Net Worth - April 2007

Well it is time again for a net worth update. For those newer readers I do this every two months just to keep a pulse on how things are going.

Assets
House $240,000
RRSP $12,600
Old Work Pension $10,500
New Work Pension $800
Wife's RRSP $5200
Wife's Investment Account $5000
ING Savings Account $5800

Debt
Mortgage $148,400
Line of Credit $0

Therefore my net worth now stands at: $131,500. Overall an increase of +$46,050 or 54.5% from my last check up. Now I know this value looks huge, but keep in mind I did just get my over $7000 tax return and my house value has shot up a lot.

I should point out I determine my house value by looking at similar homes in the market place and account for improvements I make to the house. I've been keeping my estimates conservative to ensure they stay realistic. At the same time I've been realizing the market is picking up some serious steam lately. For example I recently saw a house very similar to mine with some extra improvements and an extra 100 square feet of space listed for $289,000. I just can't realistically undervalue my home by more than $50,000 so the value had to come up a bit larger of a jump than normal to cover the gap. I'm acutely aware that by using a conservative market price for my house that if there is a market crash my net worth will drop like a stone. Yet after being through a market like this once before with my last house I know you can't ignore it either.

Also please note that I'll submitting a post to the second Canadian Tour of PF Blogs which is going to be hosted by the Money Diva on May 7th. If you have any requests for a topic I'm open to ideas (since I currently don't have a clue what I'm going to write about).

The Carbon Age

After working for months (or was it stalling) the Canadian federal government finally rolled out the details of their air pollution/climate change plan. The main focus was on big businesses which generate about half of the pollution in Canada (for a quick summary see here).

There was lots of interesting points in the plan and everyone is already lining up to say 'it's great' or 'it's horrible.' Some like the 55% reduction target of air pollutants like sulfur dioxide (acid rain), nitrogen oxidizes (smog) and particulate. While others dislike how vague the plan is on reducing carbon dioxide being released into the atmosphere and how Canada will not meet its Kyoto targets.

Perhaps not realizing what they have done, the most important thing the government gave industry was the number: $15/tonne of CO2 tax starting in 2010. You see industry has seen this coming. Despite all the rhetoric to the contrary they have not had their heads in the sand. They have bought studies, funded R&D and attended conferences getting to know their options for CO2 reduction. The biggest problem with all their efforts was the economics. How much was avoiding producing a tonne of CO2 going to be worth? Now they know and now the real work begins.

In the next several months we are going to see two things happen. One a lot of current projects will be canceled since they are no longer economically feasible. The second thing will be a series of announcements on new projects starting up. Why? Well to actually engineer, fabricate and construct most of what the facilities required to clean up the emissions to the new standards will take at least four to five years. The deadline of the first phase is 2012 meaning most of these projects will have to start not six months or year down the road, but NOW.

So in the end, Canada has turned the corner and entered a new age: the carbon age. The old rules are now gone for power generation and oil & gas. The entire economics of any major construction project have just changed overnight. So what is an investor to do?

Well let's follow the money. First you will need lots of engineering for these new projects, so check out any publicly traded engineering firms such as SNC-Lavalin. Then materials to build everything such as steel (from Ispco for example) and concrete. Also there are typically a fair amount of chemicals involved in these processes so you might want to look at Dow Chemical. Then there will be the other big winners of all this: alternative energy production like wind turbines, solar panels, ethanol and biodiesel (there is so many different companies involved in these I'll leave you do your own research). Perhaps the most interesting change of all for potential investments will be the construction of a Canadian carbon credit exchange. Will the public be allowed to trade? Is so will the credits be in high demand or will the market be flooded and have the price crash like it did on the European exchange?

The other issue swirling around all of this is the fact Canada is currently run by a minority government. So if the opposition really dislikes this plan it might trigger an election and drop Canada back into limbo with its climate change plan. Hold on to your seats, this could be an interesting few weeks.

Taxes Done and Waiting

As I previously mentioned I was expecting a big tax refund this year. Initially I estimated I would be over $5000. Since then I have filed both my wife's and my returns and now I'm waiting for my over $7000 tax refund. Yes it got that high. I'm not really happy about it and now I'm getting impatient for that money so I can pay off my furnace I installed last month.

I thought it might be useful to review where all these deductions came from and how I paid so much tax in the first place.

First off I paid too much tax due to a large bonus at my previous work place. Then with moving just after paying my CPP/EI for the year (basically I paid CPP/EI twice for the year, once at each job).

This is a few deductions I used:

-I moved over 1400 km which produced a $11,000 moving deduction
- I claimed partial northern living allowance for half the year to get another couple of thousand deducted
-My wife's business income was low enough she paid no tax and transfered the remained of her basic deduction to me
-Then the RRSP's also deducted another few thousand dollars

Overall I broke over $15,000 in deductions before I even used any tax credits to finish dropping my tax bill. Yet my biggest disappointment about filing my taxes this year was waiting for my T3 slips for my wife. I honestly got the last one on April 17th. To say I was a bit mad over the wait was a bit of an understatement. I just can't understand why they can produce T4's by the end of Feb, but I can't get a T3 until mid April!

