The Best of The Blunt Bean Counter - Is it Morbid or Realistic to Plan for an Inheritance?

This summer I am posting the "best of" The Blunt Bean Counter while I work on my golf game. Today is my last re-post (where did the summer go?) and I selected a post on whether it is morbid or realistic to plan for an inheritance. I selected this post because it seems to polarize people. They either think it abhorrent to consider planning for an inheritance or don't understand why it is not practical financial planning.

I recently followed this post up with Inheriting Money - Are you a Loving Child, a Waiter or Hoverer, a post that discusses four types of behaviour by those who will inherit money.

Is it Morbid or Realistic to Plan for an Inheritance?

I have written several blog posts on estate planning and inheritances, including “Taking it to the Grave,” a blog I wrote for the Canadian Capitalist, in which I discuss whether parents should distribute future inheritances in part or in whole while they are alive and “How your Family Dynamic can affect your Estate Planning”  in which I discuss how parents have to navigate a minefield of family issues with respect to the determination of executors, the distribution of family heirlooms and the distribution of hard assets.

These blogs elicited a wide range of opinions and comments that I found fascinating. Some people believe they are better off because their parents made them work for everything and they don’t want any financial assistance from their parents either during their life or after they pass away. Others state that as long as parents are careful to ensure they don’t destroy their children’s motivation, partial inheritances make sense. Finally, others say they have been sickened as they observe children waiting at a parent’s deathbed salivating at the thought of their inheritance.

All this leads me to another very touchy subject; should a child (let’s assume the child is at least 40 years old) plan their own future based on a known or presumed inheritance? To add some perspective to this issue, it is interesting to note that a recent survey by the Investors Group states that 53% of Canadians are expecting an inheritance, with over 57% of those, expecting an inheritance greater than $100,000.

Inheritances can be categorized as either known or presumed inheritances. An inheritance would be categorized as known, when a parent(s) has/have discussed the contents of their will with their child(ren) or at least made known their intentions. In these cases, while the certainty of the inheritance in known, the quantum is subject to the vagaries of the parent(s) health, the parent(s) lifestyle, the income taxes due on the death of the last to survive parent and the economic conditions of the day. (Speaking of discussing the will with your children, it is very interesting to note that my blog post One Big Happy Family until we discuss the Will which had limited initial traction, is now by far and away the most read blog I have ever written).

An inheritance may be presumed where the financial circumstances of the family are obvious. A child cannot help but observe that the house their parents purchased 30 or 40 years ago for $25,000 is now worth $800,000 to $1,000,000, or that the cottage their family bought for $100,000 many years ago can be subdivided and is now worth $700,000.
Many average Canadian families have amassed significant net worth just by virtue of the gains on their real estate purchases. These families would not be considered wealthy based on lifestyle or income level, yet their legacy can have a significant impact upon their children. Inheritances are not only an issue for wealthy families.

I think most people will agree that where an inheritance will be so substantial that it will be life changing; parents need to downplay the inheritance issue and/or manage the inheritance by providing partial gifts during their lifetime. Rarely can a child become aware of a life-changing inheritance without losing motivation and experiencing a change in their philosophical outlook on life.

Although life changing inheritances are rare, life "affecting" inheritances are not. So, should children change how they live and how they plan for the future based on a known or presumed future inheritance? In my opinion, if the inheritance is known and will be substantial enough to alter a child’s current or future living standard, the answer is a lukewarm yes, subject to the various caveats I discuss below.

I think it is imprudent to ignore reality and where an inheritance has the attributes I note above, it should be considered as part of your future financial plan. However, I would discount the amount used for planning purposes significantly, to account for inherent risks. Those risks include the longevity of a parent, economic downturns that reduce your parent(s) yearly income stream,  potential medical costs and finally, the ultimate risk one takes in planning for an inheritance; the risk of somehow falling out of favour and being removed from your parent(s) will.

Where there is a presumed inheritance, I would suggest you need to be ultra conservative if you want to plan for the inheritance, since not only are you guessing at the inheritance amount, but you face an additional risk that your parent(s) may have offsetting liabilities such as a mortgage or line of credit of which you are unaware.

So what do the experts have to say on this matter? In the press release for the Investors Group survey, Christine Van Cauwenberghe, Director, Tax and Estate Planning, says that "Knowing the dollars and cents behind your inheritance can have an impact on your financial plans. It is smart to know what you can expect so you can plan accordingly and family dialogue is a good place to start."

