I mentioned we are building a new house, which we hope will be finished by spring 2023.
It was a stressful time to sign a purchase agreement with a builder. We wanted to arrange our financing so that the new house purchase was not contingent on us selling our existing home (been there, done that, rented for 90 days in-between, and it sucked).
Meanwhile, with inflation soaring (including building materials and labour), there was risk for the builder if they priced their quote too low.
The builder wanted a quick decision to lock in the quoted price, but we had to refinance our existing home to expand our home equity line of credit and then apply for a new builder (draw) mortgage. Oh, by the way, we had a three-week trip to Italy booked during all of this.
I’ll spare you the details, but it involved a late night Zoom call with our lawyer from an Airbnb in Florence, followed by a frantic trek to find a pen(!), a printer, and a Mail Boxes Etc* to get the documents couriered back to Lethbridge in a hurry. Good times!
*“Etc” doesn’t include printing, apparently.
We got everything set up the way we wanted and the house build is moving along nicely. Now the stressful part is dealing with rising interest rates and the potential for our existing home to fall in value before we sell it.
With a draw mortgage, we put down an initial deposit and then have a progressive schedule of deposits as the house nears completion. We plan to use our own funds (TFSAs) for the first 1.5 deposits and then dip into our existing home equity line of credit for the next 1.5 deposits, before tapping into the new builder mortgage for the remaining draws.
Unfortunately, the interest rate on our line of credit is now at 4.70% and should at least rise another 0.50% before the end of the year. Our draw mortgage is also variable at 3.80%, so that will rise in lock-step with any rate hikes.
We’re only charged interest-only payments until the house is completed and the full amount drawn. Then we can renew into a new fixed or variable rate mortgage without penalty.
So, we find ourselves in mortgage rate limbo for the time being. The planner in me wants to know exactly what our costs are going to be so I can determine our spending plan for 2023 and beyond.
My hope is that inflation gets under control, the rate hiking cycle ends this fall, and that housing prices steady and potentially find new life in the spring when we’re ready to sell our existing home.
I’ll then continue my strategy of renewing our mortgage into the best of either a five-year variable with a deep discount off of prime, or a 1-2 year fixed rate if a big variable rate discount isn’t available.
By the way, my go-to mortgage resource (Rob McLister) at MortgageLogic.news says the value zone for mortgages right now is still the 1-year fixed rate while we wait for this rate hiking cycle to sort itself out. Makes perfect sense to me.
In the meantime, I’m planning with the assumption that we’ll sell our house for 10% less than appraisal. I’m assuming the interest rate on our new mortgage will be 4.94%. And, I’m assuming a ~50% downpayment on the new house after we sell our existing home.
That leaves us with some wiggle room for landscaping, realtor fees, moving costs, and any other extras we can think of. If all goes according to our conservative plan, we’ll still have some money left over to tuck back into our TFSAs to start filling up those accounts again.
This Week’s Recap:
Many thanks to The Globe & Mail’s Erica Alini for highlighting my post on how I invest my money in a recent Carrick on Money newsletter (Erica is filling in for Rob Carrick while he’s on holidays).
That article was also mentioned in this Financial Post piece on what advisors are doing with their own portfolios.
And, it was great to be back on the Build Wealth Canada podcast with Kornel Szrejber as we discussed workplace pensions. We talked about how to invest if you have a defined benefit pension, and how to take advantage of a defined contribution pension plan, among other things.
Here on the blog, I wrote about whether you should consider moving your portfolio when it’s down.
I also explored whether you should postpone retirement amid high inflation and depressed stock and bond prices.
Finally, I explained what the retirement risk zone is and how it might prevent retirees from wisely delaying their pension and government benefits.
Weekend Reading:
Speaking of government benefits, OAS payments have risen permanently for the first time since 1973. Here’s why retirees should defer them.
On the housing front, Rob McLister offers some clues as to when Canadian home prices may bottom (subs).
Here’s a trifecta from the excellent Morgan Housel:
- How gold fish and tech companies are related (little ways the world works).
- Three rare and powerful skills.
- Why an asset that you don’t deserve can quickly become a liability.
The latest episode of the Rational Reminder podcast explored the expected returns from using a factor-tilted portfolio. Factor-tilts would include small cap and value stocks:
Compelling stuff, but I maintain my argument that most investors should avoid complicated portfolios and stick with total market index funds.
A Wealth of Common Sense’s Ben Carlson tries to make sense of this year’s wild stock market ride.
Of Dollars and Data blogger Nick Maggiulli looks at the pros and cons of a Die With Zero approach to spending.
The Department of Finance has now released details on the new First Home Savings Account to launch “at some point” in 2023.
Finally, a great piece by Tim Kiladze on how Canopy Growth, the star of Canada’s cannabis dreams, fell from grace (subs).
Have a great weekend, everyone!
Many years ago, my boss (Jerry) was all set to retire at age 58 when the federal government decided to impose a tax on the distributions of income trusts and royalty trusts. He was heavily invested in the energy sector – in oil royalty trusts with a history of generous payouts thanks to years of special tax treatment. Share prices of the trusts dropped immediately following the announcement and distributions were slashed as income trusts converted to conventional corporations.
