Can IPPs give you more room than RRSPs?

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.

stephen-cheng

Stephen Cheng, Westcoast Actuaries Inc.

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.

Boosting RRSP limits: two views

Up, up and away for RRSP limits? Photo J. Chevreau

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 jonathan@findependenceday.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.

 

 

The case for boosting RRSP limits

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.

 

Why is CPP betting on the “crock” that is active management?

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AndrewCoyne.com

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.

 

 

The upside of aging

upside_coverThe MoneySense version of this blog can be found here. For “one-stop shopping” purposes, I include the copy below as well:

To the eternally young, a phrase like “The Upside of Aging” may seem to be the ultimate oxymoron. Those of us who see more of our life path in the rearview mirror than up ahead may question such a phrase. It happens to be the title of a book I’ve just started to read, yet another recommended by Mark Venning on his longevity site at www.changerangers.com.

The book, by Milken Institute president Paul Irving, examines how long lifetimes are changing the world of health, work, innovation, policy and purpose. The Milken Institute has focused on aging for several years and takes the long view that human ingenuity should never be underestimated.

Some may reach 150

In the foreword, Milken Institute chairman Michael Milken passes along the opinion by the late Nobel laureate Robert Fogel (of the University of Chicago) that “average life spans in the developed world will easily exceed 100 within the current century.” He expects some to reach 150. Another expert cited by Milken noted that “in terms of health, a 60-year-old woman is equivalent to a 40-year-old in 1960. Today’s 80-year-old American man is similar to a 60-year-old as recently as 1975.”

Your money may have to last a long time

And as Venning notes in the fourth installment of his blog devoted to the book (here,) there’s also a huge impact for those likely to land on the MoneySense.ca website and this Financial Independence blog. Venning observes that one of the major obsessions in the aging game is financial security. Despite the huge advantage we in the west have in enjoying access to various financial planning vehicles and advisers, “a vast majority of people have not planned well or saved aside enough for their later years.” It’s clear to me that the combination of long life, financial independence and robust health must constitute a gift; but what if long life coincides with poor health and/or insufficient wealth? Might not the blessing of long life then become a curse?

One of the multiple sources in the book is American financial planner Dan Houston of the Principal Financial Group. He sees financial security not just as involving saving for retirement, but also encompassing “comprehensive financial planning for competing demands … at different stages of life.”

Longevity changes everything

Houston says longevity changes everything and it’s hard to disagree. Since I tend to look at the topic through the lens of financial independence, it’s clear to me that if nest eggs have to last longer than we and our advisers think, portfolios had better consider inflation. Inflation has always been a curse for those living on a fixed income or non-indexed pensions. The combination of minuscule interest rates and a long life seems to me an unpleasant combination. Stocks that raise their dividends regularly stand a greater chance of generating an inflation-beating source of income. Putting some of your fixed-income allocation into annuities also seems to prudent, particularly if the pricing of annuities by insurance companies doesn’t fully reflect extensions in longevity.

Most of all, however, it seems to me that taking retirement too early in life may be a losing strategy in more ways than one. Putting aside the human need to connect with other people, to have structure and routine and to keep the little grey cells stimulated, purely at a financial level, it’s a lot to expect portfolios designed to last 20 years to support 30 or 40 years of “retirement.” Rather than attempting to retire earlier than the traditional age of 65, it may be more prudent to push it back closer to 70, at least on a part-time basis. Better yet, consider taking the baseline financial independence provided by modest savings and pensions, and launching into an entire second career that can revitalize you AND provide extra income well into what we used to call our golden years. Irving refers to an “encore career,” which he himself embarked upon and which your humble blogger is attempting to chronicle in this blog.

There are, to be sure, economic and investment implications to all this. For a taste, let me quote from Milken’s foreword:

“The economic benefits far outweigh the challenges that come with an aging society. The extension of life, and the extension of healthy life, are positive developments to be celebrated, not feared. Their impact will be an economic boon, not a drag.”

