The Lockbox Strategy and 10 Other Retirement Income Tips from Nobel Laureate, William Sharpe

William Sharpe has contributed significant brain power to solving for retirement security. Learn about the lockbox strategy and other ways to set up your retirement income. The post The Lockbox Strategy and 10 Other Retirement Income Tips from Nobel Laureate, William Sharpe appeared first on NewRetirement.

The Lockbox Strategy and 10 Other Retirement Income Tips from Nobel Laureate, William Sharpe

William Sharpe is a Nobel Prize winning economist and the professor of finance, emeritus, at Stanford University’s Graduate School of Business. His Nobel was awarded for developing the Capital Asset Pricing Model (CAPM). He is also well known for the Sharpe Ratio, a number designed to summarize the desirability of an overall investment strategy. He has has also done extensive work on retirement income strategies and developed the lockbox strategy for retirement.

He has recently created a computer program covering no less than 100,000 retirement income scenarios based on different combinations of life spans and investment returns. (The program is available in a free ebook, Retirement Income Scenario Matrices.)

Huh? Don’t worry, we’ll explain it all below.

Below we have summarized (and simplified) some of Sharpe’s best retirement investing and income tips and strategies — gleaned from multiple interviews he has done over the last 15 years — for having enough income to meet your needs while ensuring you have enough to last your lifetime.

1. There Are Two Key Sources of Uncertainty with Regards to Retirement Income

One of the reasons Sharpe ran so many different scenarios is because there is a great deal of inherent uncertainty in predicting retirement income.

Sharpe told Barron’s, “You’ve got two big sources of uncertainty, and you can diminish one but not the other. If you invest your money in almost anything except an annuity with cost-of-living adjustments, you’re going to be subject to two kinds of uncertainty—investment uncertainty and mortality uncertainty.”

In the NewRetirement Planner you can model scenarios for both types of uncertainty. You can adjust your:

  • Mortality uncertainty — what is your expected longevity.
  • Rate of return and have different buckets of investments with different rates of return for each.

2. Mortality Uncertainly (Longevity Risk) is a Big Deal

Most people think about risk with regards to their money and investments. And, most people also try to mitigate that risk with the right mix of investments.

However, fewer people think carefully about longevity risk and how to deal with it. Sharpe points out that for a couple, longevity alone results in over 900 different combinations over a 30-year retirement, never mind the myriad of investment options.

A common way to plan for longevity risk is to simply plan on how to make your money last until you turn 100. However, that strategy means that you could be missing out on growth opportunities for your money and reduced income.

Never mind the fact that you might actually live even longer!

3. Lifetime Annuities Can Be a Good Way of Reducing Longevity Risk

Sharpe says, “Annuities are a potent and sensible instrument.”

A lifetime annuity is a guaranteed lifetime paycheck that you purchase with a lump sum of money. You get the income no matter how long you live.

You can model the use of a guaranteed lifetime annuity as part of your overall retirement plan in the NewRetirement Planner. Estimate how much income your money can buy now (or in the future).

4. Use Index Funds — Not Managed Portfolios or Individual Stocks

Sharpe told Money Magazine, “The only way to be assured of higher expected return is to own the entire market portfolio.” An easy way to own the entire market is to invest in index funds.”

When asked why everyone doesn’t invest that way, he replied: “Hope springs eternal. We all tend to think either that we’re above average or that we can pick other people [to manage our money] who are above average. That’s what makes markets – when one person thinks he knows more than somebody else, information is exchanged and a new stock price is set. And those of us who put our money in index funds say, ‘Thank you very much.’ We get to free-ride on other people’s convictions.”

Bonus: Index funds are easy to invest in and own. They are low fee and can be purchased and manage on your own, without using a financial advisor.

5. Variable Annuities Can Have Their Charms

Many financial experts endorse fixed lifetime annuities as a good way for retirees to guarantee lifetime income.

Variable annuities, on the other hand are frowned upon.