Canadian Content in an RRSP

During the 100th post contest I got a great series of ideas for topics from the readers, one I've been thinking about from Cardero was how much Canadian equities exposure should we have in an RRSP?

Prior to 2005 this was a simple question. We had to have 70% Canadian content in our RRSP account to not exceed the foreign content limit. Now with the flood gates wide open you have have up to 100% in foreign content, which provides Canadians a significant opportunity to invest outside of Canada. This is a good thing after all Canada only has 0.5% of the world population and something like 3% of the world's market (I can't seem to find that statistic this morning).

The issue to investing in foreign content is your not only investing in bigger markets, but also in foreign currencies. You end exposed to more than you plan on which is fine during a long time frame, but somewhat problematic if you need the money any time soon. So with all this in mind here is what I suggest people do at different time frames.

Over 20 years to retirement: Keep you Canadian equity content to no more than 33% of your portfolio. You have time you don't keep too much money in Canadian equities.

Five years or less to retirement: Now should start to reduce your equities in your portfolio and covert them to more stable fixed income. Also at this time you will want to pull back a bit from foreign markets. Depending on what you want for a fixed income/equities balance, for example 60% fixed and 40% equity, you want about half your equity in Canada. So in this case 20%, but if you want a 70/30 split you would reduce your Canadian content to 15%.

Less than 20 years and more than 5 years: Now your into a bit more of personal risk territory of what you can handle. In my case I'm holding around 25 to 30% in Canadian equities, but I plan on scaling that back as time goes on.

The exception to all of the above is if you planning on a Derek Foster style retirement where you live off of just dividends. In this case you want a lot of Canadian content to reduce your tax load to near zero, since low income Canadians don't pay tax on Canadian dividend income.

That's my take on the question. What do you think? I would love to see what other people have been doing and their opinions.

Reader's Question #5

Jordan left a question on the How Much Do I Need to Retire - Part V post that I thought needed it's own post to address.

Do you have any knowledge or forecasting the success of your retirement strategy with the mathimatical principal called "Monte Carlo".

It's the idea that there is no average return, so it tries to run your investment scenarios against historical variability thousands of times to tell you how likely your investment strategy will be to succeed for X years. (that's my understanding at least)

I don't think most people use it in their calculations or are even aware of what it is.

I've seen some retirement and planning software that offers this feature and thought it seemed very relevant for long term planning and "what if" situations.

I'm sure it could the topic could cover several posts, but I thought I'd ask what you know of it, if you can recommend any specific software and if there is a reason you would or wouldn't use it.

A free online tool is available along with some interesting articles from a retired software developer at:
http://www.flexibleretirementplanner.com/

Thanks very much for your input.

A: To start off with I'm familiar with the Monte Carlo simulation, we actually use them at work to help solve multiple variable problems into a single solution (for those of you who want to know the detailed mathematical uses check out this article).

In retirement calculations they are often used to help simulate the market by producing 'random' investment returns. The calculator will often run an enormous number of calculations over the years of your retirement savings and actual retirement to give you a probability of success that your withdrawals will work (for example 90% or 50%) for your entire planned retirement (yes you have to pick when you die). Since the returns will alter slightly on each run you can input the exact same data more than once to and get slightly different results each time. If your still a bit confused about how this works check out this article (it is a very basic description).

So overall the Monte Carlo can provide some insight on how a portfolio will do over a long period of time. The key word in that last sentence was 'insight' it will not produce a prediction of the future or address all your concerns. It will give you data, but it's up to you to decide if you can live with a 95% probability of success or 85%.

There are numerous calculators out there, some free and some that ask you to buy a copy, that all do the same general thing. The problem with these are they are almost always geared to the US market and often you can't just find the one you want with the correct features. For example I would like one that I could run different phases of retirement through with different pools of cash to generate an overall probability of success for my plan, but I just can't see to find what I'm looking for so far.

If you are from the US, I would suggest using FIREcalc which is likely the best free calculator out there (which is why I have a link to it on the left hand side under Tools called FIRE Calculator).

A few words of caution here. Monte Carlo simulations can be very useful if you know what your doing. If your new to retirement planning or you don't have a great understanding all the variables you can input into these calculators you will most likely just scare yourself to death with some weird numbers and then get depressed about this entire retirement planning thing. Don't worry your retirement plan can still work without a simulation.

My personal view of these calculators is they tend to be used by those who want assurance that they will be fine. The want to know they can survive the great depression again and the interest rates of the 1980's again, which is a bit useless in my opinion. Those events were highly unusual in terms of the history of the market. It's rather like building a house based on the 1 in a 100 year storm weather conditions. Yes your house will stand up to anything, but your going to be dumping in a lot of money to insure yourself for a rare event.

Buying/Selling a House

I've mentioned before that owning your home is a good idea in retirement since it can save you a lot of money on your yearly spending (mortgage payments or rent). Now I've seen a few posts in the last week on buying a house (see Investoid's post and Million Dollar Journey's post) and it got me thinking about a few things. So here are some tips I've picked up over the years.

1) When buying a house: NEVER FALL IN LOVE! You must be able to walk away from any deal that you can't afford and you can only do that by not falling in love with a house. Don't even think of the building as a home until you sign the final papers and collect your keys.

