In several of our past articles we have written about the importance of communicating your cash flow needs to your portfolio manager. It is so important that it is often at times the first questions we ask our clients who are no longer working. If they are receiving cash flow from their investments, is the amount still sufficient or does it need to be adjusted. If they do want to change the withdrawals, then we obtain details and ensure the funds are available for when they need it. In some cases, the cash flow need is perpetual and is set up to be done on a regular interval (such as monthly). Other times it is a one-time lump sum. Either way this needs to be planned to reduce timing risk with the markets and adverse tax consequences.
Investment Policy Statement
We prepare an Investment Policy Statement, or IPS, for every client that outlines the minimum and maximum levels of cash they will hold in their portfolio. For the majority of clients the minimum is set to zero, and the maximum is set to 40 per cent. Both the minimum and maximum amounts of cash can also be customized. The purpose of the IPS is to provide your portfolio manager guidance on how you would like your money managed, including the appropriate level of cash for planned withdrawals.
Cash flow needs
Within the IPS we document our client’s cash flow needs for the next two years. For example, if the client requires a set monthly amount from their portfolio we set up what is called a Systematic Withdrawal Plan (also referred to as a SWIP). Although the SWIP is an automated process, the portfolio manager has to make sure cash is in the investment account at the end of every month to facilitate the transfer. If the client has prepared a cash flow budget, then providing this is a good starting point in the discussion to determine the correct SWIP amount. Let’s illustrate this with a client who would like $3,000 per month transferred from her non-registered investment account to her bank account. At a minimum, we would want to have $36,000 set aside for these monthly payments. If clients wish to be even more conservative, we will set aside even more cash.
Liquidity
Prior to doing any investing we ask clients whether they need any funds within the next two years, aside from the cash flow mapped out for the SWIP. For example, if you are planning to purchase a new car or recreational vehicle then you should let your portfolio manager know, especially if you have not already set aside these funds in the bank account. Are you planning to change homes, renovate an existing house, or have any planned repairs? Perhaps you are wanting to plan a special holiday or occasion. Anything that would result in you possibly asking your portfolio manager for money in the future should be considered.
Other cash payments
In addition to the cash flow SWIP and the liquid cash required, some cash is often required for other reasons. We have clients who are supporting children or parents and have requested that we help send periodic transfers to them. Some are sending money to family in different countries and we assist them with currency conversions and wire transfers. We also make quarterly instalment payments to ÎÚÑ»´«Ã½ Revenue Agency (CRA) for most of our clients who are required to do so. There are times, when significant assets are sold, that an accountant will advise that cash be set aside to fund the tax liability. Similar to instalment payments, we can make our clients’ annual income tax payments if directed. Many of our clients instruct us to pay the annual insurance premiums for life insurance, disability, and other types of insurance. In the majority of cases, paying your insurance with a lump sum annual payment will cost less than arranging to pay it monthly.
Establishing a comfortable wedge
The cash flow components are the monthly SWIP, liquidity needs, and other requested cash payments. Some may be one-time payments, and others may be ongoing. The money that we set aside for these cash flows is called a “wedge”. Prior to doing any investing, it is important to establish a wedge that you are comfortable with. The length of the wedge is another factor. In the majority of situations our clients will have cash set within a wedge to cover the next 12 months. Our conservative clients will want to have 24 months. The reason to have funds set aside is to ensure our clients do not have to sell equity investments at the wrong point in the market cycle.
RRIF payments to bank
Some of our clients only have Registered Retirement Income Fund (RRIF) accounts. If these clients also require cash flow to live off of then we typically set up the RRIF payment to be automated and sent monthly to their bank account. The discussion normally focuses on whether the minimum RRIF amount, that the government says you must take, is sufficient. If the client would like to withdraw a greater amount then the portfolio manager would enter an elected amount that is greater than the minimum amount, into the system while at the same time ensuring that an appropriate wedge is set aside.
RRIF payment to non-registered account
Many of our clients are required to withdraw funds from their RRIF but do not require the funds. In the majority of cases we set the RRIF payment up to be December 15 for maximum deferral and flexibility. Even though December 15 is set as the default, we can always take the payment at any time between January and December 15. When RRIF payments are set up to be paid to a non-registered account then we can transfer cash and / or investments in-kind. This transfer to the non-registered account enables funds to be built up for future withdrawals.
Banking information
When a client opens up an investment account we are required to obtain the clients’ banking information for a few different reasons. One of the reasons is to enable more options for our clients when they request funds from us. The number of transactions executed electronically is rising rapidly as investors are becoming more comfortable trusting the electronic transfer of funds from one account to another. With electronic transfers, there is no risk of mail being lost and transactions are done in a timely manner.
Systematic Withdrawal Plan (SWIP)
As noted above, when transfers are done on a scheduled basis they are referred to as a SWIP. A financial institution usually requests a void cheque from the investor’s banking account to obtain the institution, transit and account numbers. SWIPs are set up to electronically transfer a predetermined amount from an investment account to a banking account. Understanding the income currently being generated from the investments, maturity dates, and liquidity of the portfolio are key components to look at when setting up an appropriate SWIP.
Investors have flexibility with respect to the amount of income they would like to receive and when they would like to receive it. The following illustrations provide the two most common SWIPs used.
Income transfer only from non-registered account
Mr. Jackson requires a high level of income from his portfolio. He has requested we send him all of the income from his investment account on the first of every month. Mr. Jackson has $900,000 invested generating approximately $34,000 per year in interest and dividend income. In addition to this income, Mr. Jackson typically would have both realized and unrealized capital gains that increases his base amount of his investment. Mr. Jackson likes the idea of the base capital of his investments still increasing in a normal year, by retaining the unrealized and realized capital gains within the account. We provided Mr. Jackson with an expected income report and noted that his monthly income ranges from $2,360 to $3,400; however, his average income is approximately $2,833 a month. This is because not all companies pay dividends in the same months. When you hold thirty different companies they will typically all have different dividend dates. Mr. Jackson asked us to automatically transfer the interest and dividend income to his bank account every month.
Set dollar amount from non-registered account
Mrs. Walker has a cash flow need of approximately $8,000 per month. Her sources of income are from CPP, OAS, and a small pension, all of which add up to approximately $5,400 per month. Mrs. Walker needed a strategy to fund the monthly shortfall of $2,600. Mrs. Walker has saved approximately $700,000 in a non-registered account. We explained to Mrs. Walker how a SWIP can be set up to transfer a flat dollar amount, such as $2,600, even if this amount exceeds the monthly income generated in the account. We established a plan that allowed for certain investments to be partially or fully liquidated over time to ensure the monthly payments could be sustained during her lifetime. The wedge is nearly always invested in cash equivalents or short term fixed income. In calculating the wedge we factor in RRIF payments transferring into the non-registered account, projected income within the account, and maturity dates of her investments. With this type of SWIP more planning is required.
If you feel you will need to establish a SWIP, modify an existing SWIP, or will require some funds in the future (such as in a lump sum), then it is best if you communicate this with your portfolio manager as soon as possible. Planning and time will help your portfolio manager reduce the risk of having to sell equity investments at the wrong time in the equity market cycle.
Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director, wealth management, with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138.
