It’s not often I read a book twice and even rarer that I’ve reviewed the second edition of a book. The rare exception is Daryl Diamond’s newly revised Your Retirement Income Blueprint, published by Wiley Canada in 2011 and now in 2014 by Milner & Associates Inc.
A major reason is revealed in the back-cover blurb I supplied for the new edition. When the original came out, I was still fully employed and the idea of retirement or financial independence were just theoretical concepts. But as I say in the blurb, now that I’m transitioning from employment to semi-retirement or self-employment, “I intend to use Daryl’s blueprint as my personal plan for drawing income from a diversified portfolio and other income sources.”
Different skill set for decumulation
Diamond rightly points out that there is a world of difference between wealth accumulation and drawing an income. He’s probably also correct that there are a lot fewer financial advisors who specialize in decumulation, compared to the legions who are focused on wealth accumulation.
Diamond – who like myself was born in 1953 – lays out a six-step plan for creating and implementing a retirement income blueprint. Even on a second read, I still found myself underlining certain passages that must not have penetrated my thick skull originally. Things like the Age Credit and Pension Tax Credit tend not to be top of mind until you actually stand to benefit from them. (And I don’t yet but can see the day fast approaching when I would!)
Where Diamond really adds value is the way he integrates tax planning with a logical order for drawing on various retirement income sources. His “Cash Wedge” or “Floor and Upside” concept seems to me a variation of Asset Dedication: setting up enough cash flow to draw down on for the first two or three years. His discussion of the order in which to draw on government and employer pensions, annuities and registered and non-registered investments is masterful. And his recommendations are not always obvious. For example, he’s generally in favor of taking OAS and CPP benefits relatively early, in part because he has an acute understanding of how higher income later in retirement can impact the aforementioned age and pension credits, or indeed receipt of OAS benefits at all.
In a similar fashion, he advocates using non-registered (or what he terms tax-paid) assets when you move into higher tax brackets.
Sweet spot for age and pension credits
While the editions aren’t hugely different – the blue front cover is virtually identical in both editions — Diamond and editor Karen Milner have done a good job updating everything to 2014. So, for example, you will learn (on page 158) that the tax-efficient net income “sweet spot” in 2014 for someone aged 65 or over is $34,873. Or, a few pages later, that the federal “tax-free zone” is $18,054, which rises to just over $20,000 if the pension credit is generated.
He also makes it clear that letting vehicles like tax-deferred RRSPs grow indefinitely can be tax-inefficient, since that creates what can be a “tax trap” after age 71, when minimum and fully taxable RRIF income starts to kick in. So he shows how you can start withdrawing income from RRSPs or RRIFs to get you to the top end of any given tax bracket, even if the extra (and taxable) income is not required that particular year. He’s also a big fan, as I am, of the Tax Free Savings Account or TFSA.
No doubt I will frequently consult this book personally as I progress to later stages of the “Findependence” journey I’ve been chronicling in these blogs.
All I can say is the $26.95 retail price of the book is trivial compared to the tens of thousands of dollars that could be saved by implementing the steps in the proper order.
Not according to veteran Bloomberg News editor and investigative reporter Bob Ivry. In his recently published book, The Seven Sins of Wall Street, Ivry pulls no punches about the continued sins of the major players like Bank of America, Citigroup, Goldman Sachs, JP Morgan Chase, Morgan Stanley and Wells Fargo.
Their collective sins? Gluttony, Wrath, Envy, Pride, Sloth and — he saves the best and most obvious for last — Greed. And as the book’s subtitle suggests (Big Banks, Their Washington Lackeys, and the Next Financial Crisis), the fact that so few of these sins were punished the first time around could mean a repeat of the crisis.
Just when you thought it was safe to go back into the water!
Too big to jail?
Sadly, it seems that the slogan “Too big to fail” could as easily be modified to “Too big to jail.” We should be “very afraid” of the shenanigans of these financial behemoths “since the crisis” Ivry writes.
Ivry brings to life the contrast between the lavish lives of the masters of the universe running these institutions, and the thousands of Americans who lost their homes to predatory lending practices and shady mortgages. And he doesn’t shrink from making his own recommendations: the financial giants need to be shrunken down to a size where they can no longer be deemed “too big to fail.” He gives voice to the outrage of Main Street and the essential proposition propagated by these banks that it’s “heads we win, tails you lose.” By which he means, the system is still such that these institutions can take enormous bets with other people’s money (i.e. depositors) and if they win, they go home with giant salaries and even more gigantic bonuses. And if they lose, well again, their mistakes are paid with other people’s money (i.e. taxpayers) and more often than not the executives not only keep their jobs but still end up with enormous bonuses.
