Friday, February 28, 2014

Social Security Pension, CPP, QPP, and OAS From Canada and USA

If you worked in Canada and the USA and paid into government pension schemes (Canada Pension Plan, Quebec PP, and US Social Security), you should know that these governments coordinate their retirement pensions for your benefit.  There is a treaty that governs this coordination and how you are taxed on the payments.

This means that:

  • Each country gives you credit for your years or quarters of work when looking at pension entitlement.  This means that you could get a partial US social security pension, even if you worked less than the 40 quarters required for Social Security.
  • You could get pension payments from both governments, say your CPP and a US social security pension.
  • You could get Canadian Old Age Security (OAS) on top of your CPP.  This is especially advantageous if you live in the USA as the treaty does not allow the Canadian government to claw back OAS if you live in the USA.
  • If you live in the USA, your CPP and OAS will not be taxed by Canada and may get the same advantageous tax treatment as US social security. 
  • On the downside, your Canadian work experience does not count towards US Medicare once you turn 65.  If you and your spouse do not meet the strict rules for government-paid Medicare, you will have to purchase it from the government or find other medical insurance.
  • Another downside is that you have to deal with varying exchange rates, the governments are not going to make you whole if one currency or the other gets devalued.
How do you go about getting your US and Canada pensions?  You need to apply to both US Social Security and Canadian CPP and OAS, and make sure you fill out the sections on working in the other country.  Keep copies and send in your forms as instructed.  Following the general theme of their respective governments, as mentioned previously:
  1. The US process will be long and the civil servants will not be sure how to help you.  It may take over a year for them to figure out how much to pay you.  Remember, in the US, we do not like to fund our government services with taxes and it shows in the service you get.
  2. The Canadian process will be quick and the civil servants will be well trained on how to handle your claim.  You can even get direct deposit to a US bank.  Recall that Canadians pay heavy taxes and government services are a priority to Canadians.
I hope this helps you get all the benefits that you earned over your lifetime.

Thursday, February 27, 2014

What is the Best Portfolio Allocation Immediately Prior to Retirement?

What should you allocate to stocks and bonds just prior to retirement, say, in the last 2 to 3 years of work?  This is a question that all of us without lucrative defined benefit pensions will have to confront at some point.

There are basically two schools of thought:

  1. Use a standard allocation based on your risk tolerance, age, and other factors, i.e. don't do anything special.
  2. Reduce the risk in your allocation by holding more cash and/or short term bonds.
Point 1. is the current wisdom "stay the course" as I discussed in earlier postings.

Point 2. is interesting and it is based on the notion that the most critical time for your retirement in terms of finances are the first 1-3 years before and after retirement.  If the stock or bond market goes down significantly, your early withdrawals will deplete your nest egg too quickly too early and you will outlive your money.  This Marketwatch article and the papers it references give a good explanation, but the figure below taken from the Thornburg webpage  illustrates it best.
Figure 1: Two scenarios for retirement at two different points in time from Thornburg
In the positive blue scenario, our lucky retiree has a 60/40 stock/bond portfolio and retires in 1989, takes out 5% in the first year and increase withdrawals by inflation, and 21 years later, the $1M nest egg has grown to $2.6M.  In the unhappy green scenario, our unlucky retiree also has a $1M nest egg split 60/40 but retires in 2008 and makes the same 5% withdrawal, but the nest egg falls to $0.8M - only 30% of the riches of our lucky retiree.  This is a rather drastic scenario as it has a high withdrawal rate (5%), and the unlucky retiree retires at the start of the "Great Recession".  But it does illustrate the concept.  You can think of these two scenarios as the "best case" and "worst case" of the 5000 scenarios run by the Vanguard Monte Carlo tool referenced in my blog previously.

There is no consensus in the industry today whether to change your allocation just prior to and after retirement, but it is something to think about and maybe discuss with your financial advisor.  My solution was to accumulate about 1.5 years of expenses in a super-low-risk bank savings account just prior to my career shift/retirement.

Wednesday, February 26, 2014

Maybe I am Too Old for a Second Career?

Had one of those moments yesterday when you know you are getting old.

My wife and I are traveling with luggage and are catching the bus from the rental car complex to Phoenix airport.  I schlep the luggage onto the bus with the bus driver and there is one seat left up front for my wife.  She sits down and the young gentleman next to her offers his seat to me and will not take no for an answer.  With resignation I sit down and think "am I that old?".

Friday, February 21, 2014

Get Paid More to Spend Than Save

It is ironic that in the USA today, you get paid more to spend a dollar, than to save a dollar.  I believe it is the same in Canada.

If you save a dollar, the best online savings account will pay you 0.85% to 1.0% per year in interest.  Bond funds might pay you 2-4%, but you may lose money if interest rates go up.