Ted Rechtshaffen, a certified financial planner at Tri-Delta Financial, in a National Post article I discuss below, says "he may be in the minority but he encourages clients to count on their inheritances when planning to some degree." He however, goes on to say he tells clients to be super-conservative. Finally, he concludes with "I know it goes against the grain because you are counting on money you don't have", adding, "it depends where your parents are in their life cycle and how clearly they have signalled their intentions".

I think Christine and Ted's comments clearly point out the conundrum here, for which there is no black and white answer. It is probably unwise to ignore a known potential inheritance, but because the final inheritance is subject to so many variables, you must risk assess that inheritance and discount its quantum by a significant amount, such that your planning becomes a paradoxical situation.

But what if you see no risk in your parent(s) financial situation deteriorating and you feel you will never be removed from the will, how can your financial planning be affected? For argument’s sake, let’s say your inheritance will be large enough to affect your future planning, but not large enough to affect your motivation or change your lifestyle.

The most obvious change to your financial plan may be to underfund your RRSP. Most Canadians struggle to make yearly RRSP contributions. They live in mortal fear that they will not have enough money to live the retirement they envision. But, if you know your parent(s) have enough funds to live out their life/lives comfortably, and say your inheritance will be in the $300,000 to $500,000 range, do you need to make your maximum RRSP contributions?

Other planning issues include whether you should purchase a home out of your price range or underfund your children’s education fund, knowing that you will receive an inheritance to pay off the mortgage or to pay off any education related loans. Alternatively, you may over fund your child’s education by sending them to a private school you would never had considered without knowledge or presumption of a future inheritance.

How you deal with debt could also be affected. If you have debt, should you just limit it to a manageable level and not concern yourself with paying it down? Or alternatively, should you pay it off because you can reallocate funds once committed to your RRSP, TFSA or RESP, knowing your inheritance will cover your RRSP, TFSA or RESP?

We have all heard about about the huge debt level many Canadians are carrying. Based on comments made by Benjamin Tal, deputy chief economist for the CIBC, one wonders if at least subconsciously some of this debt level in being carried because people know they have an inheritance coming? Mr.Tal in an article in the Toronto Star on Baby boomers set to inherit $1 trillion says "people talk about how much debt there is without looking at the size of the potential assets to come. Debt is relative to your income today, but your wealth tomorrow will improve when an inheritance comes."

So, have I seen people bank on an inheritance? Yes. To date, where I have observed such behaviour, the inheritances have come as expected. However, these cases may not be predictive of future cases.

Is it morbid to plan for an inheritance? Clearly, it is. Would most people rather have their parents instead of the inheritance? Yes. This topic is a very touchy subject and an extremely slippery slope, but to ignore the existence of a significant future inheritance that would impact your personal financial situation may be nonsensical.  However, if your financial planning takes into account a future inheritance, you should ensure you have discounted that amount to cover the various risks and variable that could curtail your inheritance and be extremely conservative in your planning.

Post script:

As the expression goes "Those who hesitate are lost". I started writing this blog back in late November, but could not come to a conclusion (if one can call the lukewarm recommendation I suggest above a conclusion) until recently on whether one should or should not plan for an inheritance. Thus, this blog post just sat. In the interim there have been two excellent articles on this topic. The first by Garry Marr of the Financial Post, titled Windfall no sure thing from which I quote Mr.Rechtshaffen above and another article by Preet Banerjee of the Globe and Mail, titled An inheritance should be a windfall, not a financial plan.

In Preet's article he notes the potential flaws of incorporating an inheritance into your financial plan. He also concludes with some words of wisdom "There are enough variables affecting your own financial success. Ideally, you shouldn’t bank on an inheritance in your financial plan, but rather treat it as an unexpected windfall. Most people would rather give it up in exchange for having their parents back".

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.

Are RRSPs the Holy Grail of Retirement Savings or the Holey Grail?

In March 2011, I wrote a blog post disputing Jamie Golombek’s assertion that RRSPs are not the Holy Grail of retirement to Canadians. In May 2011, I followed up the above noted blog with another post in which I attempted to reflect that RRSPs are only accessed under financial duress.

Based on the above two blog posts, clearly my opinion has been that RRSPs are the Holy Grail of retirement planning for Canadians. However, I am beginning to wonder if my personal experience in dealing with higher net worth people who tend not to "touch" their RRSPs, has distorted my view of the situation and RRSPs are really a "Holey Grail".

The catalyst that has led me to second guess myself as to whether RRSPs are really sacrosanct is a recent poll (of 2,013 people) undertaken by the Scotiabank on Canadians' mindset regarding RRSPs.