2) Know your tolerance for doing fix up work. If you hate fixing things be prepared to spend more. Otherwise is you don't mind minor repairs and painting you can often get a house for 5 to 10% less than the going market price.

3) Location is ALWAYS important. You may not care about being near a elementary school but the next buyer might. So keep in mind living in a good neighbourhood close to a school with shopping near by is always in demand. Also don't buy into the myth that "But I don't plan on selling and moving," no one plans on moving it just happens and to ignore that could happen in the future with a house deal is just plain foolish.

4) If your home inspection turns up any potential major issues walk away from the deal. Often an inspection will only catch the surface symptoms of a problem. Once you are pulling apart walls you might discover that a minor water leak in the bathroom is really half your house is rotting. Trust me I learn this one the hard way with my first house. What I thought was a minor drywall issue turned out to be almost $10,000 in renovations to fix the structure beam and insulation in the house.

5) When selling appearance is the only thing that matters. Most buyer's can't see past what is on the surface, so you have to sell to that. Make sure the house is spotless (I mean spotless not just clean, for example your bathroom chrome should be polished every time you wash your hands) and invite a friend over who has a nicely decorated house and beg them to be brutally honest about your house. You need to have your house looking like a show home, even though no really lives in a show home your going to have to few a week or two.

6) Don't get greedy when selling your house. Just because your real estate agent tells you can get $X more than you thought your house is worth doesn't mean you can sell it for that. After all the agent is just trying to get more commission. Get the agent to give a range of what the house is worth and do some of your own research prior to getting an agent's advice. Then pick the low end of the reasonable range. That way you will have an offer quickly and if you are lucky spawn a bidding war.

7) Terms on a deal matter. If you make an offer with fewer conditions it is more likely to be accepted. I know that even seeing the term "Subject to buyer selling their current house" makes me nervous. I don't want an offer falling through just because the buyer is an idiot about selling their house. If the price still looks good on a offer with this condition consider sending a counter offer back with that term removed. If they have broken #1 above they will accept.

8) Never buy the biggest/best house on the block. They are just a pain to sell when you have to move since your typically in the upper end or top of your neighbourhood's range.

9) If you must sell your house with an agent try to ensure your moving more than 40 km for a new job so that you can deduct the commission and legal fees from your taxes that year (See here).

10) In a hot real estate market, don't lose your head and get emotional about the deal. I know it can be hard to do, but sometimes you just need half an hour to calm down and consider everything carefully. After all you house is likely your biggest single investment and you want to be sure your doing the right thing.

If anyone else has some good ideas, please leave a comment and share.

Best of Section

I'm considering putting together a series of links to some of the 'best' of this blog. What I really need is a hand picking out some of your favorite posts. So please leave a comment with what do you like and why?

I'm thinking the How Much Do I Need to Retire series is a likely one, but after that I'm not sure. I have a few personal favorites like The Specter of Inflation, but this really isn't going to be about me but rather what you like.

Thanks for your help and enjoy your weekend.
CD

How Much Do You Need to Retire - Part V

Today marks the final day of the How Much Do You Need to Retire series. For those of you who missed the previous entries check out:

Part I - Finding out your spending in retirement.
Part II - Government Benefits
Part III - Company Pensions
Part IV - Retirement and Taxable Accounts

I apologize for the long posts this week, but the good news is the math is mostly done and now we find out if you can make your retirement dream come true. First a quick review of the numbers and when I expect to start collecting them.

From 45 to 55:
Here the only accounts I'll be using is the taxable account and our RRSP's ($6270/year). My RRSP's are the baseline while the taxable account will have to pick up the slack.

From 55 to 60:
Here I'll continue to use the RRSP ($6270/year) and taxable accounts, but I'll start using my pension money($13,154/year).

From 60 to 65:
At this stage we expect to collect CPP ($8300/year) and keep using the pension and RRSP money.

From 65+:
I'll be just using my CPP, OAS ($11,800/year) and pension money.

In order to make this clear I put together a spreadsheet to show how the money is being used at each stage. The far right column is what is required from the taxable account to meet the short fall from age 45 to 60. Please note since I'm not tracking the tax bill at this stage I just combined the RRSP into a single column.

http://spreadsheets.google.com/pub?key=pIbm-AobFY4DdHphcDvgIRQ

So if you scrolled down to the bottom right corner you would notice the total required from the taxable account is $244,430 which is higher than my predicted savings of $226,773. So my dreams are shot right? No, this is where I went wrong last time. I didn't model the draw down of the money.

So taking that $226, 773 and reducing it to pay off the mortgage at that time would cost me around $31,000. The I dig out that same calculator I've been using all week and enter the following:

Start at $226,773 - $31,000 = $195,773
Saving rate of -$1723/month (this is just that $20,680 in the spreadsheet with a negative sign)
At 4.0% for 10 years (I reduced the return to reflect a more conservative portfolio)
Results in $38,153

Then for those last five years I require $7526/year or $627/month. So that would mean:

Start at $38,153
Saving rate -$627/month
At 4.0% for 5 years
Results in $5,015 left over.

So there you go. It is possible to have me retire at 45 based on my current assumptions which also include a 1% buffer on my rate of return (all numbers are in today's dollars). An alternative to reducing your investment performance is just adding 10% margin to you spending every year. The only problem with my numbers is I haven't accounted for a vacation fund, which means just a bit more savings over the years ahead.

