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The Key

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I don’t care too much for money, money can’t buy me love
-Paul McCartney

My typical days the last 16 years may involve some combination of reading the latest academic research paper, running different scenarios of minor adjustments to a model portfolio or keeping tabs on the newest investment vehicles available to clients- all in the hopes of trying to eek out a few extra basis points of return. When this far in the weeds, it can be easy to forget the reasons we invest our money in the first place.

Growing up in the Bay Area of California, I frequented the Oakland and San Francisco zoos with family or during school field trips. While I was grateful for the time outside to play and admire the amazing animals, there was always something I was envious of: those other kids who had the cash to buy a zoo key.

A zoo key is a silly little plastic ‘key’ shaped like an elephant that allows you to play a recording at designated areas that gives background on the animal you were looking at. It probably cost $2.00 back then. It wasn’t even the recording that I was excited about, it was what that key symbolized. Having a key meant you were one of the cool, rich kids for which money was no obstacle. It was like the Tesla Model X  for an eight-year-old in the 1980s.

Last month we took a family trip to the Oakland zoo with our two young children. The following is a picture of my 2 year old son turning a key into the same recording box at the Giraffe exhibit that I wished I could have all those years back.

It hit me- does this mean I’ve made it in life? Because I can afford these minor luxuries that were beyond my family’s modest reach a generation ago, does that make us wealthy? After all, the couple dollar purchase won’t keep me up at night. My money worries center more around funding 529 plans for the kids, determining the right neighborhood for the next house we buy, or helping our parents prepare for their retirement.

This seemed to bridge the gap in my mind between money and meaning.

Perhaps these thoughts were heavy on my mind because I had just finished reading The Geometry of Wealth by Brian Portnoy, a fantastic book that prods the reader to evaluate their relationship with wealth and how it can help them live a more meaningful life- whatever that means to each individual.

An old saying came to mind at this moment- that money can’t buy you love. But in some ways it can help free you up to be able to enjoy experiences that make you happy, like going to the zoo with your children whenever you’d like. The end goal of earning wealth over time wasn’t the ability to invest in a hedge fund or own a vacation house. The goal was to have the financial freedom to enjoy those experiences with the ones we hold dear.

Financial planning expert Michael Kitces wrote, “The fundamental problem with goals-based investing… is that we don’t really have any real clue what our goals actually are”. This rung true to me, as 10 years ago I had no notion of what feelings I would have as a parent. 10 years from now I might feel strongly about a certain charitable cause or want to pick back up with the global travel we often did before having children. What being financially successful, or wealthy, meant to me in the past is likely to change over time.

The book mentions four C’s that wealth may be able to be employed towards in order to bring deeper meaning to one’s life.

  • Connection: Social connections
  • Control: The ability to direct and define your life
  • Competence: Being good at something you care about
  • Context: attachment to something bigger than ourselves

What are you investing for? What ability do you hope to have in the future that you don’t have today? If you hit the lotto tomorrow- what would you do with your time? Where would you live?

Using the framework of the four C’s above can help formulate goals. For example, it may be something like, “I enjoy volunteering for a certain nonprofit, and the ability to spend more of my time using my skills to help them is going to bring great satisfaction to me.” Or “I’d like to get to the point where I could pursue that architecture interest I’ve always had by taking some college courses.”

The author summarizes the book with the statement: “The ability to underwrite a meaningful life is achievable for anyone who combines the right mindset and the right plan.”

We at Cardinal Point couldn’t agree more.

While I spend most of my days ensuring we have an investment strategy that is grounded in academic research that can be tailored to our clients’ evolving and complicated cross border needs, we believe working with clients to help understand how we can best position their assets to help meet those future aspirations and needs is the foundation of a successful financial advisory relationship.

In my distant future that might simply mean the ability to bring grandkids to the zoo, and maybe even splurge for a plastic zoo key.

Understanding the Canada-U.S. Totalization Agreement

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Many Canadians and Americans face the reality of a career that spans both sides of the 49th parallel. Amidst an era of globalization, it is common for promotions to create cross border opportunities and for company restructurings to force a long-term cross border move. The result of having a career on both sides of the border can lead to some confusion over how an individual’s history of employment can be quantified, relative to the necessary requirements to qualify for each country’s pension plan. Specifically, how are my Canada Pension Plan (CPP), Canadian Old Age Security (OAS) and U.S. Social Security (SS) benefits affected by my work experience in both Canada and the U.S.? What if I don’t meet the minimum eligibility criteria to qualify for these pensions?