 

The 7 eternal chestnuts of personal finance

Tasty roasted chestnuts

Here is my latest MoneySense blog, covering the 7 big “eternal” chestnuts of personal finance.

For continuity purposes, I also reproduce it below:

One of the world’s best personal finance writers – Jason Zweig of the Wall Street Journal – has said there are only a handful of real personal finance columns to write. The trick, he said (and I’m paraphrasing from memory), was in being able to “reissue” these columns in a way that the public (or editors) don’t notice. Of course, you could go further and say that the news business in general revolves around a few fairly standard memes: if it bleeds, it leads.

In personal finance, however, we’re not in the business of covering disasters and personal tragedies, unless of course the market does a repeat of what it did in 2008. It’s a sad fact that, as investors in Bernie Madoff’s ponzi scheme found to their regret, that when the market tanks we discover who was swimming naked.

The June issue of MoneySense contained 42 items billed as being the “Best Tips Ever.” That issue was a “keeper” and not just because it was the last one with which I was intimately involved. I’m not going to reprise the tips here but instead have come up with a list of seven “personal finance chestnuts” that I hope may be useful to readers and perhaps other PF journalists.

Chestnut #1: Live below your means

This is the granddaddy chestnut of personal finance. If you keep spending your fool head off, you’ll forever be on a treadmill to oblivion. The only way to become financially independent is to consistently spend less than you earn, year in and year out, decade in and decade out. The difference between what you (and your spouse) earn becomes your capital and it must be invested wisely.

Chestnut #2: Pay yourself first

This is closely related to living below your means. The surplus between a higher income and a lower level of spending needs to be directed to savings and investments. Just like your employer takes your income tax off your paycheque before you even see it, you should set up a pre-authorized chequing (PAC) arrangement with your financial institution (“automatic draft” in the U.S.), so another chunk of your paycheque is siphoned right off the top to savings and investments. Yes, you may feel a bit “broke” after the double whammy of paying tribute to the taxman as well as paying yourself first, but as the years go by and your wealth steadily mounts, you’ll be glad you roasted this particular chestnut.

Chestnut # 3: Get out of debt

Starting with non-tax-deductible consumer debt (aka credit cards), then student loans, and finally any lines of credit and ultimately your mortgage. (see Chestnut #4). No investment pays off as well as eliminating high-interest debt and it’s more tax efficient to boot.

Chestnut #4: Buy a home and pay off the mortgage as soon as possible

I’ll keep saying it: the foundation of financial independence is a paid-for home. If you rent, you’re still paying a mortgage: your landlord’s! In that case, your rent will never stop and will keep getting hiked as inflation rises. When you own your own home and the mortgage is gone, you get to live rent-free and you won’t worry about your rent going ever higher in old age. Plus you don’t have to pay capital gains taxes on the sale of your principal residence. (See #7 below). But do accrue for property taxes, maintenance and (for condo owners) maintenance fees.

Chestnut #5: Be an owner, not a loaner

This means owning stocks (or equity mutual funds or ETFs), instead of interest-bearing vehicles like cash or bonds. You’ll never get rich loaning money out, which is what you do when you buy a GIC (or CD in the US) from a bank. If you want to grow your capital and keep up with inflation, you need to own stocks. Better yet, dividends are taxed less than interest and capital gains taxes can be deferred as long as you don’t crystallize profits. You will want some cash or bonds in an emergency fund and as a prudent part of your portfolio once you’re near retirement age.

Chestnut #6: If your employer offers you free money, take it.

Duh! This means you should join the company pension plan, especially if they “match” whatever you put in. And if they give you a discount on the company stock, take them up on that offer too. You wouldn’t say no to a bonus or a raise, would you? Then why wouldn’t you grab the rest of the freebies when they’re on offer?

Chestnut #7: If the government offers you free money, take that too!

