My last post about knowing when you’re able to retire based on your dividend income elicited some good questions and counter-points from Robb at Boomer and Echo. The answers I have would have involved a rather long response in the comment section, so I decided to reply in a new post. For the record, here is what Robb said:
I used to think this way, however I don’t think it’s realistic to live off dividends and never touch your capital in retirement. First of all, any RRSP savings will eventually be converted into an RRIF and face stiff withdrawal rates. Second, what if you want (or need) excess capital in one year to pay for a car, new roof, large vacation, etc.? You’d probably look to sell off some stock to access the capital. Finally, there’s the potential to work longer than needed in order to reach a target dividend income stream. It’d take a million dollars in capital to spin off $35,000 to $40,000 in dividends. Why wouldn’t you want to tap into that million dollars?
In response, I say this:
As to the point about an RRSP
Despite working in a white-collar, arm’s length government job which requires a Master’s degree, I do not have an employer-sponsored pension of any description. Although I have contributed to my RRSP in the past, with three dependants, I don’t pay a lot of tax, so I don’t feel compelled to contribute on my own to an RRSP. Heresy, I know.
The problem with RRSP’s is that all they do is defer the tax. While that is certainly a significant benefit, the other shoe, as Robb correctly points out, will drop eventually. When that money comes out of a RRIF, the tax hit can be hard. My parents are going through this right now, and are less than pleased at seeing their nest-egg trimmed significantly.
I prefer to invest money in my TFSA and in unregistered accounts.
Unregistered accounts are great for steady dividend-payers that will probably experience relatively low price appreciation. (Don’t get me wrong; prices going up is good, but I’d rather have growth-y stocks in a TFSA, so I don’t have to pay any tax whatsoever.) In the future, I also plan on borrowing to invest in dividend-paying stocks, which will mean that the interest is tax deductible.
The great thing about TFSA’s, and a feature that is often overlooked, is that the withdrawals are not considered income. As such, in a few decades, I should be able to withdraw thousands(!) of dollars per month, and the tax man doesn’t get any of it!
Now, would it be better if I had an employer-sponsored pension plan? Of course it would be, but I don’t, so I’m making the best of it. If all of my income comes from TFSA’s and dividends in unregistered accounts, my tax rate will be very low indeed.
The final point in this equation is that means-tested benefits such as OAS will not be affected by income from a TFSA at all, so I will be able to benefit that way, too. On paper, I may well be “poor”, because TFSA’s aren’t counted in those calculations. In this case, being “poor” works to my benefit.
As to selling stock
Robb correctly points out that surprises come up from time to time in life, many of which can be expensive. I may be picking nits here, but Robb says I’d probably look to sell some stocks. I may end up selling some stocks, but that would be the last option that I would look to. The earlier I was in my retirement, the truer this would be. If I’m in my late 60’s, I would rather make lifestyle changes than reduce my source of future income, except as a last resort. Twenty years later, in my late 80’s, I might be a bit more willing to dip into my cache of stocks, but I maintain that it won’t be my first choice.
I also feel it necessary to point out that part of my plan is to give myself a reasonable buffer. In my original article, this took the form of being able to live off 90% of my dividend income, allowing me to re-invest the last 10% so that my savings continue to grow.
So, could I sell stocks? Yes. Would I? I’d try very hard not to.
As to building a sufficient dividend income
It is important to realize that life is an end-game, and that when you go, you hope that you have spend a reasonable amount of your life doing things that you want to do, i.e. being retired. Quite rightly, Robb points out that you may need to work extra years (or even decades) to build your stockpile of dividend-paying stocks to a level sufficient to support yourself entirely. While I agree in principle that this may be a potential problem in some cases, I am in my early 40’s, so if I follow the typical path of working until the standard retirement age (which will surely be higher than 65 by the time I get there), I’ve got quite a bit of time to build my portfolio. Robb may have been assuming that I was planning on early retirement. I have to admit that in my younger years, I was, but that does not seem likely at this point. If we were making different assumptions, it is natural that we would come to different conclusions.
Finally on this topic, I’m afraid I have to take issue with Robb’s expected rate of return on a million dollars invested. If a million dollars were all invested at once, at current rates, yes, it could be expected to fetch $35,000 to $40,000 in dividend income per year. But I’m not going to wait until I retire to start investing. That same million dollars, invested gradually over a twenty-year working-and-investing period, would achieve a significantly higher rate of return. Taking into account doubling times, and virtuous circles of ever-growing dividend payments which in turn become new investments, I guess I’m just more optimistic about my long-term returns.
As to that million dollars
I realize that once my children and grown and on their own, my first responsibility is to myself and my wife, but if possible, we’d like to leave a reasonable/sizable inheritance for our children. If they know my wife and I are worth a bucket-load, they may not be so quick to put us in a home!
I’d like to thank Robb for his response. He made me consider my points again, and explain them more fully, and perhaps more clearly, in this second post. I also should have probably pointed out that I was mostly thinking of my own situation, which is not typical in some respects.