Advice on parents' retirement portfolio

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sophiesworld
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Advice on parents' retirement portfolio

Post by sophiesworld »

My parents in law are retiring and currently have their low 7 figure portfolio with a financial advisor (MER=1%-1.86%). We want to move them into a simple and tax efficient Canadian equivalent of a "US 3-fund boglehead portfolio". The in laws have already been convinced to make the change by my spouse, who will do all the requisite handholding and legwork.

Emergency Funds: ~1 year
Debt: None
Tax Filing Status: Married
Tax Rate: 26% Federal, 12.16%
Age: ~70
Desired Asset Allocation: 50% stocks/50% bonds
Desired Stock Allocation outside Canada: 60% Canadian, 20% US, 20%International (unsure - more about this in text)

Current Assets:

Corporate Investment Account: 18.54%
Individual Investment Account: 29.73%
His RRIF: 36.01%
Her Individual RRSP: 6.25%
Her Spousal RRSP: 9.47%

Current holdings are not listed since they are all proprietary funds that will be liquidated.

Pensions: ~$1400/month OAS+CPP based on February deposits.

Contributions: None expected.

Current plan:

Move all assets over to new accounts at RBC and buy the following ETFs:

50% Bonds: VAB
30% Canadian equity: VCN
10% US equity: VUN
10% International equity: VIU

Questions:
1) Is the Canada/US/Intl stock allocation reasonable? Is there a better choice of funds?
a) Use VXC (gobal ex canada) to avoid VIU/VUN overlap?
b) Use VFV (S&P 500) with lower expense ratio than VUN (total US)?
c) Use VTI (US-based ETF) instead of the Canadian ETF (VUN)?
2) What is the most tax efficient way to allocate ETFs among accounts? Assets are currently split 50/50 across taxable/non taxable accounts. Should we fill the retirement accounts with VAB and then allocate the equities to the taxable accounts? I'm a little concerned that rebalancing may be a bit challenging as required withdrawals are taken from the retirement accounts.
3) Is it correct that holding VUN in a taxable account allows for the best tax treatment - i.e. US withholding taxes can be claimed against income?
4) Should we be setting up GICs instead of using VAB for the fixed income portion of their portfolio? (7 figures)
5) Is it worth opening up TFSAs for them and using it to hold part of the emergency fund and/or part of their bond allocation?

Thanks in advance and we appreciate any advice for optimization/simplification.
Last edited by sophiesworld on 15 Mar 2016 01:13, edited 1 time in total.
2of3aintbad
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Re: Advice on parents' retirement portfolio

Post by 2of3aintbad »

I think much will depend on the amount of time you, or someone else, are willing to spend on this portfolio year after year, rebalancing, handling forced RRIF withdrawals, etc. But personally I would put the GICs and VAB in the RRIF and RRSPs. So to start with, you will have about 52% there but that % will decrease every year as you make the RRIF withdrawals. Eventually you will be below 50%, so if you want to keep that level, you might as well use the TFSA contributions each January to buy more GICs or VAB.

No TFSAs? I would max out them out with emergency savings and non-Canadian equities.
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Re: Advice on parents' retirement portfolio

Post by Peculiar_Investor »

Welcome to FWF.

Generally the proposal looks pretty decent. What, if any, are the annual income needs that the portfolio is required to generate each year? This might have some impact on how to allocate the ETFs between accounts.

To address your questions.

The Canada/US/International stock allocation looks good, as does the ETF choices. There are pros and cons to using the US listed ETFs (VTI and VEA) rather than the Canadian listed versions. Generally the US ETFs are lower MER, but you'll need to handle the currency conversion to purchase and for any rebalancing, there could be US estate tax implications and there are additional tax form requirements (T1135). Keeping everything in the Canadian listed versions keeps things simpler but at a slightly higher cost.

At the end of the day, the goal should be keeping costs low, not necessarily minimizing them. The enemy of a good plan is the dream of a perfect plan is very sage advice. Keeping it as simple as possible, but no simpler and easy to manage is important and gives a greater chance of success.