Ivry calls for a return to the days when deposits were kept separate from investment banking. Or as he colourfully phrases it, “The easiest way to make the biggest banks smaller is to separate their dice games from Granny’s deposits.” He’d also like to see them exit from commercial activities: “They ought to be financing oil exploration and coal mining, not doing it.” (my emphasis added).
If you can’t beat them …
Let me add a few points that Ivry does not cover. Since this is a blog about financial independence, it may be worth observing that if you feel there’s little you can do as a small investor about the dominance of North America’s giant banks, you could at least profit from them. If the advantages depicted by Ivry are are as overwhelming as he makes out in his book, then it might make sense to buy an ETF focused on this sector.
For U.S. financials you might try the Vanguard Financials ETF (VFH/NYSEArca), which includes not just big US banks but also wealth managers and financial services issues of all stripes. Canadians wishing to focus on U.S. banks but hedging back into Canadian currency could consider the BMO Equal Weight US Banks Hedged to CAD Index ETF (ZUB/TSX). And of course, seeing as Canada’s big banks sailed through the financial crisis practically unscathed, you could also try the iShares S&P/TSX Capped Financials ETF (XFN/TSX).
My latest MoneySense blog compares the tax-sheltered contribution room available for RRSPs and Individual Pension Plans or IPPs.
For archival purposes and continuity, I reproduce the text below.
A few weeks ago, we looked at the topic of raising RRSP limits. As noted then, it was based on a C.D. Howe Institute report that suggested one possible solution to the alleged retirement crisis was simply to go back to the half-century-plus RRSP and raise contribution limits for the (relatively) few affluent people who are forced to save in taxable accounts because they’ve maxed out on RRSP room.
If you’re at top executive or own your own business and are 40 years of age or older, there may be another way to get the benefits of RRSPs. The Individual Pension Plan or IPP is an employer-provided program that replaces RRSP savings by an employee, says Stephen Cheng, managing director of Vancouver-based Westcoast Actuaries Inc. To be eligible for an IPP, you need to receive pension-eligible T-4 employment income. Self-employment income, partnership income and dividend income are not pension-eligible, Cheng says. So if you own your own business, you’d have to pay yourself a regular salary that generates T-4 employment income.
IPP assets are creditor-proof
One advantage is that all eligible employer contributions are tax-deductible for corporation tax purposes, but won’t be taxable to the employee until the plan starts to generate pension income. Also, if the IPP is in deficit after the three-year actuarial valuation, the employer can top it up with further contributions. In addition, IPP assets are creditor-proof: always a plus for the self-employed; and as with traditional Registered Pension Plans, pension income can be split up to 50% with one’s spouse, for income tax purposes (pension splitting).
Advantage rises with age
The older you are, the more the relative room can be held in an IPP relative to an RRSP. For those in the top tax bracket, the maximum RRSP contribution is currently $24,270, an amount that does not vary by age. However, IPP room gets larger the closer you are to retirement. Maximum IPP contribution room at age 40 is $26,097, rising to $31,488 by age 50, $38,005 at 60 and a whopping $41,282 at age 65. In the latter case, the IPP has a contribution room advantage over the RRSP of a massive $17,012 a year!
Employers can make past service contributions to a new IPP in 2014, Cheng says, providing the employee received pension-eligible T-4 type employment income over the years being calculated. The employee must transfer an amount from his or her personal RRSP into the IPP (since 1997 the maximum transfer amount required for each service year has been $24,330, with lesser amounts between 1991 and 1996). For all years between 1991 and 2013, the combined maximum that can be transferred into an IPP from an RRSP comes to $510,470: just over half a million dollars! If the IPP is set up in 2014, the RRSP deduction limit will be reduced to $600 each year, starting in 2015.
The calculations are not simple but you can find a free customized IPP quote online here.
Yes, I know that BABA is an unfortunate ticker symbol if you think this is the latest way Wall Street has figured out to fleece the sheeple: BAAAAHHH!
I went ahead and picked up a few dozen shares today in the low 90s: no bargain perhaps but my reasons for doing so were in Friday’s Financial Post, which you can find here.
As the day progresses, it seems we’ve seen the top for now. You can find a short clip on the topic of its pricing from Mad Money’s Jim Cramer here.
Time for the “equanimity” part of the equation that I mentioned at the end of the piece.
The book The E-Myth Revisited makes some amusing points about small business owners. Almost to a man (or woman), they loathe accounting. They may enjoy marketing or creating new products or services, but keeping track of expenses, invoicing and the like? It’s the last thing they really want to do, which leads to the usual habit of procrastinating by shoving paper receipts into the proverbial shoe box, then presenting the whole shooting match to their accountant once a year.
