There are a number of personal and financial benefits when owning a home. There is the stability, the forced savings of mortgage payments, the potential for appreciation etc. etc. But there are two somewhat less obvious benefits of owning a home.
These benefits will help homeowners financially, both before retirement in the accumulation phase and also after retirement in the decumulation phase. These benefits will make it easier for homeowners to achieve their financial goals, decrease taxes, and minimize government benefit clawbacks.
In this post we’re going to explore two, perhaps hidden, benefits of owning a home.
There are a lot of risks that we face in retirement (including early retirement). When you enter retirement, there are lots of changes happening all at once. Along with big personal changes, and lifestyle changes, there are also big changes happening to your finances. After you enter retirement one of the biggest financial changes you’ll face is a shift from a regular income source (eg. employment) to an income source based entirely on your own savings and pension. Making this switch can create a few risks, one of those risks is the risk of running out of money.
One of the biggest risks facing retirees is something called sequence of returns risk. When a good portion of your retirement income comes from your own savings this is the biggest risk a retiree can face. But what does “sequence of returns risk” mean exactly?
Before we talk about sequence of returns risk it’s important to understand that most retirement plans are based on an assumed (and constant) investment return each year. This investment return is usually assumed to happen in a straight line with the same percentage return each year. An assumed return of return of 5% would be 5% per year starting on the day you retire, but in reality your investment return is going to fluctuate from year to year, and this is where the risk comes from.
Over the short-term you will probably see your investment return fluctuate greatly from year to year. Instead of seeing investment returns of +5%, +5%, +5%, +5%, +5%, you might see +20%, +2%, -10%, +15%, +1%. In this case the average return is still +5%, but there were some huge swings from year to year. “Sequence of returns risk” refers to this sequence, the actual investment returns you see year after year.
The big risk for retirees happens when the sequence is negative for a few years in a row. Even if average investment returns recover over the long-term, that short period of negative returns can have a devastating effect on a retiree’s portfolio.
Did you know that the Canada Pension Plan (CPP) is getting bigger? Every year since 2019 CPP has been expanding and it will continue to expand for the next 40+ years until 2065. By the end, CPP will be HUGE!
CPP is an important retirement benefit. The old “basic” CPP aimed to replace 25% of pre-retirement employment income. The expanded CPP will increase this amount to 33.33% and will cover a larger amount of pre-retirement of income. The result is that CPP will be over 50% larger in the future.
If we follow the rule of thumb* that suggests that we need 70% of pre-retirement income in retirement, then for the average Canadian the new expanded CPP could provide nearly half of retirement income in the future. When combined with OAS this means that over half of retirement income could be covered by CPP and OAS combined.
*Rules of thumb are terrible, I hate them, find out why here.
In this post we’ll look at the current maximum CPP payment, the maximum CPP contribution, the current contribution rate, and how these will change in the future as CPP expands. We’ll also look at how the current “basic” CPP will grow by over 50% in the future…
No financial plan is immune from risk. No amount of planning is going to eliminate risk entirely. In fact, there are many common risks in a financial plan that may cause issues down the road. What we need to do is identify what types of risk a financial plan may face and find ways to reduce risk or mitigate it where possible.
When we talk about risk we naturally assume that means investment risk. While this is one common type of risk, there are also many other risks we need to watch out for.
A lot of these risks can be reduced or sometimes even eliminated with proper planning. For each major type of risk below, we’ve highlighted a few ways to help mitigate the impact it may cause. But even with these tips, its usually impossible to eliminate risk entirely.
A financial plan will typically cover 30-50+ years. Over this time span there are many unknowns that may occur. A good financial plan will be flexible enough to absorb these unknowns and still be able to reach the same goals with only minor tweaks.
This flexibility is important. It’s impossible to eliminate all risk. It’s very likely that even the best laid plans will experience some disruption along the way. Having some flexibility, and knowing where that flexibility exists, will help reduce the stress and impact if the unfortunate were to happen.
Retirement spending is one of the most important assumptions in a retirement plan. Making the right retirement spending assumption can make the rest of a retirement plan much easier. Making the right assumption can also make a retirement plan much more successful.
Making the wrong retirement spending assumption however could mean running out of money in retirement, or it could mean working longer than necessary, or it could mean accumulating millions of dollars late in retirement. All things we would prefer to avoid.
Of course, there are some simple “rules” for retirement spending like assuming 70% of pre-retirement income, but given how important retirement spending is in a retirement plan these generic rules can lead to issues in the future.
When creating a retirement plan it’s important to make the right retirement spending assumption. This means avoiding generic rules and instead understanding your unique spending needs today and how they might change in retirement. This also means understanding the impact of being wrong with your retirement spending assumption and how doing a “trial run” of retirement spending can help improve the level of confidence you have in your retirement plan.
Marginal tax rates are important. The represent the income tax you pay on the next dollar of income. Knowing your marginal tax rate both now and in the future can be extremely helpful when doing tax planning.
One tax planning opportunity is to make an RRSP contribution in a high tax bracket and withdraw later in a lower tax bracket. This opportunity can help defer tax until retirement when RRSP withdrawals are made at a lower tax rate. Ideally, an RRSP contribution allows you to contribute at a high marginal tax rate and withdraw at a lower marginal tax rate in the future.
This difference in tax rates can lead to a lot of tax savings. Contribute at a 40% tax rate now and withdraw at a 20% or 30% tax rate in the future and for every $1,000 that goes into an RRSP there is $100 to $200 in tax savings over a lifetime. Expand that to tens or hundreds of thousands of dollars of contribution and you can begin to see the incredible opportunity that a bit of tax planning can create.
But what if your marginal tax rate in retirement isn’t quite what you think it will be? What if its higher than you think? What if the typical marginal tax rate tables are missing something? You might be underestimating your future marginal tax rate in retirement.
In this post we’re going to explore a tax credit called the Age Amount and in particular the way that the Age Amount is reduced (or clawed back) based on income in retirement.
We’re also going to explore how this may affect your marginal tax rate in retirement. As we’ll see, the marginal tax rate you’re planning for may not be the marginal tax rate you actually experience in retirement.