This is along the same lines, except of course the government seldom really gives you money, unless you’re among society’s most disadvantaged. For we more affluent folk, there’s no escaping taxes (or death) but you CAN minimize the outflow to the taxman’s grasping hands by taking advantage of whatever few tax breaks he permits. No capital gains on a principal residence is a huge tax break. Apart from that, this means maxing out your RRSP (or your IRA in the U.S.) And don’t forget the Tax-Free Savings Account (TFSA) (or the Roth in the US), which is the mirror image. In the former, you get a tax deduction upfront on contributions; for the latter, you get no upfront deduction but never have to pay tax on investment income generated, even when you withdraw it in retirement. Not quite free money, since you were taxed upfront on the income needed to generate the capital, but almost!

 

 

Gold & Findependence

silver-and-gold-bullionSince the price of gold crashed a few weeks ago, I’ve twice blogged on the topic over at MoneySense.ca, as you can read here. I’ve also done a bit of radio and TV commentary on the topic. As noted at MoneySense, personally I’m somewhere between the 5% “gold as insurance” camp and the “gold bug” camp that allocates upwards of 15 to 25% of a total portfolio to the yellow metal as a permanent strategic allocation in a well balanced portfolio.

My second MoneySense blog looks at Nick Barisheff’s just-released book, $10,000 Gold, a prediction which if it came true would mean a seven-bagger from the most recent post-correction price of $1460 or so. Of course, gold has started to recover from the shocking drop that grabbed the media’s attention earlier this month.

So how does gold fit in with the concept of financial independence? Historically, it has held its own in providing a degree of capital preservation. Anyone who experienced the hyperinflation of Weimar Germany or more recently Zimbabwe can attest to the value of “real money” when contrasted with mere pieces of paper that once promised to pay the underlying metal “to the bearer on demand,” but today are no more real than digits in a computer somewhere.

Bricks & Mortar are another tangible investment I like

So the question isn’t so much whether gold could possibly rise seven fold or ten fold from here, although that’s roughly what it DID accomplish over the past decade. The question is whether paper money backed only by governments with unlimited access to printing presses can continue to be perceived as having value. Just as real estate investors see value in bricks and mortar and the assured streams of income known as “rent,” so too do some investors feel comfortable having at least some of their wealth in tangible precious metals or comparable financial derivatives they hope will retain value if mere paper money falls in value (i.e. ETFs like GLD or SLV). As readers of Findependence Day know, a major subplot of the book is the conflict between Sheena’s desire for tangible bricks and mortar and Jamie’s preference for paper/electronic assets like stocks and bonds.

I’m a Capital Preservation Asset Allocation Bug

Does all this make me a gold bug? No, it makes me a capital preservation asset allocation bug: SOME gold, some cash, some bonds, some stocks and some real estate. And of course, that’s just the investment part of the equation. To this we should add employer pensions and Government pensions like Social Security or the Canada Pension Plan. If someone came to me saying they believed ONLY in their employer pension plan or ONLY in their Social Security or CPP pensions, I’d be just as worried on their behalf as I would be if they told me they had only paper money or — for that matter — only gold coins.

Together, this is my recipe for financial independence.

Podcast about Findependence Day with SPP’s Sheryl Smolkin

Thanks to Sheryl Smolkin of Moneyville and the Saskatchewan Pension Plan for the following 10-minute audio podcast about Findependence Day. Among the  many insightful questions Sheryl asked was whether the “Didi Quinlan” character was modelled after Gail Vaz-Oxlade, Suze Orman or other financial reality TV shows. She also probes about the origins of the Vinyl Museum and other aspects of the novel drawn from real life.

You can access the podcast by clicking here. Note that to get to the actual audio you need to click the blue segment entitled Jonathan Chevreau Podcast. Those who prefer to simply read an abbreviated (but not verbatim) transcript can just keep reading the text that follow’s Sheryl’s link.