But no accountant I know will accept such an arrangement, or if they do they’d have to charge a prohibitively high rate for the service. In practice — and I base this on running a personal corporation since 1999 — you at least have to put all the receipts and paperwork into folders representing the major expense categories, then summarize it all on a spreadsheet so the accountant can make some sense of it.
At one point, I experimented with shrink-wrapped accounting software, which typically cost a few hundred dollars. But I was never comfortable with it so stuck to the shoebox-and-spreadsheet routine. Until this summer, when courtesy of the very helpful folks at Knightsbridge, I discovered Accounting by Wave.
This software has several good things going for it. First, it’s free. Second, it’s cloud-based, so you can store all your info on “the cloud” and access it from whatever computer you have access to: there’s even an iPhone app. Third, it’s Canadian. And fourth, it’s relatively intuitive and easy to use. What more do you want?
Not surprisingly, the software has 1.5 million happy users, most of them the small businesses, consultants and freelancers the company has targeted. And wouldn’t you know it, right off the topic they promise “shoebox accounting stops now.”
Integrated with your business bank account
The software lets you input your corporate bank account information so right off the bat payments to your account and disbursements from it are automatically recorded. You’ll have to spend some time reconciliation expenses incurred via credit cards, cash disbursements and the like but an hour spent every week or two should suffice for most home-office setups like mine. And it sure beats dreading the annual spreadsheet ritual!
The software is quite proficient at keeping track of customers and invoicing, and it generates various reports on demand that show the current expenses, payments and accounts receivable. And yes, it lets you add HST. Again, there’s an element of garbage in, garbage out here, so the reports will only be meaningful if you’re staying on top of all the transactions and properly categorizing them.
How does this relate to Findependence Day?
Glad you asked! If you’ve followed this blog since May, you’ll know I believe in creating multiple streams of income, whether you’re gainfully employed, semi-retired or even fully retired. Part of that is Internet-based: refer to Robert Allen’s book, Multiple Streams of Internet Income, or any of the three books by Scott Fox. (His site is here, and latest book here).
But the other piece of the equation is running your own business and keeping track of all the moving pieces. As I’ve come to appreciate, a traditional “job” really comes down to serving and satisfying a single client, which in practice means “your boss.” The traditional corporate or government job largely shields the employee from accounting: all you need to worry about is submitting the annual T-4 slip with your annual tax return, claim the usual deductions and hope for a tax refund at the end of it.
The good thing about self-employment is that (hopefully) you don’t have any boss but yourself and instead of one huge mega-client, you have many smaller clients. You may lose one from time to time but the others can keep the ship afloat until another replaces it. Seen that way, a “job” is the opposite of diversification: you have all your eggs in one basket and if your boss decides to smash that basket, you’ve got trouble.
This cloud-based software is a real boon to keeping on top of your business. Hopefully, all your earned income from multiple clients or products or services constitute a major part of your revenue stream. Of course, you should also have investment income, emergency savings and pension income (depending on your age), so that your “Findependence” isn’t riding on any one of these.
As I noted Thursday in this blog and elsewhere, I’ve always believed Canadians should have higher RRSP contribution limits and/or the equivalent space in registered pension plans.
It seems the C.D. Howe Institute agrees, based on this paper released Thursday, and which has already created a fair bit of publicity. I’ve received some email on this site (via email@example.com) to the effect that “only the rich” benefit from more RRSP room and that, in any case, low-income earners are better off with TFSAs.
I’ll quote from some of the skeptics below, but first let me reiterate the point that Ottawa will eventually get any tax revenue it may lose by raising RRSP limits now. As any retiree with a substantial RRIF knows, forced annual RRIF withdrawals will be fully taxable and may even result in the clawback of OAS or other benefits. That’s why some question my statement that higher-income earners should welcome more RRSP room.
Two pluses, one minus
I know those with big RRSPs will eventually pay the piper but remember two things. One, several years or decades of deferred and compounded growth on investments is worth a lot. Second, most of us can expect to be in a lower tax bracket in retirement than when we were working. If you can defer tax while you’re in a 46% tax bracket and pay it many years later when you have no other income and are in a 23% tax bracket, that to me is a fair trade.
A 72-year old reader with the first name James makes the following counterpoints:
… when the other shoe drops and you are withdrawing money, here are the nasty realities:
1. You may be paying higher tax rates than when you put it in! This is true in my case and you do not have to have amassed a huge fortune for that to occur.
