One investor's miserable stock market declines are the makings of another investor's high-yield retirement savings plan.
As the Monty Python gang so succinctly put it, “always look on the bright side of life.” Stocks, income trusts and corporate bonds are way down in price, which means the yield on the dividends, distributions and interest they pay is way up. Right now, you can capture their high yields and build yourself a retirement portfolio that covers your living expenses each year and leaves lots left over.
The financial planners at TriDelta Financial Planners came up with this idea and they make some very impressive claims for it. Using the example of a retired couple with a combined $500,000 in retirement savings and no company pensions, they say it's possible to generate an annual after-tax income of $45,000 a year and have lots left over.
The risks are not inconsiderable. High yields on stocks, trusts and bonds are a sign of how frightened investors are about the global financial crisis and unfolding global economic recession (prices and yields move inversely). We're starting to see companies cut their dividends in response to the current difficulties and it's a sure thing that more such announcements will come.
That's why TriDelta suggests a high-yield retirement income plan be based on a well-diversified grouping of preferred shares, investment-grade corporate bonds, solid income trusts and blue-chip dividend stocks. TriDelta offers these examples (obviously, you have to research these names to see if they're right for you): Bank of Nova Scotia and Manulife Financial Corp. among dividend stocks; RioCan Real Estate Investment Trust, Yellow Pages Income Fund and Crescent Point Energy Trust among income trusts; Loblaw Cos. and Scotiabank among preferred shares; and Shaw Communications Inc. and Sherritt International Corp. among corporate bonds.
Clearly, this type of portfolio is not as safe as one made up primarily of government bonds and guaranteed investment certificates. Higher yields always mean higher risk. Still, high-yielding securities can generate all the retirement income you need. The stocks, trusts and bonds that generate this yield may fall in value or remain flat, but you'll be fine as long as dividends, distributions and interest continue to flow.
“You could build this portfolio any time,” said Asher Tward, vice-president of estate planning at TriDelta. “The difference now is that yields are so high that you can build a portfolio that will sustain an individual without worrying about your capital.”
The example created by Mr. Tward begins with a husband and wife who at age 67 begin withdrawing the minimum amount from registered retirement income funds (RRIFs) with a combined value of $500,000. The couple have no other sources of retirement income, other than full Canada Pension Plan and Old Age Security benefits. Let's ignore the impact that owning a home would have on their finances.
Mr. Tward estimated that the RRIFs would grow at 6.5 per cent annually, which he says is achievable by mixing stocks, trusts and bonds with high yields. You'd expect long-term increases in the price of these securities to generate further gains, but that was left out of this analysis so we could focus on yield.
Drawing on his experience with his own clients, Mr. Tward estimated that our hypothetical couple would need an annual after-tax income of $45,000 that increases by 2.5 per cent annually to address inflation.
The portfolio of high-yielding securities delivers this, and more. In fact, our hypothetical couple would still have almost $300,000 left in combined RRIF assets after 25 years and more than $350,000 in non-registered investment assets.
The explanation here relates to the mandatory annual minimum withdrawal requirements on RRIFs, which have become controversial lately. The federal government has been asked to relax the required minimum withdrawal rules so that seniors don't have to sell hard-hit stocks and equity funds to raise the necessary funds. In TriDelta's retirement fund, though, the 6.5-per-cent yield supplies the money for annual RRIF withdrawals and insulates you from declines in share prices.
The minimum amount that must be withdrawn from a RRIF each year is in the 7- to 8-per-cent range in your 70s and gradually rises to 20 per cent at age 94 and older. In following this schedule, our hypothetical couple will in fairly short order begin taking out more money than they need every year (remember, they've also got CPP and OAS).
This is a common criticism of RRIFs – that they make you take more money out of your tax-sheltered retirement savings than you want or need. It's an important issue with people living into their 90s more and more. Mr. Tward's solution to this problem is to take surplus amounts withdrawn from RRIFs and put them in a tax-free savings account, or TFSA.
Starting Jan. 1, TFSAs will allow anyone 18 and older to invest up to $5,000 a year and pay not tax on the gains. They're ideal for making non-registered investments in your working years, and they're an ideal place to put any surplus RRIF withdrawals.
Mr. Tward assumed the same 6.5-per-cent growth rate for assets in the TFSA, which in our example could be used to shield almost all the surplus RRIF withdrawals from tax. The net result is that while the RRIF is gradually drawn down, the assets invested in the tax-free account grow.
We've assumed no withdrawals from the tax-free account here, but in real life this money might well be drawn down at one point or another. “This example highlights the power of the tax-free savings account,” Mr. Tward said. “If you want to go on trips or do something special for the kids or grandchildren, this pool of money is available.” The TFSA holdings also offer a cushion in case anything happens in your portfolio that hurts your rate of return.
This month, we've seen examples of how risky it can be to rely on dividends for retirement income. The investment dealer Canaccord Capital Inc. and the forest products company Norbord Inc. suspended their quarterly dividends and there's growing speculation that resource giant Teck Cominco Ltd. will do likewise.
A couple of stocks, Telus Corp. and Power Financial Corp., just raised their dividends, which is encouraging. Still, if horrendous stock market conditions and a looming recession make you nervous about setting up a retirement fund based on high-yielding stocks, trusts and bonds, then take a go-slow approach.
“You don't have to undertake this strategy on Day One,” Mr. Tward said. “You can sit in a safe position, take a lower yield in Year One and then ladder it up over time. You start maybe with some fixed income and GICs and then opportunistically buy up your positions.”
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