Retirement Planning

What are the limits of investment income?

Currently, the average annual yield of a TSX stock is 2.9%, and bond yields are between 2% and 3%. Today, with the right balance of stocks and bonds and the right choice of holdings, it is possible for your portfolio to yield 3.5% annually. Some caution is required, of course, since higher yields generally bring higher risk. As a case in point, in 2009 one of North America’s largest insurance companies, Manulife Financial Corporation, cut its dividend in half, and its stock price dropped 15% the same day.

While the stock portion of a portfolio provides some growth capital over time, the expanded capital base can be expected to generate more income. It takes time and patience, however, and some growth is offset by inflation.

If my after-tax investment income plus my Old Age Security and Canadian Pension Plan benefits do not provide me with sufficient income, what can I do?

If your investment income does not adequately meet your needs, the first consideration is how you currently allocate your income. Can you reduce your expenses and maintain your quality of living? The second consideration is whether to use some capital to supplement your income. Capital can be viewed as sacrosanct and untouchable, but in challenging economic times, it may make sense to make strategic withdrawals.

At Windcroft, we can help you determine the size and timing of such withdrawals. It is essential to ensure that your capital remains large enough to support you throughout your life. The younger you are, the more hesitant you may be to make capital withdrawals. When you talk to us, we can help you make a careful and thorough assessment of the short- and long-term implications of a withdrawal.

What about the size and timing of capital withdrawals?

As a general rule of thumb, we have found that investors with balanced portfolios can withdraw as much as 5% from their investment accounts each year and expect that their capital will still grow in line with inflation. That growth will not necessarily take place every year, but it should keep up with inflation over time. Capital withdrawals may trigger taxable capital gains, but are otherwise non-taxable.

Withdrawing 5% per year from a $1 million portfolio would allow you to spend an additional $40,000 to $50,000 per year. Withdrawals in the range of 5.5% to 8% may jeopardize your inflation protection, but they can be worth considering if you are not concerned about leaving a large estate. When determining the size of a withdrawal, the need for caution cannot be overstated: withdrawals in excess of 8% can significantly impair capital, and withdrawals of 10% undoubtedly will.

Capital withdrawals are best made after a market upswing when there are profits for the taking. The actual cost of an expensive trip or a new car in a year when stock prices are sharply down is much higher than in a year when stock prices are up. If withdrawals are made when investments are at a low, the amount withdrawn has no chance of participating in the market’s eventual recovery. As a result, the pool of capital that generates your income would be permanently impaired.

When made strategically, capital withdrawals can be a safe and effective way to supplement your income.