On the other hand, with the right choice of credit cards, you get at least 1.5% back on all purchases and up to 5% on categories like gas or restaurant purchases.  This is paid to you within a month or at worst within a year, depending on the card.  You can also get miles, discounts, or dollars just for opening a new credit card account.

Is it any wonder that household debt is rising in the US and Canada again?

Wednesday, February 19, 2014

Nortel's Long March to Dissolution

As a former nortel employee and minor creditor due to a pension claim, I check on the bankruptcy process regularly.  After over 5 years, nortel may finally be granted it's wish and be dissolved by the end of 2014.

Once it became clear that there was a lot of money at stake, there was an explosion in claims from governments that had to make up the shortfalls in nortel's many defined benefit pension plans around the world.  These large claims were contested by other creditors and the process of dissolution was reduced to a crawl.  The many many lawyers have profited from the long court case, but the people awaiting severance, disability claims, and pensions have received almost nothing.

Let's hope no other multinational with defined benefit pension plans ever attempts a bankruptcy to dissolve the company.  Chapter 11 (reorganization) is possible as demonstrated by GM, but winding up a large multinational with pension liabilities is definitely difficult .

Monday, February 17, 2014

You Have to Be A Multi-Millionaire When You Retire

Continuing on the theme of running Monte Carlo Simulations to look at retirement feasibility, I ran a scenario for a person or couple, retiring at 65, with a nest egg of 50% stocks, 40% bonds, and 10% cash, and wanting to spend $120,000 a year in retirement.

Let's assume that CPP and other pension income yield $20,000.  Let's also assume that they will live until they are 90, not out of the question if you reach 65 with today's medical technology.  Also, let's plan for 85%+ probability of success.

Run the Vanguard tool and Presto!  You need to be a multi-millionaire at 65 with a nest egg of $2,100,000 to live on $120,000 with these assumptions.  Pretty sobering thought.
You need $2.1M for your retirement.

Sunday, February 16, 2014

Monte Carlo is not Just for the Rich

One of the main tasks of a financial planner is to develop a plan so you can retire the way you want.  Part of doing the plan involves periodic evaluation of your progress and one of the neat tools to do this is Monte Carlo simulation.

What is this and why do it?

You could just look at your savings, your projected average return on your savings (say 6%), estimate inflation (3%), use your retirement age (62) estimate how much you need per year in retirement ($100K), use your projected lifespan and you would get an answer to the question "Will I be able to retire at X and live lifestyle Y for the rest of my life?".  The growth of a portfolio nest egg with this kind of assumption is shown in Figure 1, looks really good, right?  However, this estimate would not reflect what really happens with your savings.
Figure 1: Portfolio growth using average return

You could use the 4% rule and just spend 4% of your nest egg every year.  Better than no plan but still inaccurate.

The issue is that return on investments in stocks, bonds, and even savings certificates varies over time.  Some years the return on stocks is higher than average, some years it is lower, same for bonds.  If, during the first few years of retirement, the stock market and bond market are down, such as in 2008 and 2009, your nest egg loses money, and future higher returns may not make up for this loss and you run out of money before your death.  Figure 2 shows a nest egg depleted by low early returns.  The opposite is also true, if you get great returns early, you may be able to spend more in retirement, or leave more to your deserving (we hope) children.  See Figure 3, much better results.
Figure 2: Poor returns in early years drain the nest egg
Figure 3: Early higher returns maintain nest egg

So what is likely to happen?  The solution is to run a "Monte Carlo Simulation" where a number of scenarios are run with random choices of rate of return per year, based on historical data.  If you run enough simulations, you can come up with a probability that you will have enough money for retirement.  This kind of simulation could be done using Excel or another tool, but luckily the Internet gives us a number of FREE tools that do the same thing.  I like the Vanguard tool, which allows you to input your portfolio composition, years in retirement, and lifespan, and then gives you the estimate.  Figure 4 below shows the result from the Vanguard Tool, an 80% probability you will NOT run out of money..

Figure 4: Monte Carlo simulation of a retirement nest egg
I recommend you or your financial planner consider this analysis and run it regularly to evaluate your progress towards a happy retirement.

Friday, February 14, 2014

Halfway Point on Canadian CFP Course

I reached the halfway point on my Canadian CFP course on Retirement Planning.  It is still interesting to see the "Goldilocks" Canadian retirement system.

Also, I had the opportunity to test the government services of the US and Canada on social security and Canada Pension Plan by phoning both governments for information.

  • US - long waits on the phone, reasonably knowledgeable person provided some information, but no detailed knowledge of how CPP and US SS are coordinated, did not sound like a happy camper.
  • Canada - no waits, super knowledgeable person, happy camper.
So while CPP is less lucrative than US Social Security, Canadian government workers seem happier and more knowledgeable.

