Two decades ago, we began working with a couple that had $800,000 within their investment portfolio. Both had good pensions from the companies they worked for. Both had retired several years earlier and were already receiving pension payments from their employers, and both received CPP and OAS. They supplemented these income sources with a regular systematic withdrawal from their ScotiaMcLeod investment portfolio. He was 71, and she was 68.
We did a Total Wealth Plan, which showed they would have sufficient funds for retirement. One thing that stands out to us, even after completing their financial plan, is the fear they had that they would one day run out of money. Even at age 90, this same couple had an investment account that was now well over $2 million even after taking a monthly systematic withdrawal for 20 years, and they still feared that they would run out of money one day. The fear never really went away.
Through these types of client experiences and interactions, we have learned that many people have this fear. We have developed ways to communicate with clients to help lessen this fear. We often tell them that we fear the opposite — that our clients will not enjoy their hard-earned money.
Here are 10 talking points that we bring up with clients when they have these similar fears.
1. Asset mix
The natural tendency when people fear they will run out of money is to either hold cash or shift their investment holdings to more conservative investments such as guaranteed investment certificates (GICs). This is the exact opposite of what people should be doing.
If you fear you are going to run out of money, then ensuring that your money is growing and staying ahead of inflation should be the objective. We encourage our clients to primarily hold blue chip equities that have a combination of capital gains and dividend income, which can be more tax efficient than interest income.
2. Focus on generating dividends
For every $1 million a client invests with us, we have a goal of generating $35,000 to $40,000 of tax efficient dividend income and generating capital gains on top of that. Incoming cash flow from dividends is a key component that results in our clients primarily living off of the income without having to sell their underlying assets. Dividends on many blue-chip equities are as high, or higher, than GIC rates. In addition, they are taxed far more favourably.
Below we have outlined a scenario of two different clients, both in the 30 per cent tax bracket.
Client A has invested in GICs for the past 10 years, generating on average four percent per year. As GICs pay interest income which have no growth potential and are fully taxable each year, the net return is 2.8 per cent (4.0 per cent less the tax of 1.2 per cent). If Client A started the year with $1 million, they would be able to spend $28,000 annually without touching the capital.
Client B has invested the $1 million in a basket of 30 blue chip Canadian equity stocks that have an average dividend yield of 4.0 per cent but also have growth of 4.0 per cent annually on average over the last 10 years. The growth on equities is not taxed until they are sold, which has great deferral advantages. A dollar of tax tomorrow is less than a dollar of tax today.
Assuming that all stocks are liquidated at the end of every year, Client B will have a T5 for $40,000 to report each year. The tax on $40,000 of dividend income, after the dividend tax credit is applied, is significantly lower than the interest income of a GIC. In addition, Client B will have $40,000 in capital gains; however, only 50 per cent of capital gains are taxable, or $20,000.
The combination of both dividend income and only 50 percent of capital gains being taxed results in a much greater amount in your pocket.
3. Defer Canada Pension Plan
If you have paid into Canada Pension Plan (CPP) your entire life and you are in good health, then we encourage our clients to defer collecting retirement CPP benefits.
For many of our clients, deferring until age 70 makes sense, provided you are in good health and have good genetics. The reason for deferring CPP, is that once you do begin collecting CPP, you will get a higher dollar amount for the remainder of your life.
As of August 2023, the maximum monthly CPP amount you could receive at age 65 was $1,306.57. If you start payments after age 65, your payments will increase by 0.7% each month (or 8.4% annually), up to a maximum increase of 42% if you defer payments to age 70. There is no benefit to deferring payments after age 70.
4. Defer Old Age Security
One of the easiest ways to ensure you have greater cash flow throughout your life is to defer your Old Age Security (OAS). There is a meaningful difference between beginning to collect at age 65 versus deferring to a later year.
As of August 2023, the maximum monthly OAS payment amount was $698.60. If you start payments after age 65, your payments will increase by 0.6% each month (or 7.2% annually), up to a maximum increase of 36% if you defer payments to age 70. Our recommendation, for many of our clients with good health, is to defer taking their OAS until they are age 70.
5. Staying in your home
One of the main forms of equity our clients build up during their lifetime is the equity within their principal residence. The appreciation in the price of the home is 100 per cent tax free when sold.
We encourage our clients to stay in their home for as long as they are able. Even if you must hire someone to cut your grass, clean your gutters, and do other miscellaneous chores as you age, you will continue to build equity as you own the house.
6. Defer property taxes
We encourage most of our retired clients to defer their property taxes (learn more by reading our other article on this). By deferring your property taxes, you are able to keep those funds invested and make a tax efficient investment return. You also do not have outgoing cash flow.
When clients defer their property taxes, they lower their outgoing cash flow, which allows them to stay in their home longer.
7. Keep money in the bank
Earlier this year, we wrote an article about people having far too much money in chequing accounts and low-interest bank accounts. Getting that money invested throughout your life can make a meaningful difference annually, especially when compounded over many years.
It can be a significant financial sacrifice to have excessive amounts sitting in the bank earning little to no interest. I’ve heard of individuals having $100,000 sitting in a chequing account or $250,000 in a corporate account that is not appropriately invested.
The sooner the money is invested appropriately, the greater our clients’ net worth will be over time.
8. Spend within your means
Controlling spending in the earliest years of retirement can have a material impact on your retirement savings and how long they last. Nearly every financial planning article talks about how spending in the first 10 years of retirement will be higher than in the later years.
People who indulge in large purchases, and significant withdrawals from investment savings, early on in retirement (i.e. motorhome purchases, boats, expensive vehicles, extravagant travel, etc.) have a greater likelihood of depleting capital sooner. When we complete Total Wealth Plans, we map out a sustainable amount that can be spent for the desired life expectancy.
9. Investment returns
People who fear running out of money during retirement often worry about their investments returning a sufficient return to last them their entire life. When we complete Total Wealth Plans, we purposely assume a low rate of return of four per cent. We can illustrate how long a client’s money will last with different rates of return.
If your retirement age is age 60 and your investment dollar contributions have ended, the investment returns from your portfolio become even more important. More care than ever must be taken to manage this nest egg, not for a one-year period, but for a period of 30 to 40 years.
Mapping out your cash flow needs is critical. The portion that you will need to access within the next 12 months should be in cash equivalents that are not subject to fluctuations in the markets. To learn more about determining the appropriate amount to have set aside in cash, read our article: What is the ideal cash allocation?
10. Choose the right retirement date and life expectancy
When we prepare financial plans, we have to pick an age for life expectancy as one of the assumptions. We have typically used age 90 or 95 in the past. For clients who have the fear of running out of money early because of living longer, we can run a scenario that uses the assumption that our client lives to age 100.
Clients always have the choice to work a little longer to give themselves an extra retirement buffer. Retiring early and worrying about money is not the ideal situation; especially when going back to work at the same income level may not be possible.
Kevin Greenard CPA CA FMA CFP CIM is a Senior Wealth Advisor and Portfolio Manager, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timecolonist.com. Call 250.389.2138, email [email protected], or visit greenardgroup.com.