Jerry decided to postpone retirement – to keep working and give his investments time to recover (though many never did). He worked two more years before leaving the hotel. I ran into him several months later at Home Depot, where he had picked up a couple of shifts a week to keep himself busy. Part of me wondered if he still needed the income to help fund his retirement.
Many soon-to-be retirees may be wondering if they should postpone retirement after markets crashed earlier this year and we’re (still) faced with high inflation and the possibility of a recession.
Related: Your Retirement Readiness Checklist
Stocks and bonds just endured one of the worst six month periods in history from January 1 to June 30, 2022. The S&P 500 was down 20.47%, while Canadian stocks were down 9.86% and Canadian aggregate bonds were down 12.33%. Stocks and bonds have shown a modest recovery since then (as of this writing) but a balanced portfolio is still down about 10% year-to-date (Aug 11th, 2022).
If you had planned to retire this year, or even in the next three years, your portfolio has been dealt a significant body blow. Is it enough to alter your retirement plans?
When to Postpone Retirement
My former boss Jerry had his entire retirement portfolio invested in income trusts and dividend stocks. His retirement income plan was to live off of those distributions. That changed in a hurry during the “Halloween Massacre” when then Finance Minister Jim Flaherty announced changes to the taxation on income and royalty trusts. Share prices fell, and distributions got cut in half or were eliminated entirely.
Are you nearing retirement, with the majority of your portfolio invested in dividend paying stocks and REITs? Are you expecting to rely on income from these investments to fund your retirement?
Let’s assume your portfolio is down 10-20%. That’s okay, right? As long as those dividends keep rolling in. Just remember that while dividend cuts are rare, they do happen from time-to-time.
There’s no doubt investors nearing retirement have been impacted by stocks and bonds falling in 2022. This is precisely why I advocate for a safety cushion of cash that includes one or two years worth of spending money in your bank account, and the remainder of your retirement funds in a risk appropriate investment portfolio (preferably low cost ETFs). Conservative investors with sufficient resources may also opt to hold another 3-5 years worth of spending in GICs.
But that’s not helpful to you today if your portfolio is down and you don’t have a cash cushion to fall back on. That’s like telling someone who just got laid off that he or she should have had an emergency fund. Thanks, Captain Obvious.
While not a desirable solution, postponing retirement does offer a trifecta of benefits for soon-to-be retirees whose portfolios have been decimated by the recent market crash:
- You’ll have more time to earn income and save for retirement
- You’ll have fewer years of retirement withdrawals, thus extending the life of your portfolio
- Your investments have more time to recover, which also gives you time to build your safety cushion of cash and GICs
Perhaps a more desirable solution is to work part-time like Jerry did at Home Depot. Many retirees have found joy working at a golf course, garden centre, driving shuttle, or pursuing an entrepreneurial activity. Others ease into semi-retirement with their current employer, opting for 2-4 days a week or taking on a consulting role.
The point is, earnings from part-time employment can supplement your income in retirement so you rely less on investment withdrawals – especially during a market decline – or can be used for your “fun money” like spending on extra travel and hobbies.
Just Retire Already
Other soon-to-be retirees might be fretting over nothing. These are the investors who already have a safety cushion of cash, perhaps accompanied by a nice workplace pension. They’re invested in a risk appropriate portfolio that is still built with an eye to the long-term. Besides, as a balanced portfolio, it’s only down 9 percent for the year. Annoying, yes. Devastating, no.
Related: The Retirement Risk Zone
Long-term investors know that a portfolio falling 10-20% is entirely within the range of expected outcomes in a given year. That’s why they’ve built a margin of safety with enough cash and pension income to rely on for 1-5 years and give their portfolio time to recover.
Their retirement plan is conservative enough to provide income to age 95, with assets left over (including their home) in their estate.
Their cost of living is low enough to afford them flexibility in their retirement spending – with the ability to increase spending in good times and reduce spending in bad times.
These near-retirees would likely be able to retire and meet their spending needs, even amid a global pandemic, high inflation, or an economic recession. Their plan is relatively bullet-proof.
Final Thoughts
A market crash can be a scary time to retire. Real dollars are at stake, and it can be emotionally painful to see your portfolio fall 20% or more in such a short time. Seemingly sound plans can get thrown out the window in the blink of an eye.
If you’re feeling nervous about retiring soon then perhaps you need to re-examine your retirement plan. Perhaps a decade of stock market gains had clouded your judgement and made you overconfident.
Postponing retirement, even by six months to a year, can be a great way to shore up your finances and put safety measures in place so that the next time the market crashes it doesn’t take your retirement plans down with it.
Looking for a retirement reality check? Talk to me about my fee-only financial planning service.
I often recommend deferring CPP until age 70 to secure more lifetime income in retirement. It’s also possible to defer OAS to age 70 for a smaller, but still meaningful, increase in guaranteed income.
