Welcome to Episode 29 of Retire Me!
Current State of Government of Canada Bond Market
· Bond yields are low. Really low.
· Across the developed world, central banks have worked to lower short-term interest rates.
· In Canada and the United States, central banks are buying back long-term bonds. This drives up their prices and lowers their yields. They are doing this to help keep interest rates low in the long-term as well.
· This allows individuals and companies to borrow for less cost so that they invest in creating or buying real assets (ie. homes for individuals, and business investment for businesses).
· This may be a good thing for people who want to borrow money to invest in those types of assets. But what about people who want to own bonds? The prospects for those investors aren’t great.
· The blue line in the chart above shows the yield that an investor can expect from owning Canadian government bonds. For example, if an investor went out today and bought a 30 year Government of Canada bond, they can expect to get an annualized return of around 1.15% per year.
· Considering that inflation might be around 2%, it is reasonable to assume that the holder of long-term Canadian bonds may actually lose money over the long run after factoring in the cost of inflation.
Choices for long-term bond holders
Faced with the prospect of low bond yields for the foreseeable future, bond investors have several options available to them:
1. Search for yield in other places
1. you can look for riskier investments that will provide higher yields.
2. Last week I spoke with someone who let me know that he has a friend who is getting 11% annual returns investing in government infrastructure projects in Costa Rica. That may be the case, but what happens when you want to take a big chunk of that money out when you need to put a new roof on your house in retirement? Or, what happens if the bond defaults? Just remember, that risk and return go hand in hand.
3. If you lower the quality of your bond investments, be prepared that they may be more volatile, or you may end up losing money
2. Change your investment mix
1. a common stock and bond mix for a retiree is between 50% stocks and 60% stocks, with the balance in high-quality bonds.
2. Rather than accepting low long-term returns for the bond portion of your portfolio, you may elect to increase your stock allocation.
3. Again, as you accept more risk in the equity portion of your portfolio, you need to be prepared for higher volatility. There is no free lunch here either, unfortunately. Make sure that you stress test your plan in any case to make sure you are comfortable with the risks here.
3. Lower their future return expectations for bonds –
1. the days of a 60% global equity and 40% global bond portfolio generating the types of annualized returns that investors are used to seeing over the past couple of decades may be a thing of the past.
2. Rather than reach for yield in other places simply adjust your financial planning expectations and stay the course.
Reasons to still hold bonds
To this point, we have been looking at bonds simply based on their ability to generate returns in your portfolio. But, there are several reasons to hold bonds beyond just their ability to generate high returns.
1. Lower volatility – despite their lower returns, high-quality bonds should still provide diversification to a portfolio that also holds a large stock component
2. Income – this kind-of builds on the point above, but the retirees main concern is generating a steady stream of income throughout their lifetime. Stocks alone aren’t suitable for this. They generate higher returns in the long run, but they are far more volatile. Bonds should still act as a ballast in your portfolio, providing income in the lean years where stocks are down.
3. Re-balancing – again, this builds on the second point, but for retirees and accumulators alike, bonds can be used to re-balance your portfolio when stocks are doing poorly. So, when stocks go on sale, you can sell bonds to buy stocks.
4. Sometimes you just need money – high-quality marketable bonds and bond funds provide you with an option to create cash quickly. If you have an unexpected spending need, you can sell your shares in a highly liquid bond fund and have cash in your hands within a few days at most. The same cannot be said for lower quality, less-liquid bonds, or GIC’s
High-quality government bonds may not generate the returns we have become used to over the past 30 years. But, there are still many good reasons to hold them for retirees and accumulators alike.
Segment 2 - Charitable Donation Planning for Retirees
Continuing on our estate planning discussion - this is a broader look at the tax impacts of donating to charity in your lifetime and some ideas if you are considering making donations in your estate plan.
Many retirees devote their time and energy to charitable causes in retirement. Volunteering is a great way to remain healthy and active in retirement. Plus, giving back to causes that are important to us make us feel good.
In-addition giving time back to our favorite charities, donating money can also have a big impact on our income tax bills in retirement.
Review of the Canadian income tax treatment for donations
Chartiable donations entitle you to a three-tier credit in Canada.
1) The first $200 of donations for the year (to all charities) gives you a 15% federal tax credit, worth about 24% when you factor in the provincial tax credit.
