A new study shows that three in four Canadians are not on track for retirement. With the recent economic turmoil, many working Canadians are struggling to make ends meet as it is. The same survey indicated that half the population is living paycheck to paycheck, and very few have any emergency savings built up. Living in the moment means that they’re not focused on retirement goals, and many expect to be working several more years as a result.
Although workplace pensions, the Guaranteed Income Supplement (GIS), Old Age Security (OAS) and the Canada Pension Plan (CPP) can provide funds, it’s often not enough. Moreover, the higher your income is now, the less likely you are to have your future needs met by these types of programs. If you’re among the 75% who are not on track to retire, here are the changes you need to make now:
Take a Hard Look at the Money Coming In
You’ll need to set a budget, but long before you get to it you must have a full accounting of how much money is coming into the household. Then, you’ll need to deduct between 20% and 30% of the gross for emergency expenses and retirement. Focus on building emergency savings that will cover you for three to six months first.
Eliminate Bad Debts
Carrying a balance for a mortgage or vehicle isn’t usually a problem, but more and more Canadians are maxing out credit cards and racking up other smaller debts. These things should also be knocked out of the way first.
Say Goodbye to Luxury Spending
While the older population is much better at assessing value and affordability, the younger generation is geared toward luxury items. Expensive cars, lavish clothing and trending technology add to debt. If you aren’t on track for retirement, and you’re carrying unnecessary debts, you should get yourself back on track and only purchase essential and value-oriented products.
Reevaluate Your Investment Choices
Unfortunately, many investment firms take a chunk of payments, and they fail to deliver in returns. Do a cost-benefit analysis and see if you need to consider moving your money to another firm or program. Diversification, both on a local and international level, is essential, as it provides a kind of insurance in case the economy falters. Think beyond stocks, as well. Bonds, commodities and real estate holdings can provide extra layers of security.
Use a Budgeting Program
There are numerous options available, but they all serve the same essential function. Using software or an app to track expenses takes the brainwork out of it and enables you to stick to your budget without having to work so hard.
Incrementally Increase Retirement Savings
As you pay off your debts and eliminate your mortgage, and your children become self-sufficient, you’ll obviously have more money to spend on yourself. Many people jump into doing the things they’ve been holding off on, like vacations and home remodels, but this becomes a slippery slope. As you find yourself free of expenses and debts, it’s imperative to increase your retirement savings, as well. During your last decade or two of work, your goal should be buildings toward setting aside 60% of your income for retirement. Some of the cash should go into savings, but a fair amount should be invested into dividend-paying stocks, which will add a steady trickle of supplemental cash as your non-working days progress.
Reevaluate Your Goals and Get Expert Advice
Even though most people can benefit from visiting with a financial planner, very few people do. You don’t have to be wealthy to benefit from one, either. A financial planner can help you figure out ways to minimize debts and how to save and may be able to help you get lower interest rates on the debts you already carry. If you choose not to visit a financial planner, you should still reevaluate your budget and strategy on a regular basis. This way, you can find ways to increase your savings if you aren’t setting aside enough, or enjoy more of your income now, provided you’re on track for retirement.
There was a time when a person could outright retire at a certain age, but it’s not like that any more. Today’s workers have to contribute more on their own to be able to maintain the same standard of living, and they have to work longer to be prepared. It’s still possible to retire at about the age your parents and grandparents did, but it requires more planning on your part.
Every year millions of injured Americans confront critically important financial decisions as their personal injury litigation draws to a close. In planning the path forward and beyond their injuries, the stability and security of ongoing, lifelong income from their settlement, judgment or award proceeds becomes absolutely paramount. The money simply needs to last.
Only one post-injury investment option – – structured settlement annuities or “structures” – – provides a continuing tax exemption for the growth of such benefits. If the injured individual agrees to a lump sum settlement, the tax exemption for lifelong income disappears.
As of 1983, the Periodic Payment Settlements Act (see also IRS regulation Sec. 104(a)(2)) has made all income from a structured settlement annuity over the lifetime of that individual entirely, unequivocally and absolutely tax-free. Contrasted with a lump sum payment in which only the initial payment is tax free and all subsequent earnings are subject to all applicable forms of state and federal taxation, the structured settlement is considered an insurance policy for payments rather than asset to be taxed upon growth. This view, accepted by Congress in that 1983 Act, makes the value of a structure staggering.
