A Little Realignment

LSSThe proverb that nothing is certain but death and taxes is one that I think we’ve all heard and agree with, begrudgingly. Certainly I recall how much I hated filing my taxes when I was a freelancer, not because I resented having to pay income tax but because it just seemed so damn complicated to gather all the numbers in order to fulfill one of my civic duties. That period of my worklife left such a bad taste in my mouth that it took me years to settle my situation (i.e., finally filing retroactively) even though I was only a regular worker with a few simple tax slips.

Now I’m the total opposite of how I used to be. As of December 23, I downloaded the Studio Tax application and prepared my 2017 return because I already know all the numbers to fill in except one or two which will be confirmed when I get all my tax slips. In the meantime, I entered educated guesses for those few unconfirmed numbers based on my last three previous filings, and the one certainty I do have is that the final result won’t be wildly different once I get the accurate figures in late-January or early-February.

Decisions, Decisions!
My thinking has changed a little since the last of my eight-post series last year on how to get out and stay out of debt. In that post, I explained how, once out of debt, I distributed my savings so that I could live well before retirement yet be assured of having a comfortable retirement starting at 60. Then, in the “Counting My Blessings” section of my “disjointed thoughts” post last October, I wrote that “it’s not like I’m deferring toward retirement every dollar I save like a zealot praying to a skybound entity in the hope of gaining entry into a blissful afterlife.”

Sometime after that post, however, I stared at the numbers in my spreadsheets and began wondering two things:

  1. Will I really have enough when I retire?
  2. If I did max out my RRSP contributions, would I be cutting too close to the bone?

So I made copies of my spreadsheets and used them to work out alternate scenarios. If I didn’t like how the numbers played out, I would toss out those copies and not think about it again. But I did like what I saw, I would alter my originals to reflect the new scheme I came up with.

Although the last year at work has been challenging, there’s one thing I can safely count on: I’ll still be there by this time next year. That’s an important point because one principle of my financial strategy has been to ensure not only that I don’t live paycheque to paycheque or month to month but also that I should have access to at least six months’ net salary should the unthinkable (being dismissed from my job) happen. Thus I made a few styling adjustments to one sheet of my workbooks in order to highlight how often and how long I would:

  1. be under that 6-month minimum figure, and
  2. have less than $2,500 unsheltered, easily accessible cash on hand for emergencies and unplanned incidentals.

It turns out that, under my new distribution scheme, the former would only happen twice (from January to mid-July 2018 and from September 2020 to early-May 2021) and the latter would only happen twice as well (from January to late-June 2018 and two of five two-week periods from January to mid-March 2019) — and that’s all based on very conservative income estimations and the continuation of ultra low interest rates. Then, thinking back to the 23 months (November 2011 to October 2013) during which I held the reigns so very tightly in order to get out of debt, I realized that this new scenario is not only bearable but in fact infinitely better than when I was struggling out of debt since the two conditions are at least partially met right through retirement in late-2025.

How lucky I am! I can max out both my RRSP and TFSA by late September 2018 and still live well. There are definitely perks to being single and having a decent job.

Pensions and Savings
The other way in which I’m lucky is that I’m among the last ones at work who has a defined benefits pension, meaning that I already have firm figures on how much I’ll receive from it per year if I retire at 60. It would obviously be a much nicer amount if I stayed until 65, but by now I can’t countenance the thought. The last estimate I could get my hands on dates back to a year ago and is likely slightly better now. Then, one morning this December, the Québec government pension plan sent me a statement showing me how much I would get at 60 or 65 if all remains roughly equal. And, starting at 65, I would get Old Age Security from the federal government, which is currently just under $584 a month and will likely be a bit more by the time I retire since it’s indexed to the Canadian Consumer Price index.

All these amounts are taxable, but even if I add up the raw numbers, I wouldn’t have nearly enough to get through a year at the level to which I’ve become accustomed.

