Blessed by the Potato

A common myth is that you can’t withdraw from your RRSP until retirement (except for programs like the HBP or LLP). There’s actually no such restriction: you can withdraw at any time, but the withdrawal will get added to your income for the year, and you will lose that room. Now, most of the time that means you’re going to want to wait until retirement before withdrawing anyway.

But what if you’re in a period of your life where your income is temporarily low? Mat/pat leave, or a job loss, for example? It may make sense then to pull some of your money or investments out of the tax shelter when you can do so at a lower tax rate.

Reminder: The RRSP is beneficial in two basic ways: it provides tax-free compounding of your investments, and lets you contribute with pre-tax money, so you can engage in tax arbitrage by deferring the tax until later, when you might be in a lower tax bracket. Much of the time the tax arbitrage is not much of a benefit, as clawbacks of various programs can make your effective tax rate in retirement higher than raw income might suggest. But, if you have a year with minimal income (because of job loss, mat leave, etc.) then you may find yourself in the lowest possible tax bracket (lower than when you contributed the money) so there’s an advantage to withdrawing then. But you’ll be trading away the one benefit for the other. Is it worth it?

There are a few basic scenarios to consider, and your own different tax rates and rates of return will play a role, too.

The biggest question to start with is whether or not you have excess RRSP room. For many younger people who start saving early, getting 18% of your pay in RRSP room and a chunk of TFSA room (~10% of the YMPE) means that you’ll have more tax shelter space than you will fill. In that case, burning some of it up to withdraw in a low-income year is an easier decision: you pay tax at a lower rate, then put it back in when you’re in a higher bracket. The benefit from tax-arbitrage just between the bottom rate of 20% and a middling ~30% is a one-time gain of ~10%, which is going to far exceed one or two years of tax on investment growth (assuming you don’t actually need the money to pay for your expenses while out of the workforce).

If you have excess RRSP room, it’s a pretty easy choice to withdraw during a lower-earning year. You can even plan in advance for this where possible. For instance, you may ordinarily use your TFSA for long-term savings, but if you’re pregnant and expecting to be off work the following year, you might choose instead to use your RRSP (or even withdraw some funds from your TFSA to contribute to your RRSP), then withdraw those funds when your earnings are lower the next year.

We’re not all in that boat though — if you started building up a non-registered account before the TFSA was introduced, or if your RRSP room is used up by a pension, or if you have earnings that don’t generate RRSP space (like grad school stipends or dividends from your small business), or if you just simply have a high savings rate (which may be needed for early retirement plans or because you wasted your 20s in grad school and have to play catch-up or because you’re renting-and-investing-the-difference), then you might not have any available RRSP contribution room to put back what you take out in a low-income year. In that case, you’ll want to be more careful and certain that a withdrawal in a low-income year will really help you before you go through with it and burn the space.

Now it’s harder. You could get the one-time benefit of pulling money out at a low rate, but then you’re going to have non-registered investments that grow more slowly due to the tax drag than registered ones — and if you expect to be in a low bracket at retirement anyway (or for several more years as your disability takes time to resolve), then taking the money out early is of no real benefit to you.

There are going to be a number of factors at play: you’ll have a higher rate of compounding on your RRSP investments than non-registered ones (made even more complicated by the fact that some capital gains can be deferred a long time even in a non-registered account). The length of time to consider will matter, too: if you’ll have to pull the money out in a few years anyway, then it may make sense to withdraw early, as the difference in growth rates may not add up to much compared to the difference in effective tax rates of the withdrawal. If it would be a few decades before you would otherwise take money out of your maxed-out RRSP, then even a modest tax drag can add up to a large effect and you’d be better off just leaving things alone in your off year.

To help look at a few scenarios, I’ve put together a spreadsheet available here. You can play around with it to see which is better, and also how much you’d be off by in different scenarios if your assumptions are wrong.

For example, we can run a scenario where Wayfare is 37 and would be in the 20% tax bracket this year, but in a few years is able to return to work and get back to the 30% tax bracket, and then will stay in that bracket until the money is needed in 18 years (retirement at 55). Let’s assume her investments grow at 7% inside the RRSP, and at 6.5% outside. In that case, she is a bit better off to withdraw early (~$122 extra in the future for $1000 withdrawn today). If instead the disability is permanent, and the later withdrawal would also be at 20%, then she would have been better off leaving the money in her RRSP. The optimism costs ~$193 (in lost growth in future dollars) for $1000 withdrawn today (about 8% of her future investment value). If her non-registered investments are less tax-efficient and only grow at 5.9% (because her earnings power returns, for example), it’s an even worse deal to withdraw early.

It’s a tough call — you have to know the future to say for sure how much (if any) you’ll save.

And for the case of someone with no spare RRSP room and non-registered investments, there’s a similar dilemma of whether to realize the gains now in a low bracket, paying tax now so you have less to continue investing, but resetting your cost basis higher for the future. The second tab of that spreadsheet looks at some cases for that decision.

