need to be able to plan for the assistance (or if the assistance will not be available, they want to help you minimize these financial concerns by planning in advance for such things as a reverse mortgage).

There is no magic bullet to get the discussion started. Maybe one of the above strategies will work for your family dynamics. In any case, ensuring your parents have started their estate planning is beneficial for them and you and your siblings, especially if the children are executors of their estate.

I suggest proper planning includes most of the following:
  • preparation of wills (should not be finalized until the family meeting discussed below)
  • personal care and financial powers of attorney
  • personal and possibly corporate tax planning
  • estate and probate planning
  • introductions to your parent’s key financial, insurance, tax etc. advisors

Documenting Assets and Wishes

Having your parents complete their estate planning is a huge first step. However, if they do not document their assets, wishes, digital passwords etc. they will leave you and or your siblings and the executors a huge mess and a morose game of hide and seek at a time of mourning and distress. I therefore suggest strongly you get your parents to complete an estate organizer or listing of their assets and location. 

The listing will include at minimum the following:
  • location of important documents like will(s) and power of attorneys
  • where the safety deposit key and jewelry can be found
  • details of all bank, investment and real estate information
  • location of insurance policies and details of the policies
  • a summary listing of financial advisors' names and contact information
  • details of digital information from cryptocurrency to Facebook passwords
  • details of any prepaid funeral arrangements and/or wishes in regard to their burial 
There are several estate organizers on the internet or if you have a financial advisor, they will likely have one.

In 2012, I wrote a blog post A Tale of a Fathers Selfless Act of Love. This should act as your guide to the ultimate in planning and documentation. The link to the actual article noted in the blog is here.

Setup a Family Meeting

If your parents have planned and documented, then the final and penultimate task would be a family meeting (if not done as part of the planning). 
Some people suggest a family meeting have a formal agenda, others a less formal tone. In any event, the meeting’s objective is to ensure your parents' choices and decisions are heard in their voice by the family, so there is never a dispute to what you really wanted. 
Your parents can accomplish the following by having a family meeting:

1. Share their spiritual and personal values and hopes for the future of their family (see this blog post I wrote on ethical wills).

2. Discuss their healthcare wishes for all to hear. This would be the time to clarify who the power of attorney is for healthcare and their views on the right to resuscitation and even assisted death. For anyone who watches the TV show This is Us, in a recent episode Rebecca (the mother who has early onset Alzheimer’s) calls a family meeting to discuss who will make her health care decisions and how she expects her family to live and carry on once her Alzheimer’s progresses. I thought this was a great example set by the show.

3. Share their draft wills to determine if their thoughts on asset distribution are aligned with what their children want. Some parents will be open about the will, some will disclose certain information without actual financial details, and some will not want to discuss the will. If your parents have an open discussion about their planned distribution of assets, they may be surprised their perception is not reality. For example, they may have thought the children would want to share the cottage, but only one child even has interest in the cottage and they don’t have the financial means for the upkeep. This discussion can result in changes to the draft will.

4. Discuss any possible perceived or actual inequalities in their will(s) and their rationale. The rationale does not have to be accepted by all, but everyone can now at least understand these were not arbitrary or punitive decisions and could save significant family dis-harmony after their passing.

5. Identify who will be named executors. Most children have no idea of the responsibilities and the burden of being named an executor of the will. Your parents can explain the duties of the executor and determine if the children or child they wish to be an executor(s) are/is willing to undertake the position.

6. Indicate their burial plans and desires.

These are some of the key issues a meeting can address, but the agenda is only limited by what your parents wish to discuss. In the end, the meeting provides a forum for your parents to discuss their wishes for healthcare and asset distributions in their own words and voices; which leaves no room for speculation upon their passing.
Talking to your parents about planning, documenting and meeting on their estate is a tall order. However, whatever you can accomplish from the above list will be beneficial for the estate, your parents and siblings and the executors. 

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. Please note the blog post is time sensitive and subject to changes in legislation or law.