Year Work Québec Canada Total
2026-2029 17,520 6,876 0 24,396
2030 16,150 6,876 2,335 25,361
2031 + 14,232 6,876 7,005 28,204

Remember that unlike a lot of people, I won’t need a pre-retirement period to get used to earning less since I already know exactly how much I need per year to sustain my current (comfortable but not outrageous) lifestyle. That’s where the retirement savings will need to kick in, but I couldn’t help wondering, “How long would they last?”

The Certainty of Taxes
The idea behind an RRSP is that you will have to pay income taxes when withdrawing from it, but given how one would be at a much lower tax bracket by that time (aided as well by extra breaks from age 65 and older), the amount of taxes paid will be much less than it would be now. And while any interest on savings in a non-registered account is also taxed, those in a TFSA never are since contributions to it are made after tax. The best situation, if it can be achieved, would be not to touch the RRSP until forced to convert it to a RRIF at 71 and withdraw a certain percentage every year as shown below.

But the need to convert to a RRIF would be 11 years into my planned retirement date, so could I pull off waiting until 2037 before starting to withdraw from it?

Enter my 2017 tax return, my geekiness, and my almost infinite patience to work out a long and complicated idea.

After carefully studying the forms for several years of tax filing in Studio Tax, I noticed that as much as there are some changes over time — new taxes or breaks, an ever-increasing personal deduction amount, and varying maximum deductions amounts and percentages of allowable deductions — the calculation from year to year is eerily similar and some changes are easily predictable. For example, the annual factor applied to the personal deduction amount is 1.013 federally and 1.0109 provincially.

So, I added a new sheet in one of my two financial workbooks and replicated all the formulas that would summarize exactly my 2017 return in Excel, simplifying it by entering only the lines that I would ever be likely to use and ignoring all the others. Then, since I have worksheets predicting my income for every pay period until my retirement and what will likely be my allowable contribution room in my RRSP, I calculated the likely results of all my filings up to and including 2025, highlighting the cells that will likely require an edit to a different amount or percentage when that time would come. As a result, any change in future calculations — major or minor —
can easily be integrated into that sheet. The only variable that’s up in the air right now is tax on dividends, as I’ve put off joining my employer’s shares savings program to 2018, meaning I don’t yet know the impact of that at tax time.

Still, when that all seemed to work well and make sense, I added the rows that would be applicable when my income would consist of pensions or would become applicable once I reached 65. My goal is to have $42.5K per year of spendable cash plus whatever income tax I would need to pay for the previous fiscal year. As expected, as I started plugging the numbers, since no deduction would be taken at the source from that point, I would have to start paying taxes rather than receiving returns from 2026 onwards. That being said, I got to see with my own eyes the veracity of Québec government officials’ assertion that a sizeable percentage of people here don’t pay any income tax because there’s not only an age-based deduction but one for people who live alone year-round and earn little. (That’s about the only tax break singles get given politicans’ constant emphasis on “middle-class families.”) In fact, it would seem that Québec will only be wanting its pound of flesh from me once I reach 71.

I then entered the percentages in the second table above to my RRSP worksheet and added another sheet to that workbook to replicate the first table above for each year in order to see how much I would need to take from general or TFSA savings and find out if indeed I could hold off to 71 before touching my RRSP/RRIF, and how long would my TFSA and other savings would last. All my predictions on interest earnings were based on today’s historically low rates of return and my legendary low-risk appetite when investing. However, since most experts agree that the currently low interest rates won’t be staying that way for much longer, I’m confident that my estimate on that front is very low-balled, which is consistent with my approach of underestimating income and overestimating expenses.

Just so you know, I didn’t grab that figure of $42.5K/year plus the previous year’s tax bill out of thin air. I have three projected revenue figures in one of my spreadsheets: all sources of income including interest (taxable and non-taxable), take-home pay if I don’t participate in my employer’s share savings program, and take-home pay if I do. I also know from another spreadsheet how much I spend on average each year, which excludes what I sock away in savings, not to mention the percentage of all income I tend to save on a normal year (i.e., 27-30 percent, which I gather is higher than the average Canadian). So that $42.5K figure is based on my projected 2025 take-home pay and is roughly the median between if I were and I weren’t to participate in my employer’s program. In other words, it should be an amount far greater than what I’d be accustomed to spending each year.

