Tuesday, July 28, 2015

Your Retirement Income Blueprint

Retirement advisor Daryl Diamond says that many financial advisors can help people accumulate wealth during their working years, but when it comes to planning how to create income during retirement, “advisors who are proficient in this area are not all that easy to find.” His book Your Retirement Income Blueprint lays out his “six-step plan to design and build a secure retirement.”

I found this book very helpful in discussing the important issues to consider when creating retirement income. I believe it will help me to better plan my own retirement. However, there were a number of specific areas where I disagree with Diamond. I have already written about the biggest of these, that he advocates withdrawal rates that are too high; I won’t say more about this issue here.

For me, the best part of this book is the discussion of RRSP withdrawal strategies. Common tax advice is to defer taxes as long as possible, which means draining non-registered savings and TFSAs until you’re forced at age 71 to draw from RRSPs and RRIFs. However, my own simulations seemed to show that it can make sense to draw from RRSPs early.

Diamond says “the prolonged deferral of RRSP and other registered money can possibly lead you to a tax trap.” Large RRIF withdrawals can push you into higher tax brackets and even lead to OAS clawbacks. He advocates the idea of “topping up to bracket,” which means drawing RRSP or RRIF income up to the top of your current tax bracket starting after you retire but well before you turn 71.

A common rule of thumb is that you will need 70% of your pre-retirement income during retirement. This rule of thumb has many critics. Diamond’s position is more subtle. He says that while this rule of thumb “may have some application during the accumulation years, it is far better for you to be more specific about your own situation as you approach retirement.” However, he warns that “about half of those who are newly retired find that they end up spending more than they expected in their first two years of retirement.”

On fees, Diamond finds that “too many investors who choose to use an advisor are paying fees but getting little to nothing in exchange.” However, he softens his stance claiming that there are many “mutual funds providing higher, after-fee returns than comparable investments with lower fees.” All academic evidence says that funds with high past returns don’t tend to keep up the high performance. Mutual fund performance chasing of the type Diamond seems to be promoting is a losing game for most investors.

Diamond makes a strong case that most (but not all) people should take CPP early if they have retired early. His reasons include giving your assets more time to grow, but the most compelling reason to me is the survivor’s benefit. When one spouse dies, the other spouse gets a survivor’s benefit. But the total of this benefit and the survivor’s own CPP payments are capped. So, why delay CPP payments to boost the payment amount just to get capped later on?

Unfortunately, in a discussion of annuities, the examples don’t include any indexing. This gives an unrealistic view of annuity payouts. A payment that looks good when you’re 60 won’t look as good at 65 after 5 years of inflation. It will look much worse after a couple of decades of inflation.

A detail about RRSPs and RRIFs that I didn’t know is that if you are still under 71 and have turned your RRSP into a RRIF, “you have the option, should you wish to stop the income from your RRIF, to change it back to an RRSP.”

Diamond’s discussion of TFSAs is somewhat misleading on two points. He says TSFAs have “very flexible ‘in-out’ provisions—any withdrawals restore contribution room.” Those who know about TFSA penalties know that the room isn’t restored until the next calendar year. Freely popping money in and out is a formula for getting a letter from CRA demanding penalties.

“Contributions may be made to a spouse’s TFSA without attribution to the contributor.” This is true. However, if the money is pulled back out of the TFSA and invested in non-registered accounts, the new gains are attributed back to the original TSFA contributor.

“What people pay in management fees on their investments ... is often a minor issue compared to what they needlessly pay in taxes.” This just isn’t true. Both are important issues. However, paying an extra 1% per year in management fees can reduce retirement income by 25% or more. Even an egregious tax error such as failing to split a $60,000 income across both spouses reduces income by about 13%. Clearly, both management fees and taxes matter a great deal.

Diamond explains the problems with variable annuities and Guaranteed Minimum Withdrawal Benefit (GMWB) contracts, but goes too easy on them. A guaranteed minimum payout of 4% may sound reasonable, but it isn’t indexed. He does explain that the very high fees on your capital make it unlikely that payments will increase much, but then says “that does not mean that variable annuities aren’t good.” I’ve never seen a good one. They seem perfectly designed to hide huge fees and exploit people’s lack of understanding of the devastating effects of inflation over decades.

Diamond is positive about monthly income funds because “the capital value of the investments will fluctuate with markets but the number of units or shares remains unchanged.” This sense of not dipping into capital is often just an illusion. Many of these income funds not only don’t increase payments with inflation, but they have had to cut payments. Your account statement makes it look like your capital is intact, but the fund itself has been dipping into your capital to pay you each month.

Diamond believes people often need critical illness insurance and long-term care insurance throughout retirement. He says the “odds are nearly 50%” that you’ll need some form of long-term care. Doesn’t that mean the insurance company will have to charge a hefty premium? By the time you factor in the insurance company’s overhead and profit margin, the premium would have to cost about as much as the care itself. Diamond would have to provide some numbers for this to make any sense to me.

