This is a guest post by invitation, from financial planner Graeme Hughes…
During the course of my financial planning career, I was privileged to help hundreds of families work to achieve their financial goals. Talking to families about what they really wanted in life, and how they planned to go about getting it, was by far the best part of the work. And I can honestly say I enjoyed every single conversation.
My clients had many different approaches to managing their finances; from full-on do-it-yourselfers, to the completely disinterested. But among all these families, I noticed there were some significant difficulties that arose time and time again. Although these are all fairly fundamental issues, it was surprising to see how often they were either ignored or, at a minimum, inadequately considered.
They are all challenges that can be successfully managed with some attention and, in many cases, good advice from a qualified professional. Identified here are three in particular that I frequently had to address.
The most common investment mistakes.
RRSPs Are A Two-Sided Transaction – Plan Carefully
One of the most common mistakes I saw was with regard to RRSP contributions. So often investors make RRSP contributions almost out of force of habit. What they have on their mind, of course, is that nice tax credit their RRSP contribution is going to generate for them. What rarely comes to mind is the impact that taking income from the RRSP will have once they are retired.
That causes issues for two groups of people: those who retire wealthy, and those who retire with very modest pension incomes. But for both groups, the issue is the same: you end up saying “no thank you” to money from the Government of Canada so that you can spend your own instead. This is just bad planning.
For wealthy retirees, I think it’s fairly well known that you can over-contribute to your RRSPs. Having large RRSPs along with healthy pension income can trigger clawbacks of Old Age Security payments, disqualify you for some tax credits, and can push you into an unreasonably-high income tax bracket.
What’s less well-known is the impact RRSPs can have on lower-income seniors, particularly those retiring with only the Canada Pension Plan (CPP) and Old Age Security (OAS) amounts for pensions. In many cases these seniors would also get the Guaranteed Income Supplement (GIS), which is an add-on benefit to the OAS. However, the GIS is an income-tested benefit and RRSP withdrawals absolutely count as income for this purpose.
So often I have seen seniors withdrawing from their modest RRSPs in retirement while not realizing that, had they not been making those withdrawals, they would have been receiving valuable GIS benefits rather than drawing down retirement savings. By better allocating their resources prior to retirement they could have greatly improved their overall retirement picture.
Even for wealthier retirees with substantial savings but no employer pensions, it is possible to obtain 7 years of GIS benefits by drawing down TFSAs or savings between age 65 and 71 and letting the RRSPs grow until mandatory withdrawals start at age 72. Those benefits can be worth tens of thousands of dollars and should absolutely be taken into consideration when planning for retirement.
Getting the most from government programs, and ensuring you are minimizing your post-retirement tax burden takes careful retirement income planning. This planning should start well before retirement and input from a trusted professional can be invaluable.
Managing Your Pension May Require More Expertise Than You Realize
Of course, many Canadians are fortunate enough to have an employer-sponsored, defined-benefit pension plan which helps immensely when it comes to being financially prepared for retirement. But an important decision often has to be made when you either quit your employer or retire: do you stay in the pension plan or commute the value to an RRSP?
The allure of that big, lump-sum transfer to your RRSP can be hard to resist. For many, the decision to commute the value of the pension is made on that basis alone. What many fail to appreciate is that this decision can have a huge impact on where you end up in retirement. Choosing poorly can be very expensive.
There are many factors that come into play when assessing whether a pension transfer makes sense. One of the first considerations is the health of the plan itself. In one town I worked in, there was a forestry company that was the major local employer and was facing significant economic challenges. At one point they issued an ultimatum to all of their long-tenured employees and retirees: they could commute their pension now and received 65% of the value they were entitled to as payment in full, or they could stay in the plan with the understanding that if the company became insolvent they would possibly lose everything. That’s a pretty tough choice to face and highlights the reality that not all pensions are created equal.
Besides the health of the pension, the decision to commute or remain in the plan is also impacted by the rate of return needed in an RRSP to equal the benefits provided under the pension. Especially with pensions for government employees, sometimes an individual investor would need very high and very consistent returns in order to match the fully-indexed benefits of their pension plan.
Further, many pension transfers involve an “excess amount” under CRA rules that will be fully taxed at the time of transfer if the employee has insufficient RRSP contribution room to shelter it. This up-front taxation pushes the required return even higher since the whole amount of the commuted value cannot remain tax sheltered.
Beyond these larger issues are considerations of marital status, estate plans, longevity, investment process and risk tolerance, along with the structure of other income streams and assets during retirement.
Optimizing a large and valuable pension to provide the most benefit to you in retirement is a complicated matter with many factors to carefully consider. Insights from a trusted professional can help ensure that your decision works in the best way possible for your individual circumstances.
End Of Life Issues Are Not About You
This last challenge is one that is near and dear to my heart. I cannot tell you the number of families I have worked with that have been torn apart when Mom or Dad has passed away. In many cases, the hurt and the destroyed relationships that resulted did not have to happen.
I want to make this very, very, clear: end of life planning is NOT about you. It is about your family and those closest to you. It is something you take care to do well for their sake. Not yours.
Not having well-prepared emergency and end-of-life arrangements is irresponsible, no matter what age you are. Having a properly-considered and well-written Will, Power of Attorney and/or Representation Agreement are critical. Do not try to do this yourself or use a cheap kit from the local drug store. Both the planning and the law behind these issues are complicated and they change materially from province-to-province.
I have personally seen documents rejected by the courts because they simply did not lay out intentions in a clear enough way that they could be confidently interpreted.
When this happens, it’s left up to the family to arrange a committeeship (in the case of incapacity) or apply to the courts to be appointed executor of an estate. These processes can be expensive and time consuming and only add stress to an already difficult situation. Further, dying without a useable Will means your assets will be distributed according to a pre-determined formula enshrined in provincial legislation. That distribution may or may not meet the needs of your family.
Aside from having appropriate planning completed, my strongest recommendation is to communicate those plans with those who will be impacted: your executor, your immediate family and any significant beneficiaries. Ideally, when the time comes, your Will should not contain any surprises for the people that are important to you. Certainly, at a minimum, no one should be in the dark about the role they are being asked to play as either an appointed representative or executor.
Qualified Experts Can Be Worth Every Penny You Pay
I am a huge believer in do-it-yourself investment management. Managing a portfolio does not need to be excessively difficult and the fee savings over professional management are significant.
However, as shown above there are peripheral issues that arise where paying for qualified help can greatly improve your outcomes. On your way to meeting your financial goals, don’t underestimate the value that a good accountant, lawyer, and even financial planner, can bring. Don’t be lured into paying for services you don’t need, but don’t hesitate to pay for those you do. You may be surprised at the difference it makes.
Graeme Hughes is an accredited Financial Planner with 23 years of experience in the financial services industry. During the course of his career he completed hundreds of financial plans and recommended and sold hundreds of millions of dollars of investment products. He believes that financial independence is a goal anyone can aspire to and is passionate about helping others to live life on their own terms.
Note: Graeme also operates the wonderful blog The Money Geek.