An obvious question now is will I obsess over these numbers to ensure I make this dream come true? No not really. I'm just happy knowing it is possible. After all I know there will be unplanned expenses over the years, changes in income, inflation changes, investment under and over performance and most likely at least one more kid. A retire calculation is only a educated guess of how much you need, it by its very nature can't be correct. There are simply too many assumptions this far out. Any comments or ideas on how to improve this mess of calculations is welcome.

How Much Do You Need to Retire - Part IV

So far this week we have looked at your yearly spending in retirement (Part I), government programs (Part II) and company pension plans (Part III). Today we are going to look at RRSP's and taxable investment accounts.

1) RRSP

Both of these types of account are very similar in the fact they can be just about any investment product. The only real difference is how they are taxed. In a RRSP you get a tax refund on the income tax you originally paid for that money and then that money can grow tax free until you withdraw it (presumably in your retirement).

Despite the almost universal advice that investing in a RRSP is a good thing by most mutual fund companies and banks it actually doesn't help some people. An RRSP is used to delay the tax not avoid it. So if your in the lowest income bracket already and you expect to be the same in retirement it really doesn't give you much of a break. Yet as you climb tax brackets an RRSP becomes increasingly useful since you hope to avoid the high tax rate now and take it out at a lower tax rate in retirement.

Case in point my wife doesn't have her own RRSP. Instead we buy her a Spousal RRSP which gives me a tax credit and puts the money in her name. The idea of the this is to split the RRSP's I would normally buy between two people so when we pull them out in early retirement we can reduce our total tax paid on the money. So for example instead of withdrawing $20,000 a year in my name, we can split the money up and only pay tax on $10,000 each.

For those of you who were paying attention during the last budget you might ask, but can't we split pensions now? Yes you can split pensions, but the government never said you could split an RRSP. In fact the only way an RRSP fall under those rules if if you covert it to a RIF and your older than 65. So keep buying those Spousal RRSP for early retirement.

In my case we have around $12,500 in my RRSP and $5200 in my wife's Spousal RRSP. Using that same calculator from yesterday's post, I input the following:

My RRSP is at $12,500
Adding $135/month ($100/month + 35% tax refund)
At 5.5% interest (to keep it in today's dollars)
For 16 years, I end up with $71,490

Spousal RRSP is at $5,200
Adding $135/month ($100/month + 35% tax refund)
At 5.5% interest (to keep it in today's dollars)
For 16 years, I end up with $53,926

So in total I will have $125,416. Now assuming I'm only going to use these from 45 to 65, I can use 5%/per year of my total or $6270/year. By the way 5% is a bit of a conservative estimate since the money will be gaining interest as I pull it down (20 years x 5%/year = 100%).

2) Taxable Investment Accounts

As I mentioned before a taxable account is similar to an RRSP with the choices you have to pick from. The major difference is how you are tax on your gains. You need to understand the differences between interest, dividends and capital gains. For details I suggest reading this. The overall summary is capital gains and dividends are better than interest in a taxable account.

Currently my cash flow will allow me to save an additional $700/month beyond my current RRSP savings. My wife currently has $5000 in her taxable account.

Starting at $5,000
Adding $700/month
At 6.5% interest (the higher interest rate here reflects how this account is more aggressive)
For 16 years, I end up with $226,773.

Summary

Alright I agree $226, 773 looks like a lot of money, but there are still some significant costs this has to cover, but I can pull down almost $6270/year from my RRSP's. So in tomorrow's post I'll break down how these numbers relate to each other and how to simulate a draw down on a large pool of money.

How Much Do You Need to Retire - Part III

Today is the third post in the How Much Do You Need to Retire series. In Part I we calculated your yearly spending in retirement, while in Part II we covered government benefits. In Part III we are going to look at a company pension plans.

1) Company Pension Plans

Each pension plan is unique to some degree, so it is impossible for me to cover every detail of every pension plan. So if you don't know the details of your plan get on the phone with your HR department and request the information otherwise it is hard to determine what you are going to get.

Pension plans come in two basic types: defined benefit or defined contribution. Defined benefit used to be the standard of most companies for a number of years. You contributed to the plan during your working life and then once you retired you got a set amount from the plan based on some type of formula. These plans could be very generous. I know one lady who is closing in on retirement that is expecting 70% of her current income (averaged over the last 10 years) in retirement from her plan. The problem with these plans is they are costly to run, so many companies have been shifting over to defined contribution. In a defined contribution plan the company will match a set amount of money you add to the plan. Once you retire you will get a lump some of money that you can buy an annuity with or transfer to a Registered Income Fund (RIF) which is similar to an RRSP, but you have to take out a minimum amount each year based on your age (your options may vary depending on your plan).

I switched jobs last year and was told I had accumulated about $10,500 in my previous defined benefit pension plan. My new pension plan is defined contribution. I pay in 5% of my salary and my employer matches another 5%.

To estimate how much I will get from my total pensions I'm going to assume a 7% rate of return and reduce that by 1.5% to reflect inflation so I get a number in today's dollars (if your wondering why I'm using such a low inflation number check out these two posts: #1, #2). Therefore I will use a 5.5% rate of return. I should point out that I've been averaging over 8% on these investments, but I'm using a 1% buffer on my calculations.