The poll states that “one-third of RRSP holders (36 per cent) reporting taking money out of their RRSP this year, up from 23 per cent back in 2005”. The poll also reported “the average amount Canadians withdrew from their RRSP was $24,531. In 2005, the average amount Canadians withdrew from their RRSP was $10,716". 

What I personally found shocking about the poll was that “Canadians aged 55+ (41 per cent) are more likely than 18-34 year olds (32 per cent) and 45-54 year olds (30 per cent) to have taken money out of their RRSPs”. Although one must take into account people greater than 55 years old will have larger RRSPs from which to withdraw, one would think that of anyone, those closest to retirement would consider their RRSPs as Holy Grails. However, as noted by the Canadian Investor in the comments area, some +55 year olds may be accessing their RRSPs as part of their retirement plan, in essence lowering and/or smoothing their income tax liability and funding retirement expenses.

I summarize the poll numbers below (Note: I have used the numbers in the Scotiabank press release and from an article in the Financial Post by Garry Marr on “What not to buy with your RRSP”, to pull these numbers together, as I could not directly access the survey).

Reasons People Withdraw from Their RRSPs

Buy a first home - 40%

Pay down debt - 16%

Convert to a RRIF - 15%

Cover day-to-day expenses - 14%

Home renovations - 8%

Vacations - 6%

Education - 4%

Medical - 3%

Holy Cow - Did you really use your RRSP for a Suntan?

So, let’s step back for a moment to review the reasons provided by Canadians for withdrawing money from their RRSPs and examine whether my postulation that RRSPs are the retirement Holy Grail is flawed.

In total, 14% of RRSP withdrawals are used for home renovations and vacations; two fairly self-indulgent and discretionary expenses, that most would suggest should not be funded by a RRSP. What is scary is that number would be much higher if we added the percentage of day-to-day expense withdrawals that were for discretionary expenses such as tablets and TV's. Ouch, not much of a holy grail.

Holy or Holey?

The Scotiabank poll still reflects that 64% of the population do not access their RRSPs and that percentage would move closer to 70% if we exclude the legislated conversion of RRSPs to RRIFs, which are not true withdrawals.

If you believe that first time home purchases are technically just loans from your RRSP and not true withdrawals, the percentage increases to almost 85%. Finally, if you believe paying back debt is just a result of financial duress and not because RRSPs are holey, it could be argued the percentage of people accessing their RRSPs is a relatively small narcissistic percentage.

So let's look at the top two reasons for RRSP withdrawals in greater detail.

Buying a First Home

As noted above, the largest single reason for withdrawing money from a RRSP is the purchase of a first home. This is an extremely complex issue to analyze, because the CRA has condoned the use of RRSP funds for first-time home buyers. Many people make RRSP contributions they would never have made in the first place, knowing they will get an immediate income tax deduction and tax refund, while keenly aware that they will utilize these RRSP funds to assist in purchasing a home in the short-term.
 
In the Scotiabank press release, Bev Moir, a ScotiaMcLeod Wealth Advisor, said the following: "Investing in a home and investing in retirement are both important parts of life and finding a way to balance both is key. If Canadians are going to take money out of their RRSP for a major purchase like a house, they need to have a plan in place to return that money as soon as they can so they don't limit their options in the future. “  

The problem I have with Ms. Moir's statement is that it ignores the reality of the situation. People buying their first home typically struggle to just repay the yearly minimum Home Buyers Plan (HBP), which is re-payable over 15 years. In my CA practice, it is my experience that many people do not make the required yearly HBP repayment. The consequence of non-payment is that the required payment amount becomes taxable income in that year; which results in additional income tax and a further deterioration of potential retirement funds. Even where people have a plan and make the yearly repayments, years of tax-free compounding are forgone and their future retirement options may be limited to some extent.

Here is what Rob Carrick of the Globe and Mail has to say on this topic. In his book How Not To Move Back In With Your Parents Rob says that when people ask him should they contribute to their RRSP so they can withdraw money under the HBP his answer is "Uh no. You contribute to an RRSP to save for retirement. If you need some of your RRSP to afford a house, fine. But there's too much of a tendency for people to see RRSPs as a savings account from which money can, if necessary, be withdrawn."

Personally, I don't think using a RRSP to purchase your first home negates my Holy Grail argument. The intention of the HBP program is in essence to provide a 15 year or shorter term "self" mortgage, while keeping your RRSP whole; however, like any legislation that has more than one objective, both objectives cannot be fully satisfied.

