RETIREMENT PLANNING FOR SMALL BUSINESS OWNERS AND INCORPORATED PROFESSIONALS

There’s more to retirement planning than RRSPs. If you’re a small business owner or an incorporated professional in Canada, you might want to explore

• IPPs (Individual Pension Plans)
• PPPs (Personal Pension Plans): a blend of defined benefit and defined contribution
• RCAs (Retirement Compensation Arrangements)

Clark Steffy knows about retirement planning. He’s the Regional Vice President, Sales for Atlantic Canada, Ontario and Western Canada at Industrial Alliance Insurance and Financial Services. . You'll find more about Clark on LinkedIn.

I worked at IA years ago but our paths didn’t cross because I was in the world of personal life and health insurance. He was in group savings and retirement. We got introduced through David Peck, the first guest on Tea At Taxevity.

The Interview

Other Considerations

Universal life insurance can provide tax-free retirement income later and protection today (see the overlooked advantages). Since disability could impair your ability to earn the money you’d save for retirement, consider income replacement insurance.

Links

• The problem of “trapped” retained earnings
• The overlooked advantages of universal life insurance
• Why you need to reach The Moolala Guide to Rockin’ Your RRSP by Bruce Sellery
• Longevity over the last 100,000 years
• Will you have financial freedom at 35, 55 or 75?
• Are you saving too much for retirement?
• Prescription for Canada’s ailing pension system
• The original and overlooked Tax-Free Savings Account (TFSA)
• Losing ground: saving for retirement

PS Before acting, consider your options.

THREE WAYS FOR HOCKEY PLAYERS (and you) TO SAVE FOR RETIREMENT

Did you read about the financial woes of former hockey players? No, I'm not asking you to bail out NHLers. Top athletes get paid well but usually have short careers. They may not prepare financially for unexpected costs during retirement. If you scan the comments, you won't find much sympathy for the players.

Let's look beyond hockey to the problem of longevity: the risk of outliving your savings. There are three ways we can protect ourselves.

1. save more money now
2. reduce the risk of unexpected expenses
3. find ways to earn more money

Save More Money Now

There's not much to say about this boring but essential option. Saving more is one of the three practical ways to increase your net worth.

Why sacrifice today when nothing bad may happen? Optimism beats pessimism. Yet that's no guarantee that we'll be spared from a major financial setback in the future.

Reduce The Risk Of Unexpected Expenses

We can't tell what's going to happen to us. Our lives can change in an instant no matter what precautions we take. Think of an accident. We could be at the wrong place at the wrong time. We can't tell. That's why they're called accidents.

The cheapest way to prepare for some risks is with safe leverage: insurance. That's a great option for the costs of disability,  premature death or a critical illness. You could get a payout that's much larger than your investment. That's because your money is pooled and invested to pay the few claims that occur. You benefit from the combined magic of leveraging, compound interest and probabilities. If you think the insurers make too much in the transaction, buy their shares.

If you're among the majority who don't make a claim, it's easy to think that you "wasted" your money when you look back. In a sense you did, but you had peace of mind. Some forms of coverage refund your premiums if you don't make a claim. That gives you a form of retirement savings. You don't get that option with your car or home insurance.

It's sad to see people spending more to insure their cars than themselves. Priorities …

Find Ways To Earn More Money

Ah, the lure of get-rich-quick schemes. Why use the first two options when we might make a fortune by investing in the popular investments of the day? The choices of previous years didn't meet our expectations but this time is different, right? It's easy to forget that risk accompanies reward, and that past performance isn't a floor for future performance.

Finding ways to earn more income is a safer strategy. There are ways to bulletproof your career and insure against the risk of  losing your livelihood. It's tougher for athletes to stay employable when switching to a field for which they have no real training. Tim Horton was an exception.

We can fall on ice without warning. We're more resilient when we're younger and invest in protection.

