We don’t invest our hard earned money for the sake of having a portfolio; we invest so we can have life experiences and be happy. Only with the confidence of an income we cannot outlive will we attempt to achieve our desired life experiences and ultimately true happiness. Focusing just on our portfolio or a specific number or Rate of Return may hit a mark but miss the objective.
Being happy in many respects is a choice and a journey. As a financial planner I can help my clients on the road to happiness by helping them get to a position of never having to worry about running out of money. From a financial planning perspective there are five steps to get to this place and potential happiness:
The first step – decide what’s really important
Starting with being very clear about what is important to us excites us and gives us the drive to do the work necessary. It gives us a reason to do and keep doing the things to get us to what’s really important. At the deepest level, the things that are important to us are expressed by our values – enduring beliefs that do not change. Values have a priority and this helps us in our decision making. An example of my values list is – Family, health, impacting the lives of people and leaving a legacy. This represents very clearly the things that will get my time and money. As Walt Disney said – “When your values are clear, your decisions are easy.”
The second step – fixed and desired expenses
When we stop working, our living expenses do not decline at first– we still live in the same place, drive the same car, and pay the same utility bills. Knowing what these numbers are will help us understand the lowest threshold of income we need that will not impact our basic lifestyle – and typically tell us that achieving this level of income is quite realistic. Next, going through the exercise of deciding how much income we would want to have all the other experiences in life first requires us to clarify and confirm what’s really important – a key step for happiness. Decide what’s important and spend your money on that. Lastly, understanding how our fixed and desired income will change throughout our lives forces us to come to terms with aging and potentially the desire to spend more of our money earlier in our retirement.
The third step – sources of income
Understanding all sources of income should come after understanding fixed and desired expenses so as not to limit our desires. We can always go back if the math doesn’t work – spending too much can be avoided – spending too little is a disservice to yourself and those you love.
There are three primary sources of income we may have in retirement:
This includes the Canada Pension, Old Age security, government and/or private pensions. Understanding the options available such as when they could begin and the payment amounts and tradeoffs, the differences in indexing and survivor benefits are all very important and need to be researched and strategies planned. Pension income is guaranteed and often indexed and can often exceed a couples fixed expenses – going a long way in achieving a strong level of comfort. This is passive income at its greatest as it requires no effort to earn.
Business and Rental Income
I’ve lumped these together only in that this source of income often requires some effort on us to act or manage. Given that there will likely be a time when we won’t want to act or manage this type if income also requires a strategy to liquidate any assets involved. This source of income has various tax implications which could be beneficial (or not) if not planned properly. For example, too much taxable business income could exceed one spouses OAS claw back limit – $73,756 (for 2016) which effectively adds a 15% tax on income over this amount increasing the marginal tax rate to over 46%!
The average individual will not have the desire to understand the tax impact nor be able to develop a strategy for this source of income and needs to have a good CPA and a financial planner who understand the tax implications. How and when this income is withdrawn will impact the overall strategy given all other sources of income.
Income from investments
Income from investments includes all income that will be withdrawn from our registered (i.e. RSP’s/ RIF’s, LIRA’s/LIF’s, TFSA’s etc.) or non-registered investment accounts. This is passive income as it requires little involvement (if working with a Financial Advisor).
Income from registered accounts (RSP’s/ RIF’s, LIRA’s/LIF’s) is 100% taxable and can be income split at age 65. The longer investments are left to grow tax deferred in registered accounts, the greater the assets held will be. However, it is possible to have too much in registered accounts – especially when the income withdrawn causes a OAS claw back (see above) So projecting how much investments will grow based on annual contributions and rates of return can provide us with the potential income we can expect.
Non-registered accounts are typically the most tax efficient source of income – each withdrawal is proportionally taxed based on the adjusted cost of the investments and the market value at redemption. For this reason, non-registered assets are typically the source for initial income.
Not only must we understand how this source of income will grow and be taxed – we need to understand how to manage our investment portfolio’s to maximize the returns. This of course is the topic for another article!
The fourth step – clarify and strategize
Reviewing a strategy for how best to withdrawn income, how to minimize tax, what expense could be minimized or avoided needs to be done at least annually. This is where the big picture is looked at and all the pieces considered.
The fifth step – regular reviews
If you’ve completed all these steps, but never repeat them – your great work would be for nothing. This process must be repeated each year – understand current expenses and sources of income, strategize, and project forward. This continues to build your confidence in your plan – allowing you to continue to seek out experiences and not worry about whether you will have enough.
So, working through these steps will help you get to a position where you are comfortable you will have an income you cannot outlive. The last piece is then your decision – will you use your time to decide and do, what makes you happy?
Richard WR Yasinski CFP