How These Calculations Led to a Little Realignment
Many financial planners out there seem to agree that you need to prepare to have 70 percent of your income at the time retirement. Some say it can be a bit less since some of your expenses will disappear upon retirement, like work clothes and transportation, not to mention that your days of setting money aside for retirement will be over. Others try to come up with a more firm number along with a reminder among all of them that you have to plan on living 30 years into retirement.

Frankly, what I was never able to understand in that piece of advice is whether they were saying that you needed 70 percent of your pre-tax or after-tax income. It seemed to me it should be the latter since that’s what you’ve always had to work with (assuming you didn’t foolishly spend your tax return instead of reinvesting it), not to mention you’re supposed to be in a lower tax bracket by then, which is said to be the benefit of having saved into an RRSP. But having spent so much time figuring out exactly how much cash I could have spent actually ended up in savings, I realized, as I just stated, that I’m already shaving off nearly a third of any net income each year that I could have spent elsewhere if I didn’t pay as much attention as I do.

How Much “Paying Attention”
Precisely $76.75 of all my revenues in 2017 (or 0.16%) can’t be traced, but much of that is probably change I used to feed the clothes dryer, and the remainder of that are nickels and dimes that I just throw into a jar. (I have remarkably few nickels and dimes in there.) That goes to show why I’m better not handling actual cash and relying on paying everything electronically or from my debit or credit card which I consistently pay off well before the 21-day grace period on purchases.

 

The other thing financial planners go on about (almost to the point of scaring you) is how inflation will affect your savings. There’s a valid point there, but only to a certain extent. As I explained in my “Get Out of Debt” series last year, taking a yearly approach to your budget provides a lot of absorbency when prices do go up. In fact, that’s the reason why I don’t think my most recent number crunching was a fool’s errand in any way. I know that prices will go up by the time I retire, but I will have gradually adapted to them already and thus they’ll be buffered in. What’s more, when one of the financial institutions I use increased the return on savings by a tiny bit (0.15 percent, to be precise), the positive impact was surprisingly noticeable, just like when the Québec government decreased the tax rate by 1 percent for the first slice of one’s earnings. So even if rates go up only 2 percent by 2025, which I suspect is a conservative estimate, my savings pot by that year will be considerably greater than what I’m now predicting it will be. Plus, if you followed my logic for selecting that $42.5K/year target, that gives me a HUGE buffer for inflation right there.

So in the end, what I found is that, based on my current savings projections, my TFSA would dry up in 2040 (the year I would turn 80) and I would have used nearly $55K more than the amount I invested into it, while my RIFF, from which I would need to start withdrawing a minimum percentage in 2037 (the January 1st I will have turned 71), would dry up by 2055 (the year I would turn 90) and I would have used more than $150K than what I invested into it. Given my bad health habits and the genetic predisposition on both sides of my family, I seriously doubt I’ll reach 90, but this calculation nevertheless demonstates that I could live quite well for 30 years into retirement.

That being said, it’ll be interesting to see what will be the effect of rising interest rates in the coming years. The first three of eight announcements from the Bank of Canada in 2018 will be on January 17, March 7 and April 18, and I expect at least one 0.25 percent increase by April at the latest, and most analysts expect a total increase of at least 0.5 percent by the end of 2018, meaning two increases in that year alone. I plugged in a single 0.15 percent increase as of January 24 and that alone would extend my TFSA by a year, so all the signs are pointing to my having more than enough to retire at 60.

The bottom line is that I’m no longer in the least bit worried about retirement, if everything else stays relatively constant. This little realignment will be a minor short-term adjustment or “sacrifice” that will yield a major long-term gain — not to mention, complete peace of mind.