Links

• The painful truth about the NHL and its pensions (Globe & Mail, Oct 2010)
• Three practical ways to increase your net worth
• The pros and cons of financial leveraging
• Dumb money 2009: what went wrong
• Tips to bulletproof your career
• Employable: Three lessons from a popcorn farm
• Insuring against the risk of losing your livelihood
• 13 questions to evaluate an investment that's "too good to be true"
• image courtesy of Oliver Weinitschke (Finland)

Podcast Episode 89 (4:05)

direct download | Internet Archive page

PS Don't forget about lottery tickets. Somebody's going to win and it could be you …

ARE YOU SAVING TOO MUCH FOR RETIREMENT?

When you think of  a rose, do you marvel at the beauty of the flower or think about the prickly thorns?  You get both.

Retirement is like a rose. We're lured by the beauty, but continually reminded of the high price. We face many obstacles. Investment returns are volatile. Company pension plans are disappearing. We're living longer. Medicine does ever-more but costs more and more. Governments face financial crunches because of the aging population. So we personally need to save more more more.

What if the math is wrong?

What if we're actually saving too much? Maybe we don't need 70% of our pre-retirement income when we stop working. That's the discussion in Living on less and loving it in Ellen Roseman’s blog.

Before you start spending your retirement dollars today, consider these two questions:

1. who benefits if you save too much?
2. who loses if you save too little?

You do in both cases.

Saving Too Much

If you think you’re saving too much, you may have more than you need. You’ll never know because the final tally takes place when both you and your spouse have died. The remaining value of your estate, can go to your heirs, causes you support and taxes.

You can't predict the future. We couldn’t have predicted the past.

We are living longer than ever. Even if you’re frugal, you could easily face unexpected expenses. Suppose you require a wheelchair. Could you get into your home without a ramp? Would you need a different vehicle? How do you use your kitchen? Is your bathroom accessible by wheelchair? How do you get into the tub? Maybe you need to move to a nursing home. They aren’t cheap.

Even if you’re healthy, your retirement savings could expire before you do. That’s the risk of longevity. Imagine losing financially by living longer. How horrible.

Saving more than you think you need gives peace of mind. You immunize yourself from economic downturns on the route to retirement too.

You might still run out of money but you’re taking extra precautions to reduce that likelihood.

Saving Too Little

Do you really want to imagine the scenario of running out of money after decades of hard work? Even if you want to start working again, what kind of employment could you find? McJobs might get replaced by cheap, reliable robots. You might not have the physical stamina to work.

The government is there to help as a last resort but how much money do you think they'll have as the population ages?

Maybe you've got children and grandchildren. Maybe they can and will support you. Will they resent you too? How will your dignity be affected?

Under saving increases your financial risks and makes you vulnerable to adversity. As with exercise and diet, the savings habit takes time and persistence to show results. Starter sooner gives more time for the magic of compounding growth.

How Much Is Enough?

Suppose you think you you can retire in comfort on 50% of your current income. Do you know how much capital you'll need? There are many unknowns. We're living longer. Investment returns are volatile. Inflation could return. If your real returns drop 1% below your projections, what does that do to you?

There's a book called The Number by Lee Eisenberg. It's readable but the title is misleading. You won’t find simple formulas to estimate how much money you need to retire. Instead, you how retirement money actually gets spent. That could be an eye-opener, especially if you haven’t save much money to date.

If you haven't read The Millionaire Next Door by Thomas Stanley and William Danko, do. You'll come away with a much different understanding of the self-made wealthy. They live below their means and save save save. This prepares them for adversity and opportunity now and for the rest of their lives. How's that for a plan?

Would you rather accumulate more than you need or end your life financially dependent?

Links

• Living on less and loving it (Ellen Roseman)
• Three practical ways to increase your net worth
• Prescription for Canada’s ailing pension system
• image courtesy of Peter Suneson (Sweden)

Podcast Episode 63 (5:06)

direct download | Internet Archive page

PS Prepare to enjoy the retirement rose but pay heed lest the thorns prick you and draw blood.

Preston Manning on Financial Planning

Political parties are marketing machines for winning elections.