Let’s re-examine the eligibility requirements for these three pension plans: CPP and SS are based upon one’s earnings record. The difference is that the SS minimum criteria for eligibility requires ten years of service, while a CPP benefit mandates only a single payment into the pension in order to become eligible. OAS criteria follows a different qualification path based upon residency rules vs. work history, specifically, the amount of time one has resided in Canada since the age of 18. A full OAS benefit is paid once the individual has amassed 40 years of Canadian residency since the age of 18. A partial benefit can be paid when the applicant has a minimum of 10 years of Canadian residency (assuming Canadian residence when payments commence) or 20 years of Canadian residency (assuming U.S. residence when payments commence). For more specific details on CPP, OAS and SS, please visit: “Cross Border Retirement Income: Canada Pension Plan, Canadian Old Age Security, U.S. Social Security and the Windfall Elimination Provision.” The question thus remains; what if I do not meet these eligibility requirements?

This concern marked a call to action and on Aug. 1st, 1984, the birth of the Canada-U.S. Totalization Agreement came to be. There was a subsequent amendment on Oct. 1st, 1997. The manifestation of this Agreement allows an individual to “totalize” their history spent north and south of the border to qualify for U.S. Social Security and/or Canadian Old Age Security. The tallying of cross border residence/work history in tandem allows an individual to potentially meet eligibility requirements that would not have otherwise been met if U.S and Canadian histories stood in isolation from one another. It’s imperative to recognize that although the Agreement tackles the pension (OAS or SS) qualification hurdle, it does not enhance the resulting benefit in question. In other words, your U.S. Social Security benefit will be based upon U.S. work history and your Canadian Old Age Security will be centered on the duration of Canadian residence beyond age 18. Let’s review a few examples.

Mr. Smith, a Canadian citizen and U.S. green card holder, decides to retire in 2019. His career culminates under the following circumstances: thirty years working in Ontario for GM Canada and six years earning gainful employment income under GM U.S. in Detroit. Mr. Smith decides to return to his roots back in Canada. For simplicity’s sake, let’s assume he has spent forty years in Canada beyond the age of 18 by the time he reaches 65. In this case, he qualifies for a full OAS benefit and a CPP benefit based upon his Canadian earnings record, but he does not meet the minimum years of service when he was employed in the United States to qualify for U.S Social Security. In steps the application of the Canada-U.S. Totalization Agreement, allowing Mr. Smith to leverage his CPP credits to make up the 4-year deficit in order to meet SS qualifications. Even though Mr. Smith now qualifies, his SS benefit will be based upon his six-year earnings record vs. the ten-year minimum requirement. Had the Agreement not existed, Mr. Smith would not have been able to receive any SS benefit.

Let’s turn our attention to how the Agreement can play out in a slightly different scenario. In this scenario the circumstances are as follows: Ms. Jones is a U.S. citizen and Canadian permanent resident. She has spent all but five years living and working in the U.S. with  plans to continue Canadian residency  going forward. With only 5 years as a Canadian resident, Ms. Jones has not met the ten-year minimum residency requirement to receive a partial OAS benefit.  The Agreement, though, triggers the ability to pull U.S. residence history to bring total residency time to the minimum OAS requirement for partial OAS benefits. However, it does not boost the OAS benefit to a higher amount, rather, it simply allows Ms. Jones to qualify to receive an OAS benefit based upon the five years she has resided in Canada since the age of 18. Like the previous example, had the Agreement not been made, Ms. Jones would not have been able to meet the qualifications for OAS eligibility.

With this scenario in mind, how does one apply the Agreement to claim their own pension benefits?

The pension plans of Canada and the U.S. communicate with each other quite well. As such, if you live in the U.S. can visit or write any U.S. Social Security office to apply for either U.S. or Canadian benefits.

If you live in Canada and hope to apply for U.S. benefits simply visit or write to any U.S. Social Security office located near the border.

So where do you find yourself? Are you caught in the middle of this unique issue? You are not alone in your quest to find a path forward. With regulations and agreements constantly in flux, it’s important to examine your options through the lens of current cross border agreements. To find out more, contact Cardinal Point.

Managing Exchange Rate Risk

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Where do you see the exchange rate going? This is a common question amongst our client base, many of whom enjoy a cross border lifestyle.  In fact, as Americans living in Canada may have noticed, the exchange rate is right up there with hockey and the weather in Canada’s national conversation.

The trouble is, accurately predicting the exchange rate is exceedingly difficult over both short- and long-term periods.  Even amongst currency analysts, who are the experts in this field, there is usually no consensus, a lone exception possibly existing when the loonie is trading at extreme values (either above par, or at 60 cents on the dollar).