Of course, we’re actually facing these decisions. While going in I thought it would make sense to take advantage of a low-income year, after looking at a few scenarios we’re not going to burn any RRSP room as long as there’s still non-registered investments standing behind the emergency fund.

In the 2nd quarter update I said that things were bad, I wasn’t blogging much, etc. Well September was so much worse, with quite a few all-nighters near the end of the month for a major grant, and I ended the third quarter up 12 pounds — putting me over the “never” point that started this whole goal.

That’s just bad, no sugar-coating that (mmm… sugar-coating).

On the bright side, the crazy busy period is just about over: I’ve got the long weekend here to finish up the changes to the book to get the 2nd edition out the door, and then things should be relatively quiet for the rest of the year [engages in all the superstitious rituals].

Considering my very modest progress before, just getting back to normal isn’t enough — I have to step things up. One thing that was working earlier in the year was to actually track everything that went into my junk-food hole (and I never should have stopped that). A commitment mechanism is another good way to go, but I’m not quite sure what to commit to yet: I could donate money to a cause I’m against, or let Netbug do my meal planning. What I think might be fitting would be to cut the price on stuff I sell: the course and e-book. I’ve created an exponential scheme for the course price to be cut and a linear one for the ebook depending on how badly I fail come the end of the year.

The Ontario Municipal Employees Retirement System (OMERS) is one of those big pension funds you hear about, providing sweet defined benefit pensions to government workers, and buying up companies and assets to help fund those pensions.

A reader asks:

Because I participate in an OMERS’ pension fund at work, I have the opportunity to invest in Additional Voluntary Contribution (AVC) within the same fund. This fund has been doing quite well so should I consider this?

The AVC is a neat option at OMERS: you can treat them like a mutual fund or ETF and invest in the same investment portfolio they’re using to try to meet their members’ pension obligations, on top of what they’re investing for you for your pension. It’s widely diversified with reasonably low overhead/MER-equivalent (~0.6%), and you can set it up to automatically take contributions straight from your paycheque. As a one-fund solution, you don’t have to see the performance of individual asset classes or worry about diversification and rebalancing decisions, you’ll just see the smoothed over-all performance.

I should note that this is not buying additional service or pension credits — it’s an investment managed by them, with no guarantees about what the funds will pay for in retirement (unlike the DB pension itself). The fact sheet also mentions limitations to the timing of withdrawals that limit the liquidity, which appears to limit you to only withdrawing in a 2-month window in the year, and then only 20% of what you have invested, which can really limit flexibility if these funds are for anything other than retirement.

Now, if anyone could waltz in and sign up to invest in the OMERS AVC, this would be a really interesting option to present alongside Tangerine, robo-advisors, and TD e-series. However, only people who are already OMERS members can do it. And that’s where my natural paranoia suggests this is not the way to go. OMERS has a great management team, the portfolio is diversified, and has competitive past performance relative to a passive index fund portfolio… but you’re already depending on them to come through for your DB pension, which is likely a big part of any member’s retirement plans. And as great a basket as it may be, you’ve already got a lot of eggs in that OMERS basket. In the unlikely event that they fall on their faces and have to trim DB benefits, you wouldn’t want the rest of your investment portfolio with them, too. And it adds one more thing to transfer (or think about transferring) if you get another job.

What do you think, would giving the AVC a pass be prudence or overly paranoid?

Edited to add: Over on Twitter, Sandi adds this:

I’d want to know what % future income relies on OMERS before cautioning against. (“It depends!!”)

And of course, that’s a good extra factor to consider. If you have 30 years of service with OMERS, your basket with them is going to be much bigger (and the over-exposure may be more of a concern) than if you have 5, and most of your retirement needs are funded elsewhere (where doubling up for some additional investments may not be a big concern).

In a widely seen CBC Marketplace report, the reporters spread the unhelpful tidbit that there’s a magical difference between the spelling of advisor and adviser. They say:

“Advisers” are regulated and have a legal responsibility to act in your best interest. “Advisors” are … not the same.

And since then I’ve seen that “tip” repeated many times when people are looking for advice: “go find an adviser” they may say, not having one themselves. However, it is missing the broader lesson and is unhelpful: job titles are misleading and unhelpful in the financial services industry. More importantly:

Advisor may not be regulated, but adviser is not used.

In what appears to be the original report kicking off the mini-controversy, of 121,932 registrants they looked at, only 17 across the country used the title of “Adviser”. Basically nobody uses that title, so when people repeat the “o” vs “e” issue and suggest that you go find an adviser — such a creature (effectively) does not exist! In an article at advisor.ca they did a check, and of 26 people who did use the term on their LinkedIn profiles, 24 did so in error; others may also use it under the aegis of another licensing body (such as insurance sales).

