Knowing When To Shift Gears � Part One

Warren MacKenzie It’s easy to take action to avoid a mechanical problem when a warning light on the dashboard tells us the engine needs oil. But there’s no warning light to alert us to the danger of not using our capital wisely. And, more serious than an engine failure, not using capital wisely may mean we waste a lifetime of hard work and sacrifice.

If they don’t use their capital wisely, many retirees not only waste an opportunity for their own happiness, but worse yet, they may create a problem for their heirs. I will explain later how a large inheritance may be an obstacle to happiness.

For retirees the problem is that for 35-45 years they were focused on working hard, saving and accumulating wealth—but when they retire it’s time to shift gears from the accumulation mode to the spending mode. However, it’s difficult to break a habit developed over a lifetime.

Here Are Some Reasons Why Retirees May Not Use Their Capital Wisely:

It’s hard to break a lifetime habit of saving.
They naturally think more is better (but with wealth this is not always so).
They’re not clear on their goals so they don’t know how much they need.
They don’t have a financial plan that makes it clear that there is a surplus, and often the size of the surplus is unknown.
They think that if they spend less, more will be available for their heirs (and they mistakenly think this is always a good thing).
They want to protect themselves against unlikely but possible expenses.
They’ve not calculated the certain and guaranteed costs (income tax being one of the costs) of protecting against unlikely future events.
Major decisions usually involve both a financial element and an emotional element—lacking a financial plan which separates the financial and emotional components they often make the wrong decision.
They’ve not considered the six reasons to give children an advance on their inheritance (explained in part two of this series).
In family gatherings, money is a subject that is never talked about.
The media and financial advisors focus on ways to manage money wisely— and there is almost never a discussion on how to use money wisely.

So what’s the problem if retirees focus on managing their money wisely but never get around to using their money wisely?

1. They give up the opportunity to live a richer lifestyle.

2. Without a proper financial plan they worry unnecessarily about the future.

3. They may leave an inheritance which is large enough to allow heirs to change their lifestyle and this may cause more grief than happiness.

4. They lose an opportunity to enjoy seeing the good they can do by helping family when children or grandchildren need it the most.

5. They lose the opportunity to experience the joy that can come from helping others and giving back to their community.

6. They pay more in income tax.

7. They waste a lifetime of saving and sacrifice.

What Information Will Help Retirees Use Their Capital To Achieve Their Most Importance Goals?

First thing is to be clear on your goals. How do you want to live? Where do you want to live? What are the things that are most important to you? How much do you want to leave to your heirs?

If your number one goal is to leave as much as possible to your children, then the best strategy is to focus on getting the highest (risk adjusted) rate of return and to cut back on spending. In part two of this series I will explain why the goal of leaving as much as possible may not be the best for the children and should be carefully considered.

For the happiness of both parents and children it makes good sense to have a family discussion and to settle on a fixed amount as an inheritance. This can be arranged easily and tax efficiently by using tax exempt insurance. Once this amount has been decided on then it is easy to have a financial plan prepared which will show how much capital you need to have today in order to achieve all of your goals (including leaving a certain amount to your heirs).

Of course the financial plan should be prepared using conservative assumptions including higher than expected expenses and lower than expected investment returns. The plan should also assume (if realistic) that you live to age 100 and if health care is a concern you can build in a cost for health care. But with these assumptions, if you still have more capital than you need to achieve your goals, it’s a waste if you don’t make a plan to use your surplus. In fact, retirees have a responsibility to dispose of their surplus because leaving an estate which is large enough to allow heirs to change their lifestyle could be as dangerous for your heirs as leaving a loaded gun lying around the house when grandchildren are visiting.

The other important step is to have family meetings which include discussions about individual goals and family goals, financial and legacy issues, as well as family stories and history so that a family identity is established. With honest communication and with all heirs knowing the terms of the will, and a strong sense of family identity, it is less likely that there will be any dispute over the estate.

If retirees want their heirs to be happy (and they all do) it’s important that they realize that happiness comes from friends and family, from accomplishments, from accepting responsibility, having a good work ethic, having experience in solving problems and overcoming challenges, and generally from leading a successful life. If an inheritance is so large heirs don’t need to learn these lessons, they may suffer in the future, because no amount of money is enough to avoid problems and challenges. It’s just that rich people have different problems.

Retirees should realize that even a tight-knit family can change over the years as children get married and in-laws and grandchildren become part of the equation. It is normal for there to be differences of opinion when people with different backgrounds and experiences become part of the family. Sometimes parents are the glue that keeps the family together and, out of respect for the parents, while they are alive, some differences of opinion might not be clearly expressed. But when the parents are gone differences of opinion may be expressed and may become more serious. If this happens the probability of the family being torn apart because of a dispute over the estate is directly related to the size of the estate.

This is why it is so important to have family meetings to discuss the will and the estate plan. Heirs should understand both the content of the will and the reasons why parents made the decisions that they made. Surprises are great on birthdays but surprises when the will is read can often lead to misunderstandings and lawsuits.

Warren MacKenzie, CPA, CA, CIM – Senior Financial Analyst at Optimize Wealth Management