The loonie is not currently at either extreme, but it has been volatile.  It fell about 8% against the greenback in 2018, rose significantly in January 2019 and moved lower through March.  Why is it so volatile, and why is it inherently difficult to predict the direction of the exchange rate?  The rate is impacted by more than one factor, which may push it in opposite directions.  For instance, the loonie is sometimes described as a petro-currency, driven by the price of oil.  As the price of oil (which is priced in USD) increases, all else being equal, the Canadian dollar would also increase relative to the US dollar.

The loonie is also driven by the differential between US and Canadian interest rates.  If rates on Canadian bonds are higher than those available in the US, then investors from outside Canada will tend to invest more money in Canada.  To purchase these investments, they need to convert their money into Canadian currency, driving the demand for loonies upward. This raises the value of the loonie relative to the US greenback.

It’s certainly possible to have the price of oil and the interest rate differential between Canada and the US pushing the exchange rate in opposite directions.  In the situation where oil prices are declining yet Canadian interest rates are rising relative to the US, it’s an open question which factor will have more impact.

Aside from these types of macroeconomic currency catalysts, there’s a school of thought that looks at what the value of a currency “should” be, based on equalizing what money can buy in various countries.  This is known as Purchasing Power Parity.  On this basis, the Canadian dollar is undervalued and should be worth somewhat more than it is now.  Unfortunately, it can stay this way for years, and does not spend much time at parity.  As a result, this metric is interesting but not necessarily any more helpful than other foreign exchange predictions for long term planning.

Given the notion that experts and scholars cannot make accurate predictions, how can cross-border financial planning be undertaken, and investment portfolios designed, for clients with assets in both currencies domiciled on either side of the border?  Financial planning is, to some extent, the practice of making assumptions about the future in order to provide clients with a picture of how that future will unfold provided the assumptions are perfectly correct.  As a result, financial plans are best presented with the caveat that they need to be refined over time to accommodate revisions to the assumptions as conditions change.

Unfortunately, the foreign exchange rate over the client’s lifetime is not the only unknown variable to consider.  Future rates of inflation and taxes on both sides of the border, as well as returns on investments in the stock and bond markets, are critical inputs.  Since the actual future values for these variables are uncertain, risk management tactics are utilized in portfolio design to reduce these risks.  This is equally true when it comes to currency risk.

One important consideration in cross-border wealth management is hedging investment securities into the currency of the country where retirement income will ultimately be spent.  It is often argued, correctly, that currency fluctuations tend to even out over the long term, and there is a financial cost to hedging strategies.  However, over the short term, those fluctuations can have a significant impact on investment portfolios and the income they provide.  While this extra layer of volatility can be worrisome for clients at any stage of life, it becomes increasingly critical when it has a direct impact on the amount of retirement spending a client can do from one year to the next.  A cross-border wealth management firm like Cardinal Point will use a prudent hedging strategy to manage the costs and benefits appropriately.

In addition, where possible, migrating assets over time into the client’s expected currency of residence in retirement can make a lot of sense.  For example, Americans working in Canada who plan to move back to America in retirement may hold their RRSPs in US dollars. The result is the minimization of the currency impact they experience long term.  Reducing the variability of future returns based on  exchange rate risk brings a dimension of certainty into an uncertain future.

Finally, it’s important to pay attention to the costs of converting money from one currency to another.  These costs can be 2% or more of the amount of money being converted.  If there is an ongoing need for a certain currency, a bank account denominated in the currency can be used to meet this need.  It’s best to minimize the movement from one currency to another, which can occur when money is moved between bank accounts, or a credit card issued in one country is used outside that country.  Where the need for conversion exists, using a specialized service provider such as OFX can result in significant savings on the transaction.

The exchange rate between the US and Canadian dollar is a significant source of risk for many clients. For Americans living in Canada and Canadians living in America, working with a cross-border financial planning firm is a prudent way to manage this significant financial and emotional process.

Cross Border Retirement Income: Canada Pension Plans, Canadian Old Age Security, U.S. Social Security and the Windfall Elimination Provision

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Calling all eligible benefit holders of the Canada Pension Plan (CPP), Canadian Old Age Security (OAS) and U.S. Social Security (SS)…

Does your or your spouse’s story narrate a history of employment in both Canada and the U.S.? If so, you may have the privilege of drawing from SS, OAS and CPP. The confusion lies amidst the qualifications and how these benefits interact with one another given the Windfall Elimination Provision (WEP).

Let’s break it down…

Social Security (SS)
To qualify for retirement benefits under U.S. Social Security, you must have 40 credits of covered work.  Each credit represents a quarter (i.e. 3 months) of full-time employment.  Thus, generally speaking, you must have 10 years of full time employment in order to qualify