Despite my numerous criticisms of parts of this book, I’m quite happy I read it. I have found it challenging to decide on the best way to handle a portfolio through retirement, and Diamond has provided a good framework for working through the various issues. I recommend this book to those who will have to live in retirement on their own savings.

34 comments:

  1. An interesting set of comments, did not know about the RRSP->RRIF->RRSP under 71 trickery. A stable monthly income seems to be the Panacea that most folks want in retirement, but creating this without a pension might have you do things that in the long run hurt your overall financial world (yeh, sounds like financial baffle-gab to me too, but, does seem to be the case).

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    1. @Big Cajun Man: The business of turning a RRIF back into an RRSP was new to me as well.

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    2. Getting a stable monthly income out of regular investment assets is like getting stock-like returns out of bonds - the chances are not good. Annuities are the closest thing we have.

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    3. @Richard: Annuities give more stability at the cost of low income because they are based on current interest rates. What's worse is that most annuities are sold without any indexing for inflation, so people get duped into thinking the income is not too bad. Only after it's too late do they see the damage inflation can do.

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  2. Yes, this is one of the more valuable and informative retirement books out there.

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    1. @Dave: In some ways, I agree. But watch out for some contradictions. Diamond says that fees matter but then is very forgiving of products with high fees. He talks about the importance of considering inflation but leaves it out of consideration at a number of critical places.

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  3. This was an interesting and informative post as I am 56 and recently retired. I need to determine how I going to live off my investments so Diamond's book will be a good read

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    1. @Mark: Hopefully, this book can help you. A big area to be wary for a retiree who is only 56 is that Diamond's withdrawal rate recommendations are only really safe for 20 years or so. You need your money longer.

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  4. Michael,
    I see that Diamond and yourself recommend begin withdrawing RRSP money as soon as you retire. Do you have a post on this? I did a search and did not find one. I am interested in whether you did this on a specific case or some general basis so I can compare to my calculation. I am close to early retirement and have been mulling over this strategy. The calculation I have done shows that it is best (by not a large amount of value) for me to defer withdrawal until age 71, even if it does claw back some OAS. I used my retirement forecast spreadsheet (which handles taxes and OAS clawback among other things).Spreadsheet is on my blog at http://pabroon.blogspot.ca/
    Thanks
    Steve

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    1. @Steven: I haven't written about whether to draw down RRSPs as soon as you retire because I haven't figured it out yet. I've done a few simulations where it seemed like the right thing to do, but the results are very sensitive to the assumptions. For couples, it really matters how long until the first one dies (not fun to think about). If I ever think I've got some part of this figured out, I'll write about it.

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    2. Michael,
      I finally got around to doing the calculations myself. Like you, I had been thinking about it for a while. The results are as you suggested that for most people it is best to begin drawing RRSP at retirement, but my results show that maybe not as much as you draw from non-registered investments (accounting for assets in each). I have posted the results here: http://pabroon.blogspot.ca/2015/08/financial-studies-1-rrsp-withdrawal.html I look forward to any comments you may have.
      Steve

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    3. @Steven: After a very quick look, your spreadsheet looks thorough. I'm in the middle of an intense week helping to run the Canadian Little League Championships. I've made a note to myself to take a closer look hopefully next week.

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  5. I'm not an expert, but a couple of other considerations?

    - if you have a lot of rsp left when you die & it transfers to your spouse, they may become heavily taxed/clawed back (I think Diamond mentioned this??)

    - I think govt subsidized long term care near end-of-life is based on income (ie, rif) and not assets, so maybe better to have non-taxable investments rather than rif at that time, if you don't want your estate eroded

    do these make sense?

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    1. @Anonymous: Yes, Diamond mentioned these points. They definitely make sense.

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  6. I enjoyed Daryl's book as well. Read it a couple of years ago and have yet to post a review of it. I will try and do that later this year, add it to my list.

    The biggest takeaways for me from his book was his focus on winding down the RRSP before age 71, looking at strategies associated with that, and taking CPP as soon as possible - bird in hand approach. This makes sense to me since it helps those newly retired who more often than not, spend more money earlier in retirement than later.

    Good review Michael.
    Mark

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    1. @Mark: For my own situation I had doubts about the usual advice to delay draining RRSPs. It was good to see that someone else agrees (not that I have a problem being a lone wolf if I'm convinced I'm right :-)

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  7. I'm 59, wife is 56, both recently retired with non-indexed Co. Pensions. I will start drawing CPP later this year. Ran the numbers on RRSP withdrawals starting now to age 90 with 5% return and 3% inflation. Results show a nice flow of increasing income with the withdrawal amount at 71 slightly above Govt mandated minimum withdrawal. Seems like the best way to go for us is to start RRSP withdrawals now, take CPP at 60 to support Snowbird lifestyle while health is good. Using inflation when factoring in withdrawals from RRSP, TFSA and Taxable Investment account provides a nice increasing income stream until wife is 90. That's the plan.

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    1. @Bruce: The non-indexation of your pensions means your RRSP/RRIF withdrawals will have to rise faster than inflation (perhaps you already knew this). As long as your running of the numbers takes this into account, I'm optimistic this will work out for you.