Repayment of Debt

I discussed the issue of excessive Canadian debt in my blog, Debt – An Ugly Four Letter Word. Accessing RRSP funds to pay down debt is a blog on its own, so for now, I will only say, often RRSP withdrawals related to debt repayment are accessed under financial duress. Now whether this duress is self-inflicted due to excessive discretionary spending is another question entirely.

Rob Carrick in his book states that "there are better ways to accomplish this very worthwhile objective" than using your RRSP to repay debt. I discuss some of these ways in my above noted Debt blog post. Rob also makes a great point in noting that the statutory withholding tax rate attributable to RRSP withdrawals is often less than the person's marginal income tax rate, which can result in an income tax shortfall, which creates yet another new debt. In that regard, if a RRSP is accessed by a taxpayer in the 31% marginal tax bracket (the tax bracket the average Canadian would be in) to pay down debt, they will only be applying approximately $69 of each withdrawal to pay down their debt after the CRA takes its tax bite.

My Final Comment

At this point, I can only suggest that RRSPs are the Holy Grail for at least 70% of Canadians. However, for a disturbingly large segment of the population, RRSPs are the Holey Grail. For this percentage of the population, instant self-gratification, whether in the form of a nicer house, vacation or the latest electronic gadget, is of greater importance, than a distant concept called retirement. As for the high percentage of 55+ year olds making RRSP withdrawals, I am very concerned for their retirement if the withdrawals are not being made as part of their retirement plan.

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.

Is it Morbid or Realistic to Plan for an Inheritance?

I have written several blog posts on estate planning and inheritances, including “Taking it to the Grave,” a blog I wrote for the Canadian Capitalist, in which I discuss whether parents should distribute future inheritances in part or in whole while they are alive and “How your Family Dynamic can affect your Estate Planning”  in which I discuss how parents have to navigate a minefield of family issues with respect to the determination of executors, the distribution of family heirlooms and the distribution of hard assets.

These blogs elicited a wide range of opinions and comments that I found fascinating. Some people believe they are better off because their parents made them work for everything and they don’t want any financial assistance from their parents either during their life or after they pass away. Others state that as long as parents are careful to ensure they don’t destroy their children’s motivation, partial inheritances make sense. Finally, others say they have been sickened as they observe children waiting at a parent’s deathbed salivating at the thought of their inheritance.

All this leads me to another very touchy subject; should a child (let’s assume the child is at least 40 years old) plan their own future based on a known or presumed inheritance? To add some perspective to this issue, it is interesting to note that a recent survey by the Investors Group states that 53% of Canadians are expecting an inheritance, with over 57% of those, expecting an inheritance greater than $100,000.

Inheritances can be categorized as either known or presumed inheritances. An inheritance would be categorized as known, when a parent(s) has/have discussed the contents of their will with their child(ren) or at least made known their intentions. In these cases, while the certainty of the inheritance in known, the quantum is subject to the vagaries of the parent(s) health, the parent(s) lifestyle, the income taxes due on the death of the last to survive parent and the economic conditions of the day. (Speaking of discussing the will with your children, it is very interesting to note that my blog post One Big Happy Family until we discuss the Will which had limited initial traction, is now by far and away the most read blog I have ever written).

An inheritance may be presumed where the financial circumstances of the family are obvious. A child cannot help but observe that the house their parents purchased 30 or 40 years ago for $25,000 is now worth $800,000 to $1,000,000, or that the cottage their family bought for $100,000 many years ago can be subdivided and is now worth $700,000.
Many average Canadian families have amassed significant net worth just by virtue of the gains on their real estate purchases. These families would not be considered wealthy based on lifestyle or income level, yet their legacy can have a significant impact upon their children. Inheritances are not only an issue for wealthy families.

I think most people will agree that where an inheritance will be so substantial that it will be life changing; parents need to downplay the inheritance issue and/or manage the inheritance by providing partial gifts during their lifetime. Rarely can a child become aware of a life-changing inheritance without losing motivation and experiencing a change in their philosophical outlook on life.

Although life changing inheritances are rare, life "affecting" inheritances are not. So, should children change how they live and how they plan for the future based on a known or presumed future inheritance? In my opinion, if the inheritance is known and will be substantial enough to alter a child’s current or future living standard, the answer is a lukewarm yes, subject to the various caveats I discuss below.

I think it is imprudent to ignore reality and where an inheritance has the attributes I note above, it should be considered as part of your future financial plan. However, I would discount the amount used for planning purposes significantly, to account for inherent risks. Those risks include the longevity of a parent, economic downturns that reduce your parent(s) yearly income stream,  potential medical costs and finally, the ultimate risk one takes in planning for an inheritance; the risk of somehow falling out of favour and being removed from your parent(s) will.