You might want to read a couple of articles from our wiki, Simple index portfolios - finiki, the Canadian financial wiki and Tax-efficient investing to help address your questions about which funds to choose and which accounts to utilize for tax efficiency.
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AltaRed
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Re: Advice on parents' retirement portfolio

Post by AltaRed »

1) From my perspective, allocations to US and Int'l are too low. Since it appears the couple has the means to travel and/or spend money, a lot of what they buy will ultimately be influenced and effectively priced in USD or Euros (including gasoline at a Canadian pump). I would make it more balanced BUT that is a personal choice and one advantage to Cdn equities over ex-Canada equities is that dividend income has more generous (lower) tax treatment. VUN or VFV if held in a TFSA or RRSP will have non-recoverable US withholding taxes. Not that it is a big number but effectively results in a higher MER. Would be better to hold VTI in a RRSP (no US withholding tax) but does involve a currency conversion. XAW is perceived to be a better choice than VXC if you wish to hold all ex-Canada in one ETF. Lots of good reasons for doing so.

2) I would choose to hold the fixed income in the retirement accounts. I would not worry about re-balancing issues. If fixed income becomes underbalanced due to mandatory withdrawals, then convert some equity in non-registered into something like VAB or VSB from time to time, every few years or so. Don't fine tune re-balancing too precisely. Variations of +/- 5 percentage points do not matter much. Don't overwork the solution. Chances are the retirees will decide to buy a nice new car at some time and all that money can come out of equities. One more point: Don't re-invest distributions. Let the distributions be free cash as part of the spending money or to populate TFSA room each year.

3) Responded to in 1) above. Using VFV or VUN in a registered account will result in non-recoverable US withholding taxes. Best to use VTI in an RRSP to avoid withholding taxes altogether. However, the leakage would only be 15% of the yield of the ETF....so 15% of 2% is not huge....but is inefficient. Don't put US equity in a TFSA as TFSAs are not recognized by the IRS as retirement accounts and withholding taxes will be non-recoverable.

4) Who is going to manage the GIC ladder? At a sizeable FI component, I could forsee 10 ( one maturing every 6 months) or 15 (with 3 maturing each year, e.g. every 4 months) or 20 (with 1 maturing every quarter). VAB avoids hands on management AND the tendency to not want to renew a GIC at 2% (we see posts on FWF all the time regarding that reluctance)

5) TFSAs are the best thing going since sliced bread. A grand place to put money away as an emergency fund*, or to build as a legacy for children/grandchildren. Fill the TFSAs with part of the non-registered allocations. The best components to put there would be fixed income and/or Cdn equities and/or a REIT component such as ZRE if the retirees want to allocate a portion of their Cdn equity to REITs. It is best not to put ex-Canadian equity in a TFSA for reasons already stated, i.e. non-recoverable withholding taxes.

* although an emergency fund by definition is 'ready cash' so that means an HISA of some sort making 0.7-1.5% and that may be best left in non-registered and use the TFSA space for something that has a higher return.

It will likely not be practical to slice and dice everything 100% tax efficiently simply because there are currently 5 accounts, and 7 accounts once TFSAs are established. Avoid the tempation slice and dice a number of components in each one. It is perfectly fine to have only one holding in one account, e.g. a TFSA or non-registered, although I would suggest at least some FI in the RRIF to provide a cushion for mandatory withdrawals should there be a terrible equity market year like 2008-2009.

A key question has already been asked. Who is going to manage this portfolio long term? I have some concern about the words "the inlaws have already been convinced to make the change by my spouse". Will there be hard feelings directed toward your spouse if there are bad investment years?
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Re: Advice on parents' retirement portfolio

Post by ockham »

AltaRed wrote: 5) TFSAs are the best thing going since sliced bread. A grand place to put money away as an emergency fund*, or to build as a legacy for children/grandchildren. Fill the TFSAs with part of the non-registered allocations. The best components to put there would be fixed income and/or Cdn equities and/or a REIT component such as ZRE if the retirees want to allocate a portion of their Cdn equity to REITs. It is best not to put ex-Canadian equity in a TFSA for reasons already stated, i.e. non-recoverable withholding taxes.
AR, I'm a great admirer of your portfolio analyses, particularly your ability to cut through the noise and instead focus on the essentials. I do think, however, that the bolded statement (your statement but my bold) deserves reconsideration.

IF one's choices come down to Cdn equity in TFSA or in taxable account vs ex-Cdn equity in TFSA or in taxable account, my choice is Cdn equity in taxable and ex-Cdn equity in TFSA.