2. The whole nasty business of clawback, which has huge potential marginal tax rates.
3. The fact that the government controls the rate at which you reacquire your own money – regardless of your needs and limitations.
Any reform of RRSPs therefore should not only deal with maximum deposit limits but should remove any restriction on the amount and the timing of withdrawals. If I want to leave it in there until I die I should be able to and it can then by taxed in my estate (as a lump sum, which the government would love!) or passed on to one more generation – the spouse.
In the absence of hard numbers on this situation, I tried very hard to come up with my own scenarios using a sophisticated hand-held financial computer, and concluded it was better to collapse my entire RRSP before my 72nd birthday, but I may be on shaky ground without stronger financial planning tools than I had access to.
What if we didn’t tax CPP and OAS benefits?
Another reader, James from British Columbia, makes a suggestion that has occurred to me in the past. Instead of introducing an expanded CPP that will antagonize employers by in effect hiking their payroll costs, why not just make CPP and OAS income go further in old age by not taxing the income?
There could be a means test to apply some tax rate for high income earners, as there is now on OAS, but people who earn under $75,000 per year, for example, would pay no taxes on CPP and OAS benefits.
That simple, stroke-of-the-pen policy change by Ottawa would boost retirees incomes by at least 15% on those sources and not cost a single job. Nor would it require any provincial consensus.
It would cost Ottawa tax revenue, so of course it’s a nonstarter, but it’s not difficult to eliminate the job-killer argument if the federal government really has the will to help low-income retirees.
My take on a C.D. Howe brief issued Thursday on the case for raising RRSP contribution limits can be found in my Financial Post column today here. Also note the many comments that follow the piece, some reflective of the emails I will highlight in Friday’s blog. You can find the full e-brief here.
And in case it’s not clear in the column, I absolutely think this is a good idea: always have. It’s true those with lower incomes may not need RRSPs. TFSAs may be a better solution for them, especially if they want to avoid clawbacks of OAS or GIS in old age. But the vast majority in the middle class who lack employer pension plans (especially the lucrative DB plans) could benefit from higher limits. If, as is likely, they will retire in a lower tax bracket than they were in their high-earning years, then an RRSP is almost a necessity. And as I point out in the piece, since only a minority of Canadians are in a position to max out their RRSPs, it shouldn’t cost Ottawa all that much because of more upfront tax deductions. And unlike the TFSA, which will reap no bonanza for federal coffers on withdrawals, RRIF income will eventually bring in lots of tax revenue for the government once we retire.
Seems like a win-win to me. Stay tuned for more reader feedback tomorrow.
My latest MoneySense blog on robo-advisers can be found here.
If you’ve been listening to the news lately, then you’ve noticed that low-cost automated investment services are making the leap from the U.S. market to Canada. While in the U.S. they’re called robo-advisers, a better word for the Canadian versions might be semi-automated “light advice” services.
Recent issues of MoneySense have talked about the arrival of NestWealth, WealthSimple (which has just received regulatory approval) and WealthBar Financial Services. WealthBar’s website says it will be arriving “soon” and is registered as a portfolio manager in British Columbia, Alberta and Ontario. As well, SmartMoney—owned by Money Capital Management—is also about to launch in Canada. Most of these use exchange-traded funds (ETFs) as the underlying investment vehicle. That means investors can expect to pay either a monthly subscription fee or an asset-based fee of about 0.5% a year. Even adding in the management expense ratios (MERs) of the underlying ETFs, the total cost should come in at less than half what actively managed Canadian mutual funds or wrap accounts charge.
Apart from these startups, you can also expect to see more established firms reinventing themselves with similar models. Take ShareOwner Investments Inc., of Toronto. Since 1987, it’s been the place knowledgeable Canadian investors have bought individual stocks through DRIPS (dividend reinvestment plans). Last May, ShareOnwer announced the launch of a new portfolio building service that’s based now on individual stocks but—you guessed it—ETFs.
As with its DRIP program for individual stocks, ShareOwner’s ETF portfolio service is very cost-efficient. Contributions and distributions are automatically invested in all the ETFs in one of the five model portfolios chosen by the retail investor. As with the other services, asset allocations are reviewed and rebalanced to ensure they stay with agreed target levels. For instance, if Canadian equities are supposed to be weighted at 20% of a portfolio, the service won’t let the allocation dip below 17.5% or above 22.5%, says ShareOwner president and CEO Bruce Seago. (Previous ShareOwner head John Bart, is now retired.)