So if I start off with this calculator and plug in the following values:

Starting Amount $11,000 (my total pension money saved in both plans to date)
Then I'm adding around: $533/month
At a 5.5% rate of return for 16 years (until I turn 45).

I end up with $189,978. I know that according to my plans I can't touch this money until I turn 55, but if I'm retired at 45 I won't be adding any more money to it. So using the same calculator as above I enter in:

Starting Amount $189,978
I'm now adding $0/month
At a 5.5% return for another 10 years (until I'm 55)

I end up with $328,866. If I take that money and use the safe withdraw rate of 4% I should be able to generate $13,154/year for my retirement starting at 55.

Summary

Therefore if I take that amount and add it to my government benefits I calculated yesterday I should get $13,154 + $20,100 = $33,254/year from age 65 onward. So I know now that I'll have enough money just from CCP, OAS and my pension to pay for my retirement from age 65 onwards since my target value was $26,950 from Part I.

I had planned on covering RRSP's today as well, but this post grew too big. So come back tomorrow and I'll cover those and taxable accounts. Then on Friday we will pull all this information together into how much do I need to retire at 45.

How Much Do You Need to Retire - Part II

In yesterday's post I walked you through how to come up with a yearly income requirement for retirement in today's dollars. Now today we are going to look at government benefits.

In Canada there are a few different programs you can tap into during your retirement. The most common programs people have to account for is Old Age Security (OAS) (which is vaguely similar to Social Security in the US) and the Canada Pension Plan (CPP).

Both are important to account for in your plans in some form or another. Some people don't believe the programs will continue when the baby boomers hit retirement. I think you can't estimate inflation for twenty years either, but we still try. So for now keep them in and we will add some buffer to our calculation later. Also if you really have problems with the OAS program you can drop it out of your calculations, but I would suggest leaving the CPP in as it is a pension plan run by a government. Let's face it you've got a higher risk of your work pension going belly up that the CPP running out of money.

1) Canada Pension Plan

You’ve seen the deduction on every pay cheque for years and now here is the good news. You get to cash in on some of that forced savings. The earliest you can collect is age 60. Since you don’t know when your going to die I suggest that most people just take the cash and accept that your going to have a pension reduction of 30%. The 30% reduction is worth it when you consider you are being paid for any addition five years.

I suggest you request a statement of your CPP contributions to date to determine where you currently are. If you take that you can plug it in to an online calculator and get an estimate of what you are going to earn. If you don't have a statement still check out that online calculator link as you can get an estimate based on your income. Also you have the option of adding an age where you stop contribution to simulate early retirement. In my case I got $7100/year for me while I've been playing for the numbers for my wife and I'm going to drop back her amount to $1200/year. The reason is it is becoming apparent that after doing my taxes that she won't be contributing much for the next few years. This year's total contribution for her was under $100.

I know that doesn’t look like a lot but combined, the $8300/year is still a useful base for your retirement income. The added tax benefit of a CPP pension is income splitting is allowed. Please note that if your from Quebec you fall under the Quebec Pension Plan (see here for information).

2) Old Age Security

Just about everyone qualifies for the OAS. All you have to do is live in Canada for 10 years prior to your retirement but after you turn 18 (and be a Canadian citizen or legal resident). If you've lived in Canada for 40 years or more after you turned 18 you will qualify for the full pension. If your not there I suggest you go read the fine print to find out if you can expect anything or if you qualify for other benifits such as the Guaranteed Income Supplement or the Allowance. Based on the current rates, I expect my wife and I will collect an additional $5900/year each after we turn 65. So that would add another $11,800 to our retirement income.

Summary

Therefore in total OAS and CPP will pay me and my wife $20,100/year of inflated indexed money in today's dollars. Depending on if required retirement income is fairly modest you might find yourself most of the way towards your goal after you turn 65.

Tomorrow we will continue our series and see how a work place pension and RRSP's fit into the mix.

How Much Do You Need to Retire? - Part I

Welcome to my post for the first ever Canadian PF Blog Tour. I hope you enjoy it and I encourage you to check out the other participating posts.

Over the years you most likely have heard numerous 'rules' about the amount of income you are going to need in retirement (For example, 70% of your pre-retirement income). The problem with many of these 'rules' is they don't account for what your retirement is going to be like personally so in the end they are useless.

So how do you come up with how much your going to need? You do some math and a little soul searching.

First find your last couple of pay stubs and figure out how much money you took home last month after taxes, CPP and EI (if you have a spouse you can do this together).

Then minus anything you were saving for retirement, after all when your retired you don't need to save for it anymore.

Then minus any directly work related monthly expenses. For example you won't need too many suits when you retire or that parking space downtown. Also your bill for the gas to commute is likely to drop. Don't forget about dry cleaning or the fast food for supper that you keep buying since you don't have time to cook.

Then minus your mortgage payment (don't forget to leave your property taxes in if they are combined into your mortgage payments). We are going to assume that you were smart enough to ensure your home is paid for when entering into retirement.

Then minus what you spend on the kids every month on average (after all they should be out the door or close to it when you retire) and don't forget about that RESP contribution you've been making.