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  8. This was a good post and of special interest to me as I am 56, recently retired and considering different options for living off my investments. I will buy Diamond's book. I don't have a company pension but I am also going to follow Bruce Wiebe's chosen path.

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    1. @Marko: Hopefully you're in for a long and healthy retirement. Be sure to choose a safe withdrawal rate. For someone in your situation, it may make sense to start drawing on your RRSPs now, but not entirely for spending. It may make sense to move some of the money into a TFSA. It all depends on your mix of asset levels in your accounts.

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  9. Thanks MJ - Perhaps you could do a future post on drawing down income from various accounts?

    For example, my investments are Vanguard and BMO ETF’s held in a 4 accounts – cash, TFSA, RRSP and a LIRA invested as follows:
    55% bonds ($386K), cash ($60K) and preferred shares ($58K)
    45% equities – 34% ($122K) allocated to Canadian equity
    66% ($247K) allocated to “all world equity”
    What is the best way to draw down my investments to fund my retirement?
    Should I move 50% of my LIRA into my RRSP?
    Should I then draw down the remaining 50% remaining in the LIRA?
    Should I put it all in a RIF now?

    I think I need to see a tax specialist!

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    1. @Marko: There are many similarities between your situation and mine. I haven't figured out my own best path yet, so I'm not in a position to tell you what to do. You ask good questions, but I don't know the answers. Certainly a tax specialist should be able to help.

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  10. Yes MJ, that is the conclusion I have come to as well. Now I just need to find a good fee based tax specialist

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    1. When you find one, let us all know,

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  11. Excellent review Michael. I am 56 and retired approx 15 months ago. I read Diamonds book about 2 months ago. Many of your comments/criticisms were things I "questioned" as well while reading-
    inflation affects, product costs, health insurance needs etc. You are able to articulate and calculate these better than I can however.

    My plan has been to withdraw from RRSP and LIRA first so am happy to see another proponent of that strategy. As well the part about taking CPP early is causing me to look seriously at this option for me and for my wife.

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    1. @RBull: As long as you're using RRSP and LIRA withdrawals in place of TFSA and non-registered withdrawals, this can be part of a tax-smart strategy for some people. I fear that some retirees may misunderstand the strategy to draw on RRSPs early and simply increase their spending to unsustainable levels. Good luck.

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  12. RBull- did you move 50% of your LIRA into your RRSP? Did you move your RRSP to a RRIF? That's my intended course of action.

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  13. I'm leaning toward delaying CPP benefits. The survivors cap doesn't affect my decision since the survivor'ss expenses will decrease. The downside of starting my pension early and living to a ripe old age seems a lot larger than me missing out on a few dollars early in my retirement that I really didn’t need anyway. I'm focusing on maintaining a comfortable retirement under various scenarios.

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    1. @Blitzer68: Each situation is different. I think my wife and I are likely to be slightly better off if we take CPP early, but it is a fairly close decision.

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  14. I am currently reading the book, and find it could be more clear on many points, especially the suggestion to take CPP early, and starting to withdraw money from RRSP's well before age 71 or age 65. I think he should have explained some things better in very plain language and provided some summaries of key points a the end of each topic, not each chapter.

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    1. @Anonymous: It's hard to convey everything in just one book; the real talent is to apply it all to a specific case.

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  15. Suggestion: Many of us need a tax expert to run some different scenarios, especially if one has a substantial investment portfolio, such as close to or over $1M. It would be good to have a list of truly good tax accountants/retirement experts we could consult. (Perhaps a list by city.) )

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    1. @Anonymous: I'd like to see such a list as well, but I don't know of one.

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  16. Thanks Michael. The bulk of our savings is in RRSP's and my LIRA so need to start withdrawing there and defer TFSA and unregistered. My wife has a good (but unindexed) pension that provides for all of our basic living costs, and our savings provides discretionary $. Govt pensions should help offset this inflation creep loss on work pension, and our plan captures any remaining shortfall of purchasing power. I am using a sort of actuarial approach with actual dollar withdrawal amounts (not %'s) by resetting annually based on actual capital at year end taking us to age 95. (I don't like simple set withdrawal assumptions like 3 or 4% as they don't factor in other changing factors such as govt pensions, reductions in withdrawals at older ages etc. I haven't been able to figure out why this approach shouldn't work but welcome feedback. We're also flexible with spending and will cut back withdrawals as needed/beneficial in bad market years.

    Marko, no I have not doing any transferring yet. I've had a fair bit of cash available since starting retirement so haven't actually started doing any RRSP withdrawals yet. My institution doesn't have fees for this on my account, so I will be keeping withdrawals to $5k at a time (but as often as I want) minimizing tax to 10% , and then pay the difference at filing time. Our situations are somewhat similar and my wife is also school teacher - but retired for 3 years now.

    That is a good suggestion Anonymous. If it were easy to find a reliable good tax professional I would certainly pay something to have recommendations on our situation.

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