Monday, December 11, 2017

Biggest Mistakes Retirees Make with Their Investments

I was reading an interesting article by Jason Heath titled Here are the six biggest mistakes retirees make with their investments. It made me think, but one of my thoughts isn’t what you might expect.

I don’t want to pick on Jason because he’s a good guy who provides solid information in his articles. Like other Certified Financial Planners, Jason works primarily with wealthy people. Now, the definition of wealthy is different in each person’s mind. A person with a million dollars in investible assets might say the threshold of wealthy is $3 million. Someone with $3 million might say the threshold is $10 million. However, the typical Canadian would call the clients of CFPs wealthy.

Jason’s thoughtful list of the most common mistakes he sees is based on his client base and not the typical Canadian. To be fair, it’s unlikely Jason wrote his own headline, and it’s the headline that I think is wrong.

Here are a few of the biggest financial mistakes Canadian retirees have made:

Saved very little money.

Carried debt into retirement.

“Bought” RRSPs at the bank a few times, but cashed them out years ago.

For those of us who have built significant savings before retirement, I highly recommend Jason’s article to see if you’re guilty of some common mistakes. Maybe you’ll learn something profitable.

Friday, December 8, 2017

Short Takes: Shorting Bitcoin, Financial Survival, and more

Here are my posts for the past two weeks:

Finance for Normal People

Should You Delay Taking CPP and OAS?

Leaving a Spouse to Pick up the Pieces

Here are some short takes and some weekend reading:

New securities will make it possible to short bitcoin. This is very tempting, but I have to consider the possibility that some government or major set of banks might choose to back bitcoin. I certainly don’t think this is likely, but it’s enough to stop me from shorting bitcoin.

Jason Zweig interviewed Peter L. Bernstein. An important quote: “Survival is the only road to riches. You should try to maximize return only if losses would not threaten your survival and if you have a compelling future need for the extra gains you might earn.”

John Bogle offers 7 rules of successful investing.

Dan Bortolotti answers a question about fees for moving assets out of a brokerage. Will the new online brokerage cover these fees?

Ted Rechtshaffen explains “two major [conflicts of interest] that every consumer should be aware of, and I believe regulators should focus on”: one for financial advisors and the other for insurance brokers.

Big Cajun Man is looking into how much he can save in taxes with pension income splitting.

Monday, December 4, 2017

Leaving a Spouse to Pick up the Pieces

I’ve been helping an elderly relative sort out her finances and other matters since her husband died. I’ll call them Carol and Bob. This experience has made it very clear to me that both spouses need to at least be able to locate a record of account numbers and institutions, including banks, insurance companies, and utilities.

For the first year or so after Bob’s death, a friend of Carol’s tried to help. They found a few paper bank statements, and wandered into branches asking for help locating all accounts. They were ultimately able to find several accounts and were able to get some of Bob’s accounts into Carol’s name.

By the time I took over, I still had to get one of Bob’s TFSAs into Carol’s name, cancel some of Bob’s monthly automatic bank account payments, and get titles on the house and car fixed. It’s been months now and this is still ongoing.

Of course, there have been many other things to sort out, but the most painful tasks involve doing battle with large organizations like banks, insurance companies, and the government.

One outstanding item is a joint investment account at BMO Nesbitt Burns. The only records I have show it holding about $40k a year before Bob’s death. I have no record of its contents being transferred anywhere, but Carol isn’t getting any more account statements mailed to her. After a frustrating series of calls to BMO Nesbitt Burns, I found out they consolidated small accounts into a lower-service arm of the company. After that the trail went cold and all promises to call back with information have been broken. So, either Bob cleaned out this account shortly before he died, or it still exists somewhere but only has online statements. It’s very frustrating that BMO Nesbitt Burns is unwilling to tell Carol whether the account still exists. Given Carol’s modest income and bank account balances, she could really use the money.

A lot of pain could have been avoided if Bob had either made Carol pay attention to the finances, or had at least left an up-to-date list of institutions, account numbers, and other contact information.

Friday, December 1, 2017

Should You Delay Taking CPP and OAS?

The default age to start collecting Canada Pension Plan (CPP) payments is 65. However, you can start anywhere from age 60 to 70. Less well known is that you can delay collecting Old Age Security (OAS) payments until age 70 as well. There are incentives for delaying these payments, and it’s not easy to decide whether to take lower payments early or wait for larger payments. Here I do an analysis that helped me make up my mind.

OAS

Let’s start with OAS because it’s simpler. The default starting age is 65. However, your payments increase by 0.6% for each month you delay starting to take OAS before age 70. So, if you wait until age 70, you’ll get $1.36 for every dollar you would have received when starting at 65.

It’s important to understand that these amounts are indexed to inflation. Some people mistakenly believe that someone starting to collect at age 65 would have his payments catch up to the amounts received by someone taking OAS at age 70. This is not true.

Consider the example of twins Alice and Carol. Alice plan to take OAS at age 65 and Carol plans to wait until she is 70. Suppose Alice will initially receive $600 per month, and by the time she gets to 70, inflation indexing will increase her payments to $700. At the same time Alice is getting $700, Carol’s payments will be

$700 x 1.36 = $952 per month.

For the rest of their lives, Carol will always get 36% larger payments than Alice will get. This compensates Carol for receiving nothing for 5 years.