Then take that monthly amount and times it by 12 to get a yearly amount. This is your base number. Now we have to start adding a few things.

Add $1000/year for each property and/or car you plan to own in retirement. So if you have the house, cottage and a car you add $3000 to your base amount. This is to cover maintenance and depreciate costs for your home and car, respectively.

Then think about what hobbies you want to do in retirement and add in an estimate on the yearly cost for those. Keep yourself from going crazy here as this might make your total look way higher than it needs to be. Also I don't recommend including travel here. I'll get to that in a minute.

If you have an ongoing medical condition which you spend money treating regularly you want to also add an estimated yearly cost for that as well.

When the math is all done you now have an estimate figure of yearly costs in retirement.

For example your numbers could look like this:

Take home pay $3850/month
- retirement saving $700/month
-work expenses $130/month
-mortgage $1020/month
-kid $270/month
= $1730 Base Amount

Base Amount $1730/month * 12 months/year = $20,760/year
Add in one house and one car + $2000
Add in hobbies + $2000
Add in medical + $0

Total amount to live in retirement $24,760/year.

Now once you have your number you can divide that by two if your doing this with your spouse. So that would be $12,380/year/person. Now take your new yearly income and do an estimate to determine your tax bill. So let's use some rough numbers.

If the basic tax exemption is around $8000 that would mean only $4380 a year is taxable. Let's assume a 25% combined federal and province marginal tax rate. So the tax bill for each person would be $1095/year. So add that back in to your total amount to live. $1095*2 + $24,760 = $26,950.

This amount represents how much you need to live for your desired retirement lifestyle. It will not be a perfect estimate, but it should at least land you in the right ball park. As I mentioned early I do not suggest including travel money in this amount. Why? After your 75 birthday you are likely going to start slowing down a bit and not traveling as much. So if you include a set yearly travel amount your going to end up with an artificially high number because your assuming your traveling until your assumed death age which isn't all that realistic.

Instead your better off just starting a slush fund for travel. Take your yearly estimated travel spending and times it with the number of years you expect to be traveling. For example, if you want $3000/ year for travel from age 75 to 45 you would need $90,000 ($3000 * 30). When calculating how much you need to retire early you just add this amount to your total.

Come back tomorrow as I start into revisiting my first try of retirement calculations (Part I, Part II, Part III, Assumptions) to see if I can really save enough money to stop working at 45.

Canadian Blog Tour

Well on Monday April 16th I will be part of the first Canadian PF Blog Tour hosted by Canadian Money Advisor. This should be interesting as he has managed to get a fair number of the PF bloggers I read together. If your interested in joining check out the link below to find out more or just wait until Monday when I have a link up for the tour.











Have a great weekend,
CD

PS: Well thanks for everyone who voted on what to do about comments on this blog. Two interesting things happened in the last week. First we only had ten votes on the comments post which shows to me the vast number of the reader's don't care which option I pick. Second, I noticed the spam I was getting before wasn't around this week at all. I have yet to delete anything. So since my major problem with comments (aka: spam) isn't around for now I'm going to leave the comments wide open (option#1). The 10 votes I did have indicated a preference for option #2, so if I start getting too much spam I'm reserving the right to start moderation on the comments.

Part Time Work in Retirement

I've briefly touched on working in retirement before (see here), but during the 100th Post Contest Sheryl Swan suggested the topic of part time paid work in retirement which is a poplar topic today. So I thought I should put together a bit longer of a post.

Perhaps first I should point out there is nothing wrong with working in retirement. Some how people get confused by the word retirement and assume that means an end to working on anything, which is no longer the case. People now are using retirement to reinvent their lives and try new things. Sometimes in involves paid work and some is just volunteer work, the only difference between the two is you get a pay cheque for one of them.

I personally seen a case where someone retired and was begged to come back part time for a while at their old job and it didn't turn out. What happened? The person in question fell back into most of their old job. It started as three days a week and then turned into four days a week. Before long the person in question felt like they hadn't even retired at all.

So how do you keep this happening in your own retirement? Well I'm going to suggest a few general guidelines about part time work in retirement.

1) Try to keep your work to 24 hours a week or less. This is only to prevent you from working too much without you realizing it. If you don't mind working more feel free to ignore this guideline.

2) Paid part time work should only be used to fund your early retirement. After 60 or 65 you should be able to stop entirely without any changes to your financial retirement plan. You have to accept that your health will fail as you get older, so don't plan on working forever.

3) Try to keep the money required from your paid work down to $5000 or less a year per person for your early retirement plan. Paid work should provide only a small amount of income to make your life more comfortable, ideally you should be able to live just fine without it at all. Things change over time and the idea of working might lose its luster as you get older and you should be able to stop if you want.

4) Consider a small business idea carefully. Starting a small business often requires a lot of up front work to get it established. Also try to pick something where you can choose your work hours and turn down work you don't want. Overall I like the small business model for retirement work since being your own boss you can be very flexible.

I hope that provides a few ideas for anyone considering work in retirement. If anyone else has some other ideas please leave and comment and share it.

Top 10 Signs Your Retirement Plan Is Not Going to Work

Well in the spirit of having a little fun I came up with this little list of 10 signs your retirement plan isn't going to work.