I’ve seen too many times people repeating the “o” vs “e” spelling difference as though it’s a helpful tip when looking for advice. It’s a distraction, nothing more. The real lesson is that most job titles (whether it’s advisor, vice president, or portfolio doctor) don’t actually tell you anything about whether the person you’re sitting across from is licensed to sell a particular product, experienced enough to provide you advice, or regulated to act only in your best interest. Indeed, some of the least regulated titles (like coach, planner, planning-farmboy, or instructor) may be the best people for you, who would put your needs ahead of any commission (’cause there isn’t one), even if there isn’t a regulatory framework and force of law to make it so.

I recently read Algoirthms to Live By: the Computer Science of Human Decisions and enjoyed it. It takes a few important problems for which algorithms are used in computer science, explains what they do and some of the challenges associated with them, and then relates that back to everyday life.

This is the sort of book where I am clearly the intended audience: the authors do a decent job of making everything understandable and relatable, and there’s some humour… but you’re going to have to have some interest in the foundational problems or you will likely lose interest. That’s not to say that you have to have a math or computer science background, they do explain it all, you should just come to this with some interest and not just my recommendation.

To give you an idea, they spend the first chapter on the Secretary Problem. They explain the problem (you want to hire the best possible secretary, but have to balance that against not wanting to spend forever interviewing; oh, and after you interview and reject someone you can’t go back to them), and how this might crop up in different situations in your life (if you want the best tomatoes at the grocery store might be one example of a secretary-like problem in action). Then some practical insights from the solutions in computer science — in this case, the optimal answer is likely 1/e, or about a third. That is, if you have 100 candidates for your job, you may want to interview the first 30-40 or so with no intention of hiring them just to get an idea of the quality of the field, then after that hire the first one that’s better than any of those previous ones.

A great take-away is from the chapter on caching. In particular, the least recently used (LRU) algorithm is the scientific justification for why your desk is covered in papers where the only organizational principle is that you dropped them there, and the ones you need more are in the pile closer to your keyboard. “What might appear to others to be an unorganized mess is, in fact, a self-organizing mess.”

I also really liked the description of thrashing and context-switching in the discussion on scheduling tasks. This is not unique to this book — lots of time-management books and articles talk about having set times to handle tasks (“interrupt coalescing”), and to turn off your phone and email notifications to handle time-intensive tasks. But for some reason this one resonated a bit more for me — when I read their description of a processor thrashing I was like “this is happening to me right now.” Of course, that’s likely idiosyncratic to me and the fact that at the time I read it, I was struggling with low productivity because I had a large number of small, equally urgent tasks (vs. the usual case of having one big important project on my plate to balance with a few smaller fires) and had to keep dropping something to…

A neat new term I came across in the book to apply to some aspects of the housing bubble is “information cascade.”

“[…] under the right circumstances, this mixing of private and public data can prove toxic.

Imagine the bidders are doubtful about their own estimations of the value of an auction lot—say, the right to drill for oil in some part of the ocean. As University College London game theorist Ken Binmore notes, “the amount of oil in a tract is the same for everybody, but the buyers’ estimates of how much oil is likely to be in a tract will depend on their differing geological surveys. Such surveys aren’t only expensive, but notoriously unreliable.” In such a situation, it seems natural to look closely at your opponents’ bids, to augment your own meager private information with the public information.

But this public information might not be nearly as informative as it seems. You don’t actually get to know the other bidders’ beliefs — only their actions. And it is entirely possible that their behavior is based on your own, just as your behavior is being influenced by theirs. […]

Just as with the tragedy of the commons, this failure is not necessarily the players’ fault. An enormously influential paper by the economists Sushil Bikhchandani, David Hirshleifer, and Ivo Welch has demonstrated that under the right circumstances, a group of agents who are all behaving perfectly rationally and perfectly appropriately can nonetheless fall prey to what is effectively infinite misinformation. This has come to be known as an “information cascade.”

[…] imagine there are ten companies that might bid on the rights for a given tract. One of them has a geological survey suggesting the tract is rich with oil; another’s survey is inconclusive; the reconnaissance of the other eight suggests it’s barren. But being competitors, of course, the companies do not share their survey results with each other, and instead can only watch each other’s actions. When the auction begins, the first company, with the promising report, makes a high initial bid. The second company, encouraged by this bid to take an optimistic view of their own ambiguous survey, bids even higher. The third company has a weak survey but now doesn’t trust it in light of what they take to be two independent surveys that suggest it’s a gold mine, so they make a new high bid. The fourth company, which also has a lackluster survey, is now even more strongly inclined to disregard it, as it seems like three of their competitors all think it’s a winner. So they bid too. The “consensus” unglues from reality. A cascade has formed.

No single bidder has acted irrationally, yet the net result is catastrophe.”

This immediately reminded me of bidding wars in Toronto, where a common algorithm is to count the number of noses at the table and multiply by some constant, say $10,000, and add that to the phony asking price. An extra bidder (or 10) should not in any way affect your perception of value for the house, yet there are many instances where this sort of bidding strategy is reported.

The quotation above also shows the one caveat — it is a slightly academic style, with references and names dropped throughout (though quite readable despite that). This is great for being authoritative, but can slow the read down.