However, Sharpe thinks that variable annuities with guaranteed lifetime withdrawal benefits can be useful because an index annuity gives the investor the possibility of higher income (though with more risk).

6. The Lockbox Strategy

Sharpe developed the lockbox strategy as a way to manage risks and create retirement income.

The lockbox retirement income strategy is similar to bucket strategies. However, the lockbox strategy uses a time component. The point of the lock box strategy is to segregate assets by retirement year. Typically, each retirement year lock box would consist of a combination of assets — some that are relatively safe and others that are riskier.

Sharpe told Barrons: “In each box, you have a combination of safe assets, such as an annuity or TIPS [Treasury inflation-protected securities], and a market-based portfolio, such as one with stocks and bonds. You have the key if you need to access the funds, but the idea is that, once a year, you would sell the assets in that year’s lockbox.”

“You put all your money in locked boxes to begin with, and you just happily open locked boxes. If you’re dead, your partner opens the lockbox, and if you’re both dead, your estate opens all the lockboxes that are left.”

Advantages of a Lockbox Strategy?

Sharpe described the advantages of a lockbox strategy to Barrons. He said, “The buy-and-hold aspect of the lockbox is better than the glide path [gradually changing the allocation of the overall portfolio], and that has to do with capital asset pricing. With the traditional glide path, the money you’re going to have in 2030 is going to be a function of both how your portfolio did overall and the path it took to get there; there’s an added risk that’s not rewarded with higher expected returns.”

“Bottom line is that bucketing your assets in annual increments with different initial asset mixes in the lockboxes can provide a more efficient production of retirement income over time.”

The most important feature of “lock box” is that it is a withdrawal strategy that completely defeats sequence-of-returns issues.

What Are the Disadvantages of a Lockbox Strategy?

Setting up and managing lockboxes can be incredibly complex.

7. More About the Lockbox Strategy

In a Stanford University Thought Leader Interview, Sharpe gave another description of the lockbox strategy:

“The idea is to assess the individual’s preferences for various amounts of consumption in each future year, his or her risk tolerance vis a vis spending at various times in the future, current wealth and other sources of income, and then determine an overall plan. Part of this plan involves allocating current funds to a series of “lockboxes”, each of which is designed to provide spending in a given future year.

Thus, one might put $20,000 in a lockbox for the year 2020. The box would also include instructions for the management of the money from the present to the terminal year. Different boxes could well have different investment management strategies as well as different amounts of initial funding.”

You might want to think of lockboxes as an investment strategy and investment policy statement (a document outlining what to do when different things happen) for different time periods in your future life.

8. Knowing What You Want to Spend is Key to Any Retirement Withdrawal Strategy

Knowing how much you need to spend (and when) is a critical part of knowing how your money should be invested.

If you haven’t yet created a detailed retirement budget, now may be the time. The NewRetirement Planner enables you to set different overall spending levels for different time periods. You can also create a detailed budget with different spending levels in individual categories.

9. A Financial Advisor Can Be Very Useful

Said Sharpe to Barrons: “Comprehending the range of possible future scenarios from any retirement income strategy is very difficult indeed, and choosing one or more such strategies, along with the associated inputs, seems an almost impossible task. At the very least, retirees will need some help. Enter the financial advisor.”

“Ideally, he or she [the financial advisor] will have a deep background in the economics of investment and spending approaches, sufficient analytic tools to determine the ranges of likely outcomes from different strategies, and an ability to work with clients to find approaches that are suitable, given their situation and preferences.”

10. The Hallmarks of Good Financial Advice: Diversify. Economize. Personalize. Contextualize.

Sharpe told Money Magazine that four verbs summarize the principles of good financial advice:

Diversify!: The closer you come to holding the entire market portfolio, the higher your expected return for the risk you take.

Economize: Economize by avoiding unnecessary investment expenses, especially management fees and trading costs.