1. You are depending on double digit returns for the next 20 years.
2. You are depending on an inheritance to retire.
3. You are depending on winning the lottery to retire.
4. You are depending on your government giving you enough benefits to retire when you will have over $100,000 in debt at retirement.
5. You are depending on your kids to help you out in retirement.
6. You are not saving anything for retirement yet.
7. Your financial adviser won't return your calls after having negative returns for the last three years.
8. You don't even know if you have a pension plan at your work.
9. You think borrowing money on your credit card to invest for your retirement sounds like a good idea.
10. You are using any of the previous nine items in your own plan and you don't see a problem with it.

Got your own idea to add? Please leave a comment and share it with everyone. This post is now part of the 96th Carnival of Personal Finance.

Wills

During the 100th Post Contest, Ricardm suggested a topic of wills. A will can be a tricky thing in regards to its importance shifts around on you depending on your situation. Let's review a few different situations.

Situation #1 - Single and No Kids

Here a will is not as important for a lot of people since they have no dependents, yet it still can be useful. In this case it can be used to direct your estate to someone who may need it more than your parents (whom will typically get everything if you die without a will) such as a sibling. If you have no living relatives the government will take over your estate.

Situation #2 - Married and No Kids

In this case if you die without a will the spouse will still get everything, but in the event both of you die you will have no say on where the estate goes. Instead it follows the order in which you died. For example, if you die in a car accident and then your spouse dies later at the hospital the estate would go to your spouses parents. Your parents would get nothing. So a will in this case starts to become important.

Situation #3 - Married with Kid(s)

Once you hit this stage it is VERY important to have a will. Otherwise your kids could get part of your estate even when your wife is still alive [depending on your province your wife could get as little as the first $40,000 (in AB) up to the first $200,000 (in ON) before spliting the rest with the kid(s) - see here]. Also you have to determine who will become guardians of your kid(s).

In all of the above cases if you don't have a will the government will appoint someone to divide up your estate and charge the estate for the service. So in the interest of keeping the government out of your dead pocket you will want a short will.

Depending on your province you might be able to use a holographic will to explain your wishes (see here for where this works). A holographic will is written entirely in your handwriting and with your signature and date. It works well to provide a basic will in Situations #1 and 2 above, yet when you have kids you will likely want to see a lawyer about preparing a formal will.

That is a brief overview of wills, obviously you should do your own research by your province to determine what works for you, but in any case a will is generally a good idea to speed things along once your dead and prevent the government from taking more of your money. Good old death and taxes right?

A Short Vacation

As with any well balanced life, everyone needs to take a vacation once in a while. So with this in mind I will not be posting over the long weekend. I'll be back with a post on Tuesday next week.

Take care of yourself and try to spend one day this weekend not thinking about money. I know that's a weird suggestion from a PF blogger, but we have to remember the other half of the money equation: happiness.

CD

Comments on this Blog

Well over at Million Dollar Journey a bit a side debate started on who can leave comments on this blog. So I'm going to put this to the reader's to decide.

Your options included:

1) Let anyone post to this blog and we accept there will be spam which will have to be deleted.
2) Let anyone post to this blog, but use comment moderation to weed out the spam prior to being posted, which will result in delays between submitting a comment and having it posted.
3) Let only registered users post to this blog (the current default)

In order to have this as a fair vote I'm defaulting this blog to Option #1 for the next week. After that I'll go to what ever option you the reader's decide by the highest number of comments. So leave those comments and let me know what you want.

100th Post Contest Winner and Lock In RRSP

Congratulations to Dan who's comment was selected as the winner for the 100th post contest (Dan please send me an email with your full name and mailing address so I can send you your prize). To celebrate Dan's win I'm going to cover his suggested topic of the Lock In RRSP.

The obvious place to start with an Lock In RRSP is a definition. A lock in RRSP is also referred to as a LIRA account and comes about when you leave a company with a vested pension. When you leave the company you are offered typically two choices:

1) Take a partial pension age the regular age of your pension plan (often in your 60's) or
2) Take a lump sum transfer to a LIRA account

Now a LIRA account can be either just mutual funds, a self directed account or just about anything an RRSP can be invested into. The trick with a LIRA account is you can't withdrawl the money until the age specified by your plan or your provincial Pension Act (often around 55 at the earliest) or add money to it unless you get another pension lump sum payout that has vested.

So Locked In accounts provide a interesting challenge to your investing. You know you may not going to be adding to the account ever, so you have to pick your choices wisely based on the amount of money you got deposited to your account. Depending on how much you get for a lump sum, ETF might be a great choice since you would have very low fees for a long investment horizon. One last thing to note is if you get a small amount look up your provincial Pension Act, you might be able to un-lock small pension amounts and move it over to a regular RRSP account.

I personally like a Lock In RRSP since I can take my pension money with me after I'm vested with a company and not have to worry about the company making changes to the plan after I'm gone.

Mortgage vs Investing Debate...Again

Well with Money Diva's comment yesterday and MCM topic idea for the 100th post contest (by the way today is the last day to enter to win a $25 gift card to Chapter's book store) I've decided to touch on the entire mortgage versus investing debate again (for round #1 see here).