While the goal is to design a more secure retirement, there can be a psychological hurdle for retirees to overcome. That hurdle has to do with withdrawing (often significant) dollars from existing savings to fill the income gap while you wait for your government benefits to kick-in.
Indeed, the idea is still to meet your desired spending needs in retirement – a key objective, especially to new retirees.
This leads to what I call the retirement risk zone: The period of time between retirement and the uptake of delayed government benefits. Sometimes there’s even a delay between retirement and the uptake of a defined benefit pension.
Retirement Risk Zone
The challenge for retirees is that even though a retirement plan that has them drawing heavily from existing RRSPs, non-registered savings, and potentially even their TFSAs, works out nicely on paper, it can be extremely difficult to start spending down their assets.
That makes sense, because one of the biggest fears that retirees face is the prospect of outliving their savings. And, even though delaying CPP and OAS helps mitigate that concern, spending down actual dollars in the bank still seems counterintuitive.
Consider an example of a recently divorced woman I’ll call Leslie, who earns a good salary of $120,000 per year and spends modestly at about $62,000 per year after taxes (including her mortgage payments). She wants to retire in nine years, at age 55.
Leslie left a 20-year career in the public sector to work for a financial services company. She chose to stay in her defined benefit pension plan, which will pay her $24,000 per year starting at age 65. The new job has a defined contribution plan to which she contributes 2.5% of her salary and her employer matches that amount.
Leslie then maxes out her personal RRSP and her TFSA. She owns her home and pays an extra $5,000 per month towards her mortgage with the goal of paying it off three years after she retires.
Because of her impressive ability to save, Leslie will be able to reach her goal of retiring at 55. But she’ll then enter the “retirement risk zone” from age 55 to 65, while she waits for her defined benefit pension to kick-in, and still be in that zone from 65 to 70 while she waits to apply for her CPP and OAS benefits.
The result is a rapid reduction in her assets and net worth from age 55 to 70:
Leslie starts drawing immediately from her RRSP at age 56, at a rate of about 7.5% of the balance. She turns the defined contribution plan into a LIRA and then a LIF, and starts drawing the required minimum amount. Finally, she tops-up her spending from the non-registered savings that she built up in her final working years.
When the non-registered savings has been exhausted at age 60, Leslie turns to her TFSA to replace that income. She’ll take that balance down from $216,000 to about $70,000 by age 70.
Now, we know that withdrawing 7.5% of a portfolio is not sustainable over the long term. But Leslie has a magic trick up her sleeve. She can cut her RRSP withdrawals in half at age 65 when her defined benefit pension kicks in. By age 70, when CPP and OAS benefits begin, Leslie can start drawing the minimum amount required from a RRIF (5%).
Even with the reduction in RRSP/RRIF withdrawals, Leslie’s income from her pension and government benefits is now high enough to stop making withdrawals from her TFSA, and in fact start contributing to the tax-free account again.
This makes for a nice tax-free estate for Leslie’s only child, but also gives her a pot of money for any planned or unplanned expenses or spending shocks that may occur throughout retirement.
Finally, of note, once Leslie’s mortgage is paid off at age 58 she increases her after-tax spending by $5,000 to enhance her retirement spending. Her after-tax spending budget increases by 2.1% per year to keep pace with inflation over the long term.
Final Thoughts
While this is one unique example of the retirement risk zone, I see similar scenarios play out all the time for clients who retire between 55 and 65 and have a delay in taking their pension and/or government benefits.
It’s not even unique to those deferring CPP and/or OAS to 70. The retirement risk zone can happen anytime between retirement and the traditional uptake of government benefits.
Early retirees want to maximize their ability to spend and may also have one-time expenses like a new vehicle, home renovations, a bucket list trip, or financial support to their young adult children.
Related: Your Retirement Readiness Checklist
For these reasons it can be difficult, psychologically, to defer taking your pension and/or government benefits (even though it makes the most mathematical sense) while spending down existing savings.
That’s why it’s helpful to see the big picture with a retirement plan that shows how all of these different income puzzle pieces fit together over the long term.
The retirement risk zone can seem extremely risky until you see the pension and/or government benefit dollars kick-in and raise your income floor by a substantial amount.
So, while it’s tempting to take your pension and benefits early to ease the anxiety you face during this retirement risk zone period, know that by doing this you’ll actually be losing income in your later retirement years.
Instead, consider taking on some part-time work, or delaying your retirement by 6-12 months, or spacing out some of your planned one-time expenses (or easing asset depletion concerns by financing a large purchase over a few years), to help bridge the gap.
Better yet, as I say to my clients, it’s helpful to wrap your head around the idea of transferring risk from the market to the government and/or your company pension plan – trading your own riskier investments for a guaranteed, paid for life, indexed to inflation source of income.
The goal all along, even during the retirement risk zone period, is to generate enough income to meet your spending needs in retirement.
Take comfort knowing that by the time your CPP and OAS kicks in at age 70, you’ll often end up with more income than you need to meet your desired spending in retirement. Tuck that extra income away in your TFSA to create a tax-free estate, a source of funds for large planned one-time expenses, or as a safeguard against unplanned spending shocks.