---Preston Manning

Knowing how to win an election doesn't mean knowing how to run the country. Or having well-considered ideas. Or being financially prepared to run for office. When Preston Manning made these points at CALU 2009, his slightly squeaky voice reminded me of early Jimmy Stewart.

Preston Who?

You may recall Preston as the leader of the western Canada-based Reform Party. He now runs The Manning Centre for Building Democracy, "a national not-for-profit organization supporting research, educational, and communications initiatives designed to achieve a more democratic society in Canada guided by conservative principles."

Just don't look meaningful French content on their website at this time. Here's what you'll see today:

TRANSLATION REQUIRED
What's New: Il n'y a pas d'evenements au Centre Manning.

The English site lists five events. You might find the spotty translation from a national organization established back in 2005 surprising, offensive or amusing.

When To Sweat

Preston pointed out that a new Starbucks employee must complete 20-30 hours of training before serving you a coffee. Politicians aren't required to have any training in their core activity, law making. How would you feel if pilot boarding an airplane said "I've never been in one of these before."? Politicians learn on the job, but there's little tolerance for mistakes. Elsewhere, magician David Ben said you can sweat in public or private. But you will sweat.

Preston wants to train future politicians so they know how to make laws in the public interest. 

Financial Planning

Besides preparing politically, those who may run for office should prepare financially too. They need help with financial planning. Besides the normal issues affecting us all, what about the financial impact of

• maintaining two residences
• placing assets in a blind trust (as is required for government ministers)
• drops in personal income while in parliament
• current investment strategies (e.g., renting space to the government may look suspicious later)

The financial planning should be done now to help prepare candidates who start running for office in 10, 15 or 20 years. Preston acknowledged that CALU members have the skills and knowledge to help future candidates now. 

Plans are nothing; planning is everything.

--- Dwight D Eisenhower

Financial planning isn't glamorous or perfect. It's necessary for the rest of us too. Time zooms past. Our lives are rarely as tumultuous as a politician's, where one slip can ruin a career. If we fail to plan ... you know the rest. 

Links

• Preston Manning biography
• The Manning Centre for Building Democracy
  
• Stephen Harper at CALU (7th year in a row)
• The Four Steps To Solving Problems Like a Magician
• What You Like/Dislike About Your Trusted Financial Advisor
• The Four Financial Risks

Podcast

direct download | Internet Archive page

The Six Basic Fears From 70 Years Ago (Napoleon Hill)

[Update: It's now 2012, which means the fears are from 75 years ago. Here's a new video summary:
 
Now back to the original post]

In his classic 1937 book Think and Grow Rich, Napoleon Hill identified the six basic fears:

1. Poverty
2. Criticism
3. Ill Health
4. Loss of Love
5. Old Age
6. Death

Are we really that different 70 years later?

We're living longer, healthier and with more money. That doesn't mean the fears are gone. Let's look at the primary fear.

#1: Fear of Poverty

"(Warren) Buffett had planned to hold onto his money until his death, but he changed his mind after his wife, Susie, died in 2004." --- Fortune, Jan 2008

The fear of poverty is widespread. Even for those with lots. Warren Buffett didn't want to donate the bulk of his wealth until his death. In contrast, Bill and Melinda Gates plan to give away 95% during their lifetimes, which is causing their children to fear there won't be enough left for them.

Here are the symptons that Hill identified

Indifference

• lack of ambition
• tolerance for poverty
• mental and physical laziness
• lack of initiative, imagination, enthusiasm, self-control

Indecision

• letting others do the thinking
• sitting on the fence

Doubt

• excuses to cover up, explain or apologize for own failures
• envy or criticism of the successful

Worry

• finding fault with others
• spending beyond earnings
• neglect of personal appearance
• frowning; nervousness; lack of poise
• self-consciousness
• excess use of alcohol or other drugs

Over-caution

• seeking out negatives
• knowing all roads to disaster but none to avoid failure
• pessimism leads to indigestion, bad breath and a bad disposition

Procrastination

• putting off until tomorrow what should have been done last year
• working on excuses rather than finishing the work
• refusing to accept responsibility
• compromising

Links

• Melinda Gates Goes Public (Fortune, Jan 7, 2008)
• Fear #2: Criticism
• Fears #3-6
• The Six Financial Fears of Canadians
  
• The story behind the Six Fears video (new)

(You can download Think And Grow Rich for free. However, many sites use the book as a lure to sell you something. I couldn't find a link to recommend.)