Personalize: Personalize by taking into account the things that make your situation unique, especially the risks you face outside the financial markets. As an extreme example, imagine that all you eat is chocolate bars. In that case, you’d want to invest more in the stock of candy makers so that if they raise prices, your food will cost more but your stock will go up.

Contextualize: Remember, if you bet that market prices are wrong [by investing heavily in a single stock or sector], you have to be able to justify why you’re right and the market isn’t. Asset prices are not determined by someone from Mars.

11. Watch Fees

Sharpe estimates that asset management fees of only 1% will ultimately eat up one-tenth of a retiree’s expected lifestyle.

Here is some of his math as told to Wealthfront: “How different are the costs? To take an example: The Vanguard Total Stock Market Index Fund costs you 6 basis points a year if you have more than $10,000 invested. That’s 6 cents per hundred dollars. The average actively managed, broadly diversified U.S. stock fund costs 112 basis points, or $1.12 per hundred dollars.”

“Many people say, ‘What’s an extra 1% or so?’ But they forget that the average return on such a fund is likely to be 7-8%. The relevant ratio is 1 out of 7 or 8%. Over the long term, the hit is likely to be profound.”

Feeling Overwhelmed?

Creating the right retirement investment and withdrawal strategy for you and your needs can feel overwhelming. You have a lot of different options.

The best steps to take will include:

  1. Figuring out how much retirement income you will have
  2. Documenting your retirement spending needs — in detail
  3. Calculating the differences between retirement income and spending
  4. Planning investments and withdrawals to fill those differences in a tax efficient, low risk way while minimizing fees.

The NewRetirement Planner will help you with steps 1-3 and, if you know what you are doing, also 4.

However, if you want help with 4, you might consider working with a NewRetirement Advisor or Coach.

  • NewRetirement has flat fee fiduciary Certified Financial Advisors on staff. These professionals use our powerful online tools to keep costs low and enable personalized and efficient service.
  • We also offer low cost sessions with a retirement coach. These professionals have deep financial planning expertise and a profound knowledge of the NewRetirement Planner. They can walk you through your plans, help you understand if things are set up correctly and help solve your problems.

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Tax planning for Canadians who invest in the U.S.

There are good reasons for Canadians to invest in the U.S., including portfolio diversification. Just keep these tax-planning and compliance requirements in mind. The post Tax planning for Canadians who invest in the U.S. appeared first on MoneySense.

Tax planning for Canadians who invest in the U.S.

It’s no surprise that many Canadians invest south of the border—both in stocks and real estate. On the world stage, economically speaking, we’re small potatoes.

As of May 31, 2021, Canada’s country weight within the was less than 3%. By comparison, U.S. stocks represented almost 58%. 

The average Canadian home price in April 2021 was $695,657. In Canadian dollars, the average price of a U.S. home was significantly less expensive, at $535,194 (US $435,400). 

But before you jump into U.S. investments, know there are both Canadian and U.S. tax implications for a Canadian investor to keep in mind. 

Stocks and ETFs

When a non-resident invests in U.S stocks or U.S.-listed exchange traded funds (ETFs), the standard withholding tax on dividends is 30%. A Canadian resident is entitled to a lower withholding rate of 15% under a treaty between the two countries if they have filed a form with the brokerage where they hold the investments.

The 15% withholding tax is generally the only tax obligation a Canadian investor has to the Internal Revenue Service () unless they are a U.S. citizen. (U.S. citizens who reside in Canada must file U.S. tax returns as well as Canadian tax returns.) 

If a Canadian resident who is not a U.S. citizen sells a U.S. stock or ETF for a profit, realizing a capital gain, they do not pay tax on that gain to the U.S. government. 

Dividends, interest, capital gains and other investment income

U.S. dividends, interest, capital gains and other sources of investment income are taxable on a Canadian resident’s T1 tax return because Canadians pay tax on their worldwide income. 

Interest income earned in the U.S. generally has no withholding tax for a Canadian resident.

Any U.S. tax withheld on other sources of investment income is eligible to claim as a foreign tax credit. This generally reduces the Canadian tax otherwise payable dollar for dollar, and avoids double taxation. 