If we ignore income taxes for the moment, we can calculate the return Carol gets on her “investment” of 5 unpaid years. This return depends on how long Carol lives. The longer she collects the larger payments, the better her investment looks. A chart below (after the discussion of CPP) shows the rate of return Carol gets depending on her age of death.

A complicating factor is income taxes. If your income is high enough, some or all of OAS payments get clawed back. People with high enough incomes that they are subject to a clawback require a more complex analysis. However, the more income you have, the less important the relatively small OAS payments are to you. For our purposes here, I assume that you will not be subject to any clawing back.

Another complicating factor for low-income people is the Guaranteed Income Supplement (GIS). My analyses here don’t apply to someone whose income is low enough to collect the GIS.

CPP

The CPP case is similar to OAS, but with more complications. The default age to take CPP payments is 65, but you’re allowed to start taking payments at age 60. The price is a 0.6% reduction for each month you start early. This means that you get 64 cents on the dollar if you start at 60.

You can delay taking CPP past age 65 as well. For each month you delay from 65 to 70, your payments increase by 0.7%. So, you get 142 cents on the dollar if you wait until age 70. Similar to OAS, all these amounts are indexed to inflation. If you start early, you never catch up. The boost in monthly payments from delaying the start of CPP is permanent.

A complication with CPP is that your payments depend on your history of paying into the system. There are complex dropout rules where you don’t have to count years where your income was low. I looked at two scenarios:

CPP Scenario 1: You worked steadily enough from age 18 to 60 that you get no advantage from any dropouts, and you can drop out all the years from age 60 to 70 that you don’t work.

CPP Scenario 2: You had 7 or more years with no income from age 18 to 60 and you didn’t work past age 60. You couldn’t use any of the other special dropout rules, such as looking after children under 7.

The following chart shows the real return (the return after subtracting inflation) from delaying CPP from age 60 to 70 depending on your age at death. It also shows the real return of delaying OAS from age 65 to 70.



Analysis

CPP scenario 1 is close to a best-case for delaying payments. It can get a little better if you work past 65 and use those years to replace some lower-income years. CPP scenario 2 is close to a worst case. It can be made worse if some of the special dropouts are relevant to you, but most people fall somewhere between these two scenarios.

To understand this chart, it’s important to have a sense of what levels of real returns are high and low. Historically, 5% or 6% was what a diversified 100% stock portfolio with no costs received. More realistically from today’s high stock and bond valuations, even a 4% real return is high for a disciplined do-it-yourself investor who incurs very low costs and is 100% invested in stocks. If there is a fixed-income component, this drops to 3%. Those who have a non-fiduciary financial advisor and pay mutual fund MERs might hope for 1% to 2%. Anyone whose accounts get churned will get less, whether this churning comes from impulsive client decisions or unethical advisor actions.

Armed with this information, we see from the chart that delaying CPP and OAS doesn’t look good if you don’t make it to age 80. But they look very good at 90, and fantastic if you make it to 100.

But we don’t know how long we’ll live. So, it seems we’re no closer to an answer. I focus on making it to 100 for the simple reason that I know I’ll have enough money if I die young. It’s the possibility of living long that limits my spending today.

I have enough savings to fill the gap before I’m 70. In fact, having a definite age where significant new income arrives makes it easier to plan for a portion of my portfolio to last until I’m exactly 70. Guaranteed real returns over 5% look excellent to me, so I’ll be delaying CPP and OAS to age 70.

Objections

I don’t want to work until I’m 70.

Neither do I. I don’t even plan to work until I’m 60. You don’t have to start collecting CPP the day you stop working. As long as you have the savings to last until you’re 70, you can delay taking CPP and OAS.

I want to spend some money while I’m young enough to enjoy it.

Me too. In fact, delaying CPP and OAS helps me spend more money today. By making my future income more certain, I can safely spend more of my savings before I turn 70.

Won’t a higher CPP payment mean I’d get a smaller CPP survivor pension?

The total of your CPP payments and a survivor’s pension are subject to a maximum. However, the calculation makes adjustments to nullify the effects of taking CPP early or late. See Doug Runchey’s explanation of CPP survivor benefits for all the gory details.

I read that taxes and the desire to leave an inheritance can affect this decision in many ways.

That’s true. But it’s mostly true for the rich. Skilled financial planners mostly deal with wealthy people and write about their concerns. These are the people who are trying to figure out how they can spend $11,000 per month instead of just $10,000. People who have to get by on less have simpler choices to make.

The thought of dying before age 70 and getting nothing for all my CPP pay deductions drives me insane.

Try to focus on the fact that if you live long enough, the government will pay you more than they expected.

Everyone in my family dies young.

If you’re absolutely certain you won’t live to old age—so certain you have no intention of planning for it at all—then take CPP and OAS early. However, if you think living past 85 is a possibility, consider delaying CPP and OAS.

A bird in the hand is worth two in the bush.

We’re wired to make decisions that are good in the short term. Fortunately, a sequence of good short- to medium-term decisions usually leads to acceptable long-term results. However, CPP and OAS are cases where our tendency to take money now often doesn’t lead to the best long-term outcome.

Conclusion

It’s certainly not the case that all people should delay CPP and OAS until they’re 70. However, many who take CPP and OAS as early as possible would be better off waiting for larger payments.