The Overlooked Advantages of Universal Life

Universal Life (UL) insurance has three key advantages

1. Tax-deferred growth, potentially permanently
2. Tax-free retirement income through leveraging
3. Tax-free death benefit

Unfortunately, most Canadians are unaware or skeptical. There's a widespread belief that it’s better to buy-term-and-invest-the-difference. So affluent Canadians take advantage of UL with the endorsement of their accountants.

Buy Term and Invest The Difference
This seems like a great idea. Term insurance is cheaper than permanent insurance. So there’s more money to invest outside. Yet astute investors like Warren Buffett buy permanent insurance, especially UL.

Why is term insurance cheaper? Because it’s worth less. Coverage expires before most people do. So term insurance is well-suited for folks with young families and debts like mortgages. Term insurance is used for estate creation by people with little money. They buy term but don’t have money to “invest the difference”. They probably have unused contribution room in their RRSPs.

Life insurance was created to be an instant estate in the event of the premature death of the breadwinner. --- Herb Perone

In contrast, permanent insurance is used for estate preservation and tax planning by people with money.

The Math of Compounding

“The most powerful force in the universe is compound interest.” --- Albert Einstein

Tax cripples investment growth. Conventional investments earn

• interest (taxed at 46.41% in Ontario)
• dividends (taxed at 24.64% or 31.34%) or
• capital gains (taxed at 23.20%)

(For other provinces, see 2007 Tax Facts and Figures from PriceWaterhouseCoopers).

As with an RRSP, the tax rate on growth inside UL is 0% until withdrawals are made (then taxed your marginal tax rate). Tax deferred is tax saved --- a huge benefit.

Here’s a simple example that shows the consequences of tax: What does $1 growing at 100% per year become after 20 years? $1,048,576. Suppose growth is taxed at 35%. The after-tax accumulation shrinks to a minuscule $22,371. With sheltering, tax is applied to the ending accumulated value, giving $681,574. For the math, see the table in $1,000,000 After Taxes on Investment Growth. For another example, read Do You Understand Compound Interest?, which has a live calculator

Tax-deferred Growth
You saw the power of tax-deferred growth above.

UL lets you make deposits well above the RRSP contribution limits (the maximum is limited by the death benefit, which you select). Because withdrawals are not mandated, the savings can be paid out as part of the tax-free death benefit.

Tax-deferred growth has another advantage. Insurance charges are partially paid by investment growth that was never taxed --- the government helps pay your premiums. This can't happen with term insurance because there's no tax-favoured savings element

Tax-free Retirement Income
If you need retirement income, you have the option of getting tax-free income by using the savings as collateral for a bank loan. You can skip the loan payments and have the loan repaid with the tax-free death benefit.

Bonus
If you’re accumulating large sums, do you want to risk losing it to creditors? When properly-structured, life insurance can be creditor-protected.

The advantages of universal life insurance lead to many creative strategies.

Prescription for Canada's Ailing Pension System

Today, the Canadian Institute of Actuaries (CIA) unveiled a prescription for the country's ailing pension system at the non-profit Economic Club of Toronto. The 6 page report is quite readable and part of the Institute's desire to help guide public policy in Canada.

The prescription only addresses defined benefit pension plans.

Defined Benefit or Defined Contribution?
Fulltime employees in large companies usually get a pension through their employer. There are two common ways to convert savings into retirement income.

• defined benefit: employer bears the financial risk of providing the benefits (e.g., 2% of your final average earnings per year of service)
  
• defined contribution: employees bear the financial risks (the employer makes a contribution as you would with an RRSP and your pension depends on the growth of the savings)
  

Guess which type employers favour? Statscan reports that the portion of private sector workers covered by defined benefit plans has dropped from 29% in 1992 to 21% in 2003.