The overall debate goes like this. You have two compounding curves fighting each other in this case. Your mortgage is a negative compounding curve while investing is a positive compounding curve. In either case, they are both great ideas to put your money since they are compounding. Yet each way has some different factors to consider.

On the mortgage side, if you put your money here:
- You get your mortgage interest rate as a after tax rate of return in savings on your mortgage interest you pay
- This rate or savings, unlike any stock, will be there for the entire length of your mortgage guaranteed
-Paying off the mortgage will ensure you need less of a cash flow in retirement
-If you sell your house you can take any gains you make tax free (if it is your principle residence)
-Paying the mortgage off sooner works better in the beginning of the mortgage because you get the compounding savings over a longer period of time

On the investing side, if you put your money here:
-Over a long period of time you can on average get a higher rate of return with stocks over the current mortgage rates
-Yet you will be taxed on that rate of return regardless if it is in an RRSP or not (in the RRSP you just get to defer it and hopefully get taxed at a lower rate when you pull it out, but it still gets taxed. An exception to this is low income earners who collect dividends outside of an RRSP, but they will still be taxed on capital gains if they ever sell the stock.)
-If you borrow money to invest outside an RRSP you can deduct the interest from your taxes
-Investing earlier will make compounding work more for you with more time

So with a debate like this it is easy to get confused just with the number of variables involved. Yet let's take a step back here and think about the points I wrote above. Is it me or does the mortgage side seem to have a lot less risk involved? Also remember your savings will be on a after tax basis and if it is on your principle residence you can sell it in the future tax free, so even on a tax basis it looks good.

With all that in mind here is my two cents. In general (this doesn't apply to every case), you are better off to spend the money by paying off the mortgage on your principle residence to a point. You want to ensure you pay it off faster in the first five years for the biggest impact on your overall financial health. Then keep paying it off faster until you are sure the remaining amount will be fully paid off by the time you retire. After that point you can switch over to buying RRSP's and hopefully get a bigger bang for your RRSP tax break since you have put this off for at least five years and now have a higher salary.

Well that's my latest idea on the entire debate, what do you think?

Ten Intermediate Goals to Retirement

On the 100th post contest I had a good topic idea from The Money Diva on intermediate goals to retirement.

Early retirement planning can be rather grueling. Let's face it, you are saving for something that you will see no results from for decades down the road. It is very easy at some point to face some burnout from saving/planning for retirement. So to combat this I proudly present my top ten list for intermediate goals towards retirement savings.

1. Assess the situation.

In the beginning the assessment is going to take a while. You need to find out how much you own, where it is, and what you owe everyone else. Then you have to pick a date and start making some plans/guesses on how much to save. After the first go round you should come back to your numbers at least yearly to find out if your still on track or if you have a better estimate for something.

2. Kill all consumer debt.

Debt is like a ball and chain to your early retirement. You have to get rid of it to move on to better things. Start off with getting rid of all credit card debt before anything else (an 18% rate of return on after tax dollars is hard to beat), then move on to lines of credit and car loan(s). The idea here is to get rid of it all so you can have a big cash flow to start saving.

3. Kill the mortgage.

Ok, there is a significant debate out there around paying off your mortgage or investing for the future. The answer for each person is different, but in the case of early retirement the only number that matters is having a mortgage of $0 on your retirement date. Having no mortgage in early retirement is essential to reduce your living expenses.

4. Save $500.

Now at some point during the first three steps you likely put something away for retirement in a mutual fund. In the very beginning of saving mutual funds are hard to beat for someone just starting out. I'll touch on some good basic ones in another post.

5. Save $10,000.

With $10,000 in your account balance you can likely buy into some lower cost index funds with your bank in a nice mixture (see the Couch Potato family from Money Sense for mixture ideas). Find something that works for you and stick too it. These funds work well for someone who is still adding a significant amount each month to their account (ie: $200/month is a 2% addition to your portfolio).


6. Save $25,000.

Now at this point you can shop around for a self directed account and look at buying Exchange Traded Funds (EFT). They cost a trading fee to buy in (like a stock), but then afterwards you have a really low MER. Also at this point your $200/month is less than 1% of your portfolio, so you can afford to have it build up for a year before your rebalance your index funds.


7. Save $X.

Now at this stage you will want to flush out a few personal savings goals to bridge the gap until step 8. Pick something you like and make sure you reward yourself with something when you get there. After all we want to be happy prior to retirement, just not in retirement.

8. Save $100,000.

After chatting with various people about saving large sums of money, the all tell me the first $100,000 is the worst. After that your compounding really starts to help out and it gets easier from here.

9. Diversify investments.

Now that you have a significant nest egg built, its time to make sure you have it spread out over more than just index funds. Look at individual company stocks with good dividend growth, real estate (try a REIT if you know you could not stand being a landlord), also don't forget about those completely unsexy investments of fixed income (bonds, GIC, etc). As you get older you will want to reduce your stock market exposure to lock in your gains as you get close to your retirement date.

10. Keep setting goals.

Now here some people get confused and just set more savings goals. You also want to setup personal goals like learn a new language or pick up a new hobby. The idea here is to slowly build up your non work life to ensure you have a happy and fulfilling retirement when you finally hand in your notice.