For example, if the injured individual deposits the lump sum settlement proceeds in a bank account, any interest earned would be taxed accordingly. If the injured individual invests the money in taxable bonds or stocks, the interest and dividends would also be classified as taxable income. However, with structured settlement annuity payments, neither the growing COLA payments nor the lump sum scheduled payments, nor the payments beyond life expectancy are ever taxable. If the injured party were to decide on an annuity payout after receiving the funds, the tax benefit would be lost because the funds were accepted separately from the settlement. The critical element is that the structure must be accepted as the payout vehicle initially.
The Tremendous Value of Tax-Free Status
The tax-free effect is quite dramatic. Consider an injured individual in the 28% tax bracket with a 2% fee for a traditional, market-based investment portfolio. In addition to having the risk of a significant reduction or entire loss of funds, the individual’s income from the investment when they are successful will face federal taxes that can reduce actual net income by 30% before accounting for state and local taxes that could tack on another 5% reduction. None of these risks or reductions exists with income from a structured settlement.
For an individual in the 10% tax bracket, earning a 4% return would have the equivalent pre-tax return of 4.44%, and a 15% tax bracket would mean an equivalent pre-tax return of 4.7%.
While a peripheral advantage, the tax-free nature of the structure payout means the individual recipient is not required to deal with the timing and accounting issues associated with the need to pay estimated taxes on this money. With a taxable event, the taxes would be the quarterly responsibility of the recipient. An error in dealing with the estimated taxes could create recurring tax problems.
Therefore, structures not only safeguard the injured individual from the volatility of the stock market, they provide continuing income that one can count on down to the penny and to the day. No wild, market-swing surprises. No reductions in income for taxes. No tax filings and accounting homework.
The Gift That Keeps Giving (and Gives in Other Ways)
In addition to the tax-free opportunity, there are other critical reasons to value the structured settlement for the injured individual. First and foremost, the structure enables the individual to couple the tax advantages with the capacity to schedule weekly income and significant payouts for any future expenses like college tuition, wedding costs or retirement needs to the day and to the penny without any worry about market or 401(k) performance. In addition, because structures are considered a policy for payment rather than an asset, such proceeds generally do not affect eligibility for needs-based public assistance programs like AFDC or Medicaid, as lump sums do. Even if the injured individual is not on Medicaid at the time of the injury, eligibility for many programs — in-facility care, for example — often requires the absence of any significant assets. As a policy rather than an asset, structure income would be immune from eligibility consideration. Lump sums such as an investment account or a bank account are highly likely to be considered assets that must be eliminated for Medicaid eligibility.
Quite simply, structures may very well be the best way to make sure that the money is peace-of-mind predictable, maximizes other income and benefits and lasts for a lifetime. However, with only 5% of eligible dollars placed in structured settlement annuities, billions in tax exemptions — as well as the opportunity for continuing income security — are squandered every year.
Is a Post-Injury Financial Portfolio “Balanced” Without a Structured Settlement?
While frequently considered an all-or-nothing option, the structured settlement annuity can be used for whatever portion of the settlement, judgment or award that the injured individual chooses. As with all responsible portfolio plans, balance is a critical value.
With a structure, an injured individual can tailor and fund her entire financial future. In addition to continuing payments, what is scheduled today will be there, exactly as needed, for a lifetime of tomorrows. It is possible to establish a college fund, for example, as part of the settlement that would both schedule and quantify tuition — all tax-free.
Given its value, security and stability, is any post-injury financial plan truly “balanced” without taking advantage of structured settlements? As a highly unusual, tax-free, benefits-exempted gift from the U.S. Congress to the nation’s injured individuals, structures should be a critical feature to secure their financial futures.
