Income splitting is often talked about in reference to high-income earners, but what about the average Canadian family? For high-income earners there are income splitting strategies like spousal loans or “income sprinkling”. Spousal loans are for families with lots of non-registered savings and a large difference in marginal tax rates between spouses. “Income sprinkling” can be used by families who own a corporation (although with the new TOSI rules has changed dramatically).
But what about your average Canadian household? Are there are income splitting options for them?
One very accessible type of income splitting is a spousal RRSP. Unlike other income splitting strategies this one is very easy to set up, it doesn’t require a lawyer, and it’s easy to understand.
The big benefit of a spousal RRSP is that the average family can use it to “equalize” their registered assets before retirement. This allows for a more equal distribution of income in retirement and a lower overall tax bill for a household.
In addition to lower income tax it also opens up more opportunities to maximize government benefits in retirement.
But you might be wondering, isn’t it possible to split income after age 65 anyway?
While its true that after age 65 income splitting is much easier to do, it’s still a best practice to try to equalize registered assets before age 65. This allows for the maximum flexibility when creating a retirement drawdown strategy, especially when retiring early.
Equalizing registered assets can be extremely beneficial, especially before the age of 65 when there are fewer income splitting opportunities, for this reason we sometimes want to look at using a spousal RRSP to help split income in the future.
Having an emergency budget is not a new concept, it’s something we’ve written about before, but for retirees it’s particularly important.
An emergency budget is a slightly reduced budget that can be executed in times of uncertainty.
For retirees, “uncertainty” is at its highest during a recession, when investment assets have drastically reduced in price. But “uncertainty” could also be high during a long periods of below average investment returns, stagnate economic growth, or high inflation rates.
Emergency budgets are important for retirees that rely on investment assets to fund part of their retirement spending.
Often, retirement projections are done using an average rate of return. This provides a nice pretty graph but doesn’t accurately represent the range of investment returns retirees may experience in retirement.
Variable investment returns are one of the largest risks a retiree will face. A period of low or negative investment returns early in retirement can be devastating to a retirement plan. This is known as sequence of returns risk. The sequence in which a retiree experiences investment returns can have a big impact on their retirement plan. A series of low or negative investment returns early in retirement can have a very negative effect.
One important way to counteract the effect of sequence of returns risk is to reduce the draw on investment assets during periods when stock market returns are low and/or negative for a period of time.
Reducing the draw on investments, even by a small amount, helps increase the success rate of a retirement plan.
There are a few important factors when creating an emergency budget.
When it comes to retirement planning, one of the biggest fears is often the risk of running out of money. It can be worrisome to think about what could happen if you’re unable to support your expenses in the future.
Sometimes these fears can lead to people choosing a more conservative risk profile, or holding a lot of cash, but taking these defensive measures can often increase the risk of running out of money in the future.
A more conservative asset allocation decreases market risk, the risk we take on when we invest in the stock market. But a conservative asset allocation actually increases other types of risk, like the risk of running out of money, or the risk of being impacted by high inflation rates.
A more conservative asset allocation can actually increase risk in retirement, especially for longer retirement periods. Your typical 30-40 something couple has a very good chance of either one making it to age 100+ in the future. There is a 25% chance that one of them will make it to age 98 and a 10% chance that one of them will make it to age 101!
Without making other changes, like a lower withdrawal rate, more flexibility with spending, part-time income etc, being more conservative can actually lead to a much higher probability of running out of money before age 100.
Let’s explore why this is the case and what you need to consider when creating your retirement plan…
Low-income retirement planning requires a very different set of tools than your average retirement plan and this can sometimes lead to trouble when a soon-to-be low-income retiree gets advice that has been tailored for someone with a much higher income.
What we need to consider for a low-income retiree is very different than for your average retiree and the recommendations in a low-income retirement plan can sometimes be the opposite of a regular retirement plan.
The drawdown of investment assets, the timing of CPP and the timing of OAS are among many factors that differ in a low-income retirement plan.
When it comes to low-income retirement planning we’re primarily concerned with one thing, government benefits. We want to ensure that the way we save pre-retirement and the way we create income after retirement does not impact the amount of government benefits received.
This can be very tricky and can often lead to some less than obvious recommendations.
Before we get into some ideas to consider around low-income retirement planning lets look at why government benefits are the main consideration.
Are most people taking CPP early or late? Delaying CPP can have many advantages (and a few downsides). Delaying CPP to age 70 can see monthly CPP benefits increase by over 220% vs benefits taken at age 60.
Delaying CPP provides a lifelong inflation adjusted pension, and for those with no defined benefit pension this can be very appealing.
But as it turns out, very few people choose to delay CPP to age 70.
So, if delaying CPP has so much appeal, why aren’t more people choosing to delay?
In the analysis below we’ll see that the vast majority of people are taking CPP at or before the age of 65. Using these statistics for CPP starting age we’ll see that very few people choose to delay CPP past age 65 and only a very small percentage choose to delay all the way until age 70.
If delaying CPP to age 70 has so many advantages, why are most people choosing to take CPP early?
Over the last few years the number of low-cost investment options has exploded in Canada. There are new and easy ways to create a low-cost diversified portfolio that isn’t dragged down by high investment fees.
There were always low-cost, do it yourself options, but they required a fair amount of manual work to make contributions, invest those contributions, and rebalance periodically (and let’s not forget, the stress of keeping yourself on course during a correction or recession).
But now there are new options available. In addition to a low-cost ETF portfolio or a low-cost mutual fund portfolio, there are options like low-cost “all-in-one” ETFs and low-cost robo-advisors.
These new options provide investors with new ways to invest in a low-cost portfolio without necessarily doing all the work themselves.
This has understandably put a lot of pressure on investment advisors who have historically charged extremely high fees on the investment products they sell.
The average investment fee on a mutual fund portfolio in Canada is around 2.3%. This can cause an enormous amount of drag on an investment portfolio. A $1,000,000 investment portfolio would experience a $23,000 annual drag from investment fees! That has a direct impact on how much retirement income you can create from your investment portfolio.
But switching from a high-priced mutual fund portfolio can be hard to do.
Even with the high fees, traditional investment options continue to dominate the investing landscape in Canada, but things are starting to change. For the first time ever, ETFs have outsold mutual funds. More money is flowing into ETFs than into mutual funds (bear in mind that you can also have high-priced ETFs, and low cost mutual funds, so this isn’t necessarily the best indicator).
But… if these low-cost investment options have been around for a while, why the slow change? Why aren’t more people switching?
There are three main risks people face when making a change of this kind, financial risk, emotional risk, and social risk. These risks can be difficult to overcome. Let’s understand each one and why they make breaking up with an investment advisor hard to do…