U.S. dividends, interest, and capital gains must be reported in Canadian dollars based on the applicable foreign exchange rate. Most people use the average rate for the year to convert their income to Canadian dollars, but it is also acceptable to use the rate on the date of the transaction. 

Capital gains are a little trickier than dividends and interest because you have at least two exchange rates to determine: the exchange rate on the date of purchase, and the exchange rate on the date of sale. Because exchange rates fluctuate, it is possible that the shift in exchange rates causes a much different capital gain or loss in Canadian dollars than in US dollars. 

If an investor has purchased shares at different times, there is even more work involved. You need to figure out the exchange rate for each purchase in Canadian dollars to determine the adjusted cost base. This can be particularly challenging for someone who has a stock savings plan with a U.S.-based employer where they buy shares with each paycheque, for example. 

Canadian-listed ETFs and Canadian mutual funds that own U.S. stocks are themselves considered to be Canadian residents, just like an individual taxpayer. They will be subject to withholding tax before a dividend is received by the fund. This withholding tax is generally reported on a T3 slip (or sometimes a T5 slip, depending on the fund) and can likewise be claimed for a foreign tax credit in Canada. 

So far, these comments apply to non-registered, taxable investment accounts. There are slightly different implications if a Canadian buys U.S. stocks or ETFs in a different account. 

Registered investment accounts

(TFSAs), (RESPs), and registered disability savings plans (RDSPs) generally have the same withholding tax implications by the IRS as a taxable account. However, because these accounts are tax-free or tax-deferred, there are no tax implications for a Canadian beyond the withholding tax. 

Does this mean you should not own U.S. stocks in a TFSA, RESP or RDSP? No, but it does mean there is a slight cost to doing so, albeit for the benefit of holding a more diversified investment portfolio. 

A (RRSP) or similar tax-deferred retirement savings account gets special treatment by the IRS. There is generally no withholding tax if you own U.S. stocks or U.S.-listed ETFs. However, if you own a Canadian-listed ETF or Canadian mutual fund that owns US stocks, the tax is withheld before it gets to the fund or to your RRSP. 

For a Canadian taxpayer, the tax implications are identical whether you have an account in Canada or the U.S. The physical location of the account does not matter. 

Real estate

Canadians who invest in U.S. real estate face different implications depending upon whether the property is for personal use or is a rental property. 

A personal-use property generally has no annual tax filing requirements, whereas a rental property must be reported in both Canada and the U.S. each year. 

Rental income and expenses should be reported on both a Canadian and a U.S. tax return. A Canadian resident with a U.S. rental property must file a tax return to report the U.S. source income to the IRS. Any U.S. tax payable can generally be claimed in Canada as a foreign tax credit to reduce Canadian tax otherwise payable. 

Upon sale, there may be a capital gain or loss in Canada and the U.S. The Canadian gain or loss depends on the purchase price in Canadian dollars and the sale price in Canadian dollars, based on the exchange rates in effect at the time of each transaction. Purchase and sale costs, as well as any renovations, may reduce a capital gain (or increase a loss). 

A Canadian is generally subject to 15% withholding tax on the gross proceeds of U.S. real estate, unless they file for a withholding certificate prior to closing to reduce the tax based on the estimated capital gain. U.S. capital gains tax paid is eligible to claim in Canada as a foreign tax credit. 

If a Canadian taxpayer has more than $100,000 in foreign assets, including U.S. stocks, ETFs, rental real estate, or other investments, they need to file the form with their Canadian tax return. The $100,000 limit relates to the cost, in Canadian dollars, for the investments. Personal-use foreign real estate, as well as tax-sheltered RRSPs or tax-free TFSAs, do not need to be reported. 

These are just some of the basic tax implications for a Canadian investor who owns U.S. assets. Investing in U.S. stocks, ETFs or real estate can help diversify a portfolio, but comes with additional complexity and tax-compliance requirements as well. 

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.


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