2) Donations above $200 give you a 29% federal tax credit, worth about 47% when provincial tax is factored in.
3) If your income is over $214,368, you will get a 33% federal tax credit, worth about 51% including the provincial credit, for the portion of your donation above $200 that equals your income over $214,368.
Example: Samantha has taxable income of $220,000 and makes a donation of $20,000, the tax credit is calculated as:
· 24% x $200, plus
· 47% x $14,168, plus
· 51% x $5,632 ($220,000 - $214,368)
The 33% federal credit is available for 2016 and beyond.
The limit on charitable donations that you can claim in a year is 75% of your net income, except for the year you pass away and the year before you pass away. In those years, you can deduct 100% of your income.
Charitable Giving Strategies for retirees:
1) Combine multiple years of donations – if you contribute small amounts each year, consider combining donations over several years to get over the $200 threshold. Remember, donations of $200 and below attracts the smallest charitable tax credit. If you combine your donations over a couple of years to get over that line, the charitable tax credit will be worth more.
2) Combine charitable tax credits with your spouse and claim them on the higher income spouse’s return – consider claiming your charitable donations onto the higher-income spouse’s income tax return. This will allow you to avoid getting the low credit on $200 of donations and below twice (see above). If you or your spouse earns above $214,668, consider claiming the charitable contributions on the higher income spouse’s tax return to take advantage of the third tier of credits mentioned above.
3) Donate securities or assets to charity instead of cash – instead of donating cash to charity, consider donating actual securities or assets. This will enhance the size of your gift, as well as the income tax savings for you.
For example – Samantha wants to make a large gift to her favorite charity this year. Sam has a non-registered investment portfolio that is worth $50,000 with a cost basis of $25,000. Sam has two options:
1) She can sell the securities and donate the proceeds – Sam would realize a $25,000 capital gain (50% taxable at her marginal tax rate). After setting aside the money she would need to pay the taxes, her gift to the charity would be $43,625 ($50,000 minus ($12,500 taxable capital gains x 51% marginal tax rate)). Her donation tax receipt would be for $43,625.
2) She can donate the securities directly to the charity – there is no capital gains income inclusion for donated property, as long as the property is marketable securities (ie. stocks, bonds, ETF’s, mutual funds). So the total amount of the portfolio could be donated with no capital gains tax going back to Samantha. Her donation tax receipt would be for $50,000.
Charitable Donations made through your will
If you decide to make a donation to charity through your will, remember that the charitable donations limit is 100% of your net income in the year you pass away, plus the year before you pass away. This will give your executors some flexibility to figure out the best way to spread out your charitable tax credits and achieve the most tax savings.
When planning out charitable donations in your estate plan, consider the following:
1) Family First – while giving to charity is a noble cause, make sure that you have considered your spouse and dependents’ needs before making a sizeable charitable donation.
2) Be clear in your intentions – make sure you identify the charity you want to donate to using their exact legal name and contact information and make sure to keep it up to date. There have been legal battles between charities of similar names, or divisions of the same charity, because the will was not clear which entity the gift was meant for.
3) Make sure that your estate has enough cash to make the gift you intend – if your estate clearly states that you want to give a certain dollar figure to a particular charity, and the estate doesn’t have that cash available, your executors will be forced to sell other assets to fulfill your wishes. Make sure you have thought this through in advance and identified the assets that you wish to use to make your gift
4) Be mindful of big gifts – if you plan to make a large charitable gift in your estate plan, the value of the gift may end up being larger than the amount you can use to write off against your income taxes. In this case, you might consider a longer-term giving plan that spreads out your gift throughout your lifetime. This strategy will allow you to maximize your tax benefits and have more control over how the gift is given. You may also get some satisfaction seeing how your gifts made a difference while you are still alive.
Disclaimer - This podcast is for informational purposes only. Please consult with a financial advisor familiar with your unique financial situation before making any decisions. Nothing in this broadcast constitutes a solicitation for the sale or purchase of any securities. Any mentioned rates of return are historical or hypothetical in nature and are not a guarantee of future returns. Mark Walhout is the owner and lead financial advisor at Walhout Financial and an Investment Fund Representative at Investia Financial Services Inc.