Thursday, February 13, 2014

How to Shovel Snow at 56 Years Old

We just received 2 feet (60 cm for Canucks) of snow here in Northern Virginia, which is pretty unusual, and the schools, businesses, and governments are shut down.  I thought it would be best to share my snow shovelling tips as a 56 year old based on living in Canada and here in NoVa.

Set up a lawn chair in the garage so you can take frequent breaks and admire your work.  Bug the wife to bring coffee frequently.  Note Tim Hortons cup.

The Elbonian Heart Society recommends that the width of your shovel should be calculated as follows: (90 - age) * 0.70 = width of Shovel.  At 18, you have a big one, at 90, you don't have one at all.  At 56, you have a 24 inch shovel, use it wisely.

Leave a car outside to keep snow off the driveway.  When possible, make a tiny hole at the rear window and reverse quickly into the street, then brush all the snow onto the street.  It is advisable to check for people in the street before attempting this maneuver and a hearty shout of "WATCH OUT!!" is also helpful.

Leave a 2 foot unshoveled area near the road until the earlier of (1) you need to get out or (2) the plow dude has stopped plowing.  This will stop the caffeinated meth-crazed plow dude from dumping more hard snow and ice in your newly shovelled driveway.

Wednesday, February 12, 2014

Can a Dual Citizen Living in Canada Keep a US IRA?

After listening to the horror stories from the Cross Border Financial Planners, I decided to check with Vanguard USA and Fidelity to see what happens if we become resident in Canada but we still have IRAs in the USA. The anecdotes from the planners have IRA accounts being closed out without notice, extra tax withheld, high tax bills for the US person who moves to Canada, and so on.

Fidelity writes: no problems, you can still hold your IRAs with us and make changes to them as needed.  You have to close your regular accounts, which I already anticipated.

Vanguard says: not much, kind of a strange answer: "Our policies are going to lookvery similar to the other firms that you are speaking of." This could be yes to IRAs or could be no, and I am waiting for the ice storm in the South to pass and my representative to get back to the office to find out.  Note that the dreaded ice storm has not yet hit Boston, the home of Fidelity.

Anyway, I can always transfer all the IRAs to Fidelity to solve the problem.  But I better get out and buy some candles, duct tape, water, rice and milk for the dreaded ice storm that is mentioned on the TV every 10 minutes or so.

Tuesday, February 11, 2014

Cross Border Financial Planning $$??!!

I recently talked and emailed with a couple of Canadian firms that specialize in cross border financial planning - Americans in Canada and Canadians in the USA.  It was eye-opening.

The common theme is that the IRS, the CRA, various government agencies, banks, and investment firms will make your life miserable and you need someone to handle it all for you.  A few observations:

  • Seems lucrative.  Most quoted $10K to $30K per year to handle investments and financial planning.  One firm was adamant that they did not want to provide one-time advice for a fee, it had to be a multi-year large recurring fee engagement.
  • Many anecdotes about the problems you are about to face.  Many acronyms: CPICs, PCS, etc. It almost makes you want to stay put.
  • Part of the marketing seems to be writing books that tell you about all the problems and then recommend "..get professional advice from a cross border financial planning specialist to handle the problem..."
  • Lots of "secret sauce" to fix the problems.  Not much detail.

I will admit that being a Canadian in the USA does involve some problems and we have dealt with them for 15+ years.  You report your Canadian investments to the US government, you fill out some unique tax forms every year, your Canadian bank limits you to GIC investments, etc.  However, it never seemed like it was that big of a deal.  Rather than spending time on Sudoku, Chess, or other mind-blowing games, I do my own US and Canadian taxes.

Maybe my next career should be in cross border financial planning?

Friday, February 7, 2014

Do Expenses Drop by 30% in Retirement?

The old rule of thumb was that you would spend 30% less in retirement than when working (1). This was called the "70% Rule".  Lately, financial planners started to doubt this rule.  What are our experiences so far?

Fixed or Variable
Change per Month
Eating Out
+ $200
More time to eat out with spouse.  No drop in lunch expense as I used to brown bag to work.
Work Clothing
- $200
Less dry cleaning, less to purchase
+ $65
Company used to pay for cellphone
+ $200
More time to see shows, concerts
- $700
Need one less car

Net Change

- $435

Fixed implies the expense cannot be easily changed month to month.

So the reduction in expenses is pretty small, single digit percentage points depending on your starting point.  The biggest change is driven by fixed auto expenses.  Your experience may vary.

I am planning on no change in our expenses in retirement, particularly for the first 10-15 years.

(1) Setting a new retirement income target, Financial Post, July 23, 2013.