As we are sure you are aware, the financial markets have had a bit of a tough time going anywhere this year. The S&P 500 has been caught in a 6% trading band all year, capped on the upside by a 3% gain and on the downside by a 3% loss. It has been a back-and-forth flurry. We’ve seen a bit of the same in the bond market. After rising 3.5% in the first month of the year, the 10-year Treasury bond has given away its entire year-to-date gain and then some as of mid-June. 2015 stands in relative contrast to largely upward stock and bond market movement over the past three years. What’s different this year, and what are the risks to investment outcomes ahead?
As we have discussed in recent notes, the probabilities are very high that the U.S. Federal Reserve will raise interest rates this year. We have suggested that the markets are attempting to “price in” the first interest rate increase in close to a decade. We believe this is part of the story in why markets have acted as they have in 2015.
But there is a much larger longer-term issue facing investors lurking well beyond the short-term Fed interest rate increase to come. Bond yields (interest rates) rest at generational lows and prices at generational highs — levels never seen before by today’s investors. Let’s set the stage a bit, because the origins of this secular issue reach back more than three decades.
It may seem hard to remember, but in September 981, the yield on the 10-year U.S. Treasury bond hit a monthly peak of 15.32%. At the time, Fed Chairman Paul Volcker was conquering long-simmering inflationary pressures in the U.S. economy by raising interest rates to levels no one had ever seen. Thirty-one years later, in July 2012, that same yield on 10-year Treasury bonds stood at 1.53%, a 90% decline in coupon yield, as Fed Chairman Bernanke was attempting to slay the perception of deflation with the lowest level of interest rates investors had ever experienced. This 1981-present period encompasses one of the greatest bond bull markets in U.S. history, and certainly over our lifetimes. Prices of existing bonds rise when interest rates fall, and vice versa. So from 1981 through the present, bond investors have been rewarded with coupon yield (continuing cash flow) and rising prices (price appreciation via continually lower interest rates). Remember, this is what has already happened.
As always, what is important to investors is not what happened yesterday, but rather what they believe will happen tomorrow. And although this is not about to occur instantaneously, the longer-term direction of interest rates globally has only one road to travel – up. The key questions ultimately being, how fast and how high?
This is important for a number of reasons. First, for decades bond investments have been a “safe haven” destination for investors during periods of equity market and general economic turmoil. That may no longer be the case as we look ahead. In fact, with interest rates at generational lows and prices at all-time highs, forward bond market price risk has never been higher. An asset class that has always been considered safe is no longer, regardless of what happens to stock prices.
We need to remember that so much of what has occurred in the current market cycle has been built on “confidence” in central bankers globally. Central bankers control very short-term interest rates (think money market fund rates). Yes, quantitative easing allowed these central banks to print money and buy longer-maturity bonds, influencing longer-term yields for a time. That’s over for now in the U.S., although it is still occurring in Japan and Europe. So it is very important to note that, over the last five months, we have witnessed the 10-year U.S. Treasury yields move from 1.67% to close to 2.4%, and the Fed has not lifted a finger. In Germany, the yield on a 10-year German Government Bund was roughly .05% a month ago. As of this writing, it has risen to 1%. That’s a 20-fold increase in the 10-year interest rate inside of a month’s time.
For a global market that has risen at least in part on the back of confidence in central bankers, this type of volatility we have seen in longer-term global bond yields as of late implies investors may be concerned central bankers are starting to “lose control” of their respective bond markets. Put another way? Investors may be starting to lose confidence in central bank policies being supportive of bond investments — not a positive in a cycle where this buildup of confidence has been such a meaningful support to financial asset prices.
You may remember that what caused then-Fed Chairman Paul Volcker to drive interest rates up in the late 1970s was embedded inflationary expectations on the part of investors and the public at large. Volcker needed to break that inflationary mindset. Once inflationary expectations take hold in any system, they are very hard to reverse. A huge advantage for central bankers being able to “print money” in very large magnitude in the current cycle has been that inflationary expectations have remained subdued. In fact, consumer price indexes (CPI) as measured by government statistics have been very low in recent years.