It's important to understand what "recoverable/non-recoverable withholding taxes" means in this choice context. "Recoverable" just means that the foreign taxes withheld are (in part or in full) credited against taxes you will otherwise and in any event be paying on ex-Cdn div income. Because ex-Cdn divs are treated as ordinary income, the TFSA still saves you about 15-30% (depending on individual MTR, of course) on ex-Cdn div income. I'm thinking that for most people that's more than what the TFSA saves you on Cdn div income (once you factor in the DTC).
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Re: Advice on parents' retirement portfolio

Post by AltaRed »

ockham wrote:It's important to understand what "recoverable/non-recoverable withholding taxes" means in this choice context. "Recoverable" just means that the foreign taxes withheld are (in part or in full) credited against taxes you will otherwise and in any event be paying on ex-Cdn div income. Because ex-Cdn divs are treated as ordinary income, the TFSA still saves you about 15-30% (depending on individual MTR, of course) on ex-Cdn div income. I'm thinking that for most people that's more than what the TFSA saves you on Cdn div income (once you factor in the DTC).
Yes, I do see your point and agree the decision would/could depend on MTR. I suspect with the overall value of the portfolios, MTR might be high enough that the DTC has less effect on that decision than it might otherwise be, but that is what the OP can wrestle with if s/he wants to dig that deep.

The OP is going to be challenged in distributing 3-5 holdings across 7 accounts so there will be some tax inefficiencies anyway. It is best not to get one's knickers in a knot over the trees and forget about the forest.
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Re: Advice on parents' retirement portfolio

Post by scomac »

AltaRed wrote: A key question has already been asked. Who is going to manage this portfolio long term? I have some concern about the words "the inlaws have already been convinced to make the change by my spouse". Will there be hard feelings directed toward your spouse if there are bad investment years?
This is the very first thing that crossed my mind; if an income stream is required and one would most likely assume that to be the case, how is it going to be created and who will be responsible for conducting the trades (if not automated) to bring that about? From my perspective, it is the practical questions of how will the end goal be met rather than the way in which it is being done that are the most pertinent.

With respect to the TFSA, for me placing Canadian equities in such an account make the most sense as that lessens the impact of gross-up of dividends should the individual(s) be nearing the clawback thresshold for OAS or any other income tested benefits.
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Re: Advice on parents' retirement portfolio

Post by BRIAN5000 »

Pensions: Not known at this time.
Age: ~70
If there is a principle residence in either Vancouver or Toronto sale may cover off any extended care needs.


The pension issue is kinda important if they both have CPP & OAS and even small pensions if this portfolio is to be invested FOR the parents with the parents risk tolerance in mind (not yours) it could maybe all go into GIC's or other easily managed fixed income taking the 50/50 down to 25/75 could be appropriate. If the parents are ok with it being invested for the next generation, cause probability says that's as far as it will go :( , 50/50 seems like a reasonable allocation to me. Remember they are 70 and a 3 million portfolio at 2% + pensions will produce $60,0000 plus.
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Re: Advice on parents' retirement portfolio

Post by sophiesworld »

Thank you 20f3aintbad, Peculiar_Investor, AltaRed, ockham, scomac and BRIAN5000 for the welcome and the feedback.

Spouse and I are willing to put in the time necessary to rebalance annually and manage RRIF withdrawals. In early Jan, automatic monthly withdrawals are set up from the RRIF to meet required min withdrawals. As suggested, dividends from the taxable portion of the account go to the bank account and don't get reinvested. TFSA contributions and rebalancing can be handled at this time. The parents are more than capable of handling the practicalities of withdrawing money but spouse is there to help/support them as needed.

I was hoping to preempt the standard concerns about getting involved in family member finances, as I've seen that reaction in many threads in the boglehead forums. It's impossible to provide enough information to convince 'all the people all of the time' so please take my word for it that this degree of involvement is appropriate in the context of our family relationships and culture.

We weren't enthused about dealing with a GIC ladder so we will fill the registered accounts with VAB.
There won't be any space in the registered accounts to hold VTI and it's not worth dealing with the currency conversion whenever they want to withdraw money. Looking further into XAW (no conclusion yet)

OAS+CPP numbers have been added in the pension section. The rest of the portfolio can cover expected spending based on the 4% rule but this will help reduce the withdrawal rate.

Also updated first post to indicate one account is a corporate investment account, so money withdrawn from it is taxed as dividends. Looking further into its tax treatment.

The available TFSA space is smaller than 10% of the portfolio so no matter what goes into it, there'll still be some portion of Canadian or ex-Canada equities in the taxable accounts. I'll need to do some more thinking/modeling about the impact of Cdn vs ex-Cdn in TFSA as mentioned by several of you.

Thanks again! I'm doing some more research and may come back and add on a few questions once I know what to ask.
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