The Disadvantages
Defined benefit plans are not perfect. Employer funding requirements fluctuate, which makes corporate financial results more volatile. As a plan member, what happens if you change employers or are self-employed? Portability is a problem. If you leave employers during the first two years, your pension benefits for that period are lost (don't vest). Plans can still fail. Plan assets can be used for purposes you don't support, such as offering incentives to others for early retirement.

Asymmetry of Risks and Rewards
With defined benefit plans, the employer bears the risks and the employees get the rewards. If investment returns are poor, the employer must increase contributions. So if returns are favourable, shouldn't the employer be entitled to withdraw some of the surplus? If an employer tries, there's often an outcry. Hardly fair. Hardly an incentive for employers.

Where's the Outcry for Defined Benefit Plans?
There isn't one. Employees don't understand how much they lose. With defined contribution,

• plan members bear the risk of poor investment returns
  
• employers reduce their costs by 2% of payroll (which means costs have been shifted to plan members)
  
• returns drop because of higher administration costs, less investment expertise and higher management fees than institutional investors
  

At retirement, plan members find that their retirement savings buy less of an indexed annuity than they expected. At this point, what can they do?

What's Next?
It wasn't clear what happens next. How will business owners react? Will politicians see a need to do anything? Do Canadians care? Are there other prescriptions that could help improve the defined contribution plans which predominate?

Links

• press release from the Canadian Institute of Actuaries
• official report (6 pages, PDF)
• article from advisor.ca (June 27)
  
• Are Canadian's Saving Enough for Retirement, Part 2 (from Canadian Capitalist)
  

Losing Ground: Investing For Retirement

Every child had a pretty good shot
To get at least as far as their old man got
But something happened on the way to that place
--- Billy Joel, Allentown

When my son was 3 years old, we noticed that our coin jar was getting lighter and his piggy bank was gaining weight.
"What are you doing?" I asked.
"Saving for retirement," he replied.

Jeevan is now 12 and still careful to save his money. He bought his first term deposit recently. Not everyone starts saving so young. Why did he? He was alarmed by my tales about people I came across who

• had no pension plan
  
• lost money because of poor investments
  
• were working but not saving for retirement
• dipped into RRSPs due to job loss, disability or illness
  
• didn't repay money they took from their RRSPs to buy a home
  
• retired but didn't realize they'll likely run out of money
• retired, ran low on money and were forced to work again
  

Monkey hear, monkey fear, monkey save. We didn't need Grimm's Fairy Tales. If you're alarmed by the fear of running out of money during retirement, join the club.

As you might guess, there are publications geared at institutional investors and pension plan sponsors. The current issue of Canadian Investment Review looks at the typical Canadians instead.

Company Pension Plans
If you're among the 40% of the workforce with a company pension plan, you're fortunate. Money is being set aside for you. Ideally, you'll have a plan that pays you a specific lifetime benefit based on your years of service and your salary around the time you retire (defined benefit plan). Many employers prefer the less-expensive defined contribution plans, which transfer the investment risks to you. As with RRSPs, you make the investment decisions and your pension income depends on the value of the savings.

On Your Own
The remaining 60% have no company pension plans. Do they have the discipline to save?

I see small business owners who struggled for years and are now seeing some success. So they start the saving game late. Or spend instead of saving. It's their way of rewarding themselves for toiling in the lean years. They think their businesses will survive and become increasingly successful. So their plans to save slip into the future.

The study, Losing Ground, by Keith Ambachtsheer (University of Toronto) and Rob Bauer (University of Maastricht) shows that investing in mutual funds can chop retirement income by 22% to 64%, depending on what the fund charges.

We'll each have different solutions such as investing "better" (whatever that means to you), saving sooner or buying more lottery tickets.

So put away Grimm's Fairy Tales. Turn out the lights. Think about Losing Ground before you retire.