Clearly, long-standing ShareOwner customers own individual socks but many are now also using ETFs as the core of index part of their portfolios, particularly for international exposure outside North America. ShareOwner has about 500 Canadian and U.S. stocks. There are no commissions to buy or sell but a fee of 0.5% of assets is charged on the portfolio value, billed monthly, and capped at $40 a month for any account over $100,000. As an example, an investor may want to add $500 a month to portfolios holding between eight and 12 ETFs. The $500 will be spread among all those ETFs automatically with each payment, in the correct proportions and with no trading costs. Similarly, any cash from dividends will also be deployed and fractional shares can be accommodated.
Because the emphasis is on core, broadly diversified ETFs, the funds are mostly from BMO, BlackRock Canada’s iShares and Vanguard Canada, Seago says, although oehters are available for those who want custom portfolios. He adds that even if clients want to invest in both individual stocks and ETFs, they would maintain separate accounts for them. For the most part, the model portfolios stick to the major asset classes or stocks, bonds and cash, but those who want to do so can get previous metals or gold exposure through ETFs—one that holds mining stocks, the other that holds bullion—directly.
While the service is aimed at do-it-yourself investors, personal human advice is provided for those who feel they need help choosing an appropriate portfolio. “Building a portfolio does require thinking about risk tolerance,” says Seago. “Once you know how much risk to take, you can pick one of our portfolios—most of which usually match up with the needs of our investors. We are adding a human element on top.”
There’s a must-read on the front page of Thursday’s National Post by Andrew Coyne that you can find here. The piece highlights a new Fraser Institute study about the increasingly bloated costs of investments run by the Canada Pension Plan Investment Board (CPPIB). While Coyne is primarily a political writer and this piece is in part a political one, Coyne has always been a shrewd observer of the investing scene. Over the years, he’s occasionally weighed in on the relative merits of low-cost “passive” index-based investing and higher-cost “actively managed” investing epitomized by retail mutual funds, wrap accounts and (in the case of CPP), actively managed pension mandates.
Coyne doesn’t pull his punches. Near the end of the piece he writes:
It is simply a reflection of what is by now also widely recognized, among those without a vested interest in denying it. Active management is a crock. To consistently beat the market within a given asset class, a fund manager must be consistently smart and well-informed, he must be consistently smarter and better-informed than all the other smart and well-informed managers out there, all of whom are trying to do the same. That’s vanishingly unlikely.
CPP is playing the Loser’s Game
Clearly, Coyne is well aware of the arguments of major financial writers like John Bogle, Larry Swedroe, Mark Hebner, Dan Solin and many more. In particular, Charles Ellis’s Winning the Loser’s Game. (Click on the highlights for other representative books written by those authors. There also others by Canadians like Mark Noble, Howard Atkinson, Keith Matthews, Ted Cadsby and no doubt a few others I’ve neglected to mention.)
So, despite the overwhelming academic evidence that active management is — to use Coyne’s delightfully derogatory term — a “crock,” why then is the Canada Pension Plan Investment Board (CPPIB) taking a flyer on Canadians’ collective retirement funds? It’s about money alright, but not so much about our retirement money than the compensation sought by CPPIB senior managers.
CPPIB salaries depend on willful ignorance
As Coyne points out, compensation for CPP senior managers has leapt from $1.56 million in 2007 to $3.3 million in 2014. Despite this, he adds, this “extraordinary executive bounty” has “hardly” been associated with a comparable increase in the fund. This seems to demonstrate the wisdom of the old saying attributed to Upton Sinclair that “It is difficult to get a man to understand something, when his salary depends on his not understanding it.”
Kudos to Andrew Coyne for putting the spotlight on this issue so central to the future retirement health of average Canadians. And it’s not just about CPP. When the federal government’s Pooled Registered Pension Plans (PRPPs) were announced, I commented at the time that they should be primarily invested in passively managed ETFs from firms like Vanguard Canada, which had just arrived on our shores, or the low-cost “core” portfolios of BlackRock Canada’s iShares family of ETFs.
PRPPs also headed for the Loser’s Game
But the actively managed investment industry whose collective salaries depend on not “getting” indexing have mounted a formidable campaign to get a piece of the action of PRPPs, to the point I’m not optimistic we’ll see much takeup from the thousands of smaller employers that currently offer no pension plan at all to their workers.
The labour movement can talk all it wants to about the alternative of a “Big” CPP, but if it entails the kind of active management that Coyne describes, it’s hard to advocate allowing the CPPIB to play the “loser’s game” with even more of our money.
As of this week, I am now blogging for Motley Fool Canada. Here’s the debut post, on how DRIPs (Dividend Reinvestment Plans) constitute the “dull road to riches.” Hey, I’ll take “dull” if it also leads to “riches!”