When central bankers started to print money, many were worried this currency debasement would lead to rampant inflation. Again, that has not happened. We have studied historical inflationary cycles and have not been surprised at outcomes in the current cycle in the least. For the heightened levels of inflation to sustainably take hold, wage inflation must be present. Of course, in the current cycle, continued labor market pressures have resulted in the lowest wage growth of any cycle in recent memory. But is this about to change at the margin? The chart below shows us wage growth may be on the cusp of rising to levels we have not yet seen in the current cycle on the upside. Good for the economy, but not so good for keeping inflationary pressures as subdued as has been the case since 2009.
You may be old enough to remember that bond investments suffered meaningfully in the late 1970s as inflationary pressures rose unabated. We are not expecting a replay of that environment, but the potential for rising inflationary expectations in a generational low-interest-rate environment is not a positive for what many consider “safe” bond investments. Quite the opposite.
As we have discussed previously, total debt outstanding globally has grown very meaningfully since 2009. In this cycle, it is the governments that have been the credit expansion provocateurs via the issuance of bonds. In the U.S. alone, government debt has more than doubled from $8 trillion to more than $18.5 trillion since 2009. We have seen like circumstances in Japan, China and part of Europe. Globally, government debt has grown close to $40 trillion since 2009. It is investors and in part central banks that have purchased these bonds. What has allowed this to occur without consequence so far has been the fact that central banks have held interest rates at artificially low levels.
Although debt levels have surged, interest cost in 2014 was not much higher than we saw in 2007, 2008 and 2011. Of course, this was accomplished by the U.S. Fed dropping interest rates to zero. The U.S. has been able to issue one-year Treasury bonds at a cost of 0.1% for a number of years. 0% interest rates in many global markets have allowed governments to borrow more both to pay off old loans and finance continued expanding deficits. In late 2007, the yield on 10-year U.S. Treasuries was 4-5%. In mid-2012, it briefly dropped below 1.5%.
So here is the issue to be faced in the U.S., and we can assure you that conceptually identical circumstances exist in Japan, China and Europe. At the moment, the total cost of U.S. Government debt outstanding is approximately 2.2%. This number comes directly from the U.S. Treasury website and is documented monthly. At that level of debt cost, the U.S. paid approximately $500 billion in interest last year. In a rising-interest-rate environment, this number goes up. At just 4%, our interest costs alone would approach $1 trillion — at 6%, probably $1.4 trillion in interest-only costs. It’s no wonder the Fed has been so reluctant to raise rates. Conceptually, as interest rates move higher, government balance sheets globally will deteriorate in quality (higher interest costs). Bond investors need to be fully aware of and monitoring this set of circumstances. Remember, we have not even discussed the enormity of off-balance-sheet government liabilities/commitments such as Social Security costs and exponential Medicare funding to come. Again, governments globally face very similar debt and social cost spirals. The “quality” of their balance sheets will be tested somewhere ahead.
Our final issue of current consideration for bond investors is one of global investment concentration risk. Just what has happened to all of the debt issued by governments and corporations (using the proceeds to repurchase stock) in the current cycle? It has ended up in bond investment pools. It has been purchased by investment funds, pension funds, the retail public, etc. Don Coxe of Coxe Advisors (long-tenured on Wall Street and an analyst we respect) recently reported that 70% of total bonds outstanding on planet Earth are held by 20 investment companies. Think the very large bond houses like PIMCO, Blackrock, etc. These pools are incredibly large in terms of dollar magnitude. You can see the punchline coming, can’t you?
If these large pools ever needed to (or were instructed to by their investors) sell to preserve capital, sell to whom becomes the question? These are behemoth holders that need a behemoth buyer. And as is typical of human behavior, it’s a very high probability a number of these funds would be looking to sell or lighten up at exactly the same time. Wall Street runs in herds. The massive concentration risk in global bond holdings is a key watch point for bond investors that we believe is underappreciated.
Is the world coming to an end for bond investors? Not at all. What is most important is to understand that, in the current market cycle, bonds are not the safe haven investments they have traditionally been in cycles of the last three-plus decades. Quite the opposite. Investment risk in current bond investments is real and must be managed. Most investors in today’s market have no experience in managing through a bond bear market. That will change before the current cycle has ended. As always, having a plan of action for anticipated market outcomes (whether they ever materialize) is the key to overall investment risk management.