Where there is a presumed inheritance, I would suggest you need to be ultra conservative if you want to plan for the inheritance, since not only are you guessing at the inheritance amount, but you face an additional risk that your parent(s) may have offsetting liabilities such as a mortgage or line of credit of which you are unaware.

So what do the experts have to say on this matter? In the press release for the Investors Group survey, Christine Van Cauwenberghe, Director, Tax and Estate Planning, says that "Knowing the dollars and cents behind your inheritance can have an impact on your financial plans. It is smart to know what you can expect so you can plan accordingly and family dialogue is a good place to start."

Ted Rechtshaffen, a certified financial planner at Tri-Delta Financial, in a National Post article I discuss below, says "he may be in the minority but he encourages clients to count on their inheritances when planning to some degree." He however, goes on to say he tells clients to be super-conservative. Finally, he concludes with "I know it goes against the grain because you are counting on money you don't have", adding, "it depends where your parents are in their life cycle and how clearly they have signalled their intentions".

I think Christine and Ted's comments clearly point out the conundrum here, for which there is no black and white answer. It is probably unwise to ignore a known potential inheritance, but because the final inheritance is subject to so many variables, you must risk assess that inheritance and discount its quantum by a significant amount, such that your planning becomes a paradoxical situation.

But what if you see no risk in your parent(s) financial situation deteriorating and you feel you will never be removed from the will, how can your financial planning be affected? For argument’s sake, let’s say your inheritance will be large enough to affect your future planning, but not large enough to affect your motivation or change your lifestyle.

The most obvious change to your financial plan may be to underfund your RRSP. Most Canadians struggle to make yearly RRSP contributions. They live in mortal fear that they will not have enough money to live the retirement they envision. But, if you know your parent(s) have enough funds to live out their life/lives comfortably, and say your inheritance will be in the $300,000 to $500,000 range, do you need to make your maximum RRSP contributions?

Other planning issues include whether you should purchase a home out of your price range or underfund your children’s education fund, knowing that you will receive an inheritance to pay off the mortgage or to pay off any education related loans. Alternatively, you may over fund your child’s education by sending them to a private school you would never had considered without knowledge or presumption of a future inheritance.

How you deal with debt could also be affected. If you have debt, should you just limit it to a manageable level and not concern yourself with paying it down? Or alternatively, should you pay it off because you can reallocate funds once committed to your RRSP, TFSA or RESP, knowing your inheritance will cover your RRSP, TFSA or RESP?

We have all heard about about the huge debt level many Canadians are carrying. Based on comments made by Benjamin Tal, deputy chief economist for the CIBC, one wonders if at least subconsciously some of this debt level in being carried because people know they have an inheritance coming? Mr.Tal in an article in the Toronto Star on Baby boomers set to inherit $1 trillion says "people talk about how much debt there is without looking at the size of the potential assets to come. Debt is relative to your income today, but your wealth tomorrow will improve when an inheritance comes."

So, have I seen people bank on an inheritance? Yes. To date, where I have observed such behaviour, the inheritances have come as expected. However, these cases may not be predictive of future cases.

Is it morbid to plan for an inheritance? Clearly, it is. Would most people rather have their parents instead of the inheritance? Yes. This topic is a very touchy subject and an extremely slippery slope, but to ignore the existence of a significant future inheritance that would impact your personal financial situation may be nonsensical.  However, if your financial planning takes into account a future inheritance, you should ensure you have discounted that amount to cover the various risks and variable that could curtail your inheritance and be extremely conservative in your planning.

Post script:

As the expression goes "Those who hesitate are lost". I started writing this blog back in late November, but could not come to a conclusion (if one can call the lukewarm recommendation I suggest above a conclusion) until recently on whether one should or should not plan for an inheritance. Thus, this blog post just sat. In the interim there have been two excellent articles on this topic. The first by Garry Marr of the Financial Post, titled Windfall no sure thing from which I quote Mr.Rechtshaffen above and another article by Preet Banerjee of the Globe and Mail, titled An inheritance should be a windfall, not a financial plan.

In Preet's article he notes the potential flaws of incorporating an inheritance into your financial plan. He also concludes with some words of wisdom "There are enough variables affecting your own financial success. Ideally, you shouldn’t bank on an inheritance in your financial plan, but rather treat it as an unexpected windfall. Most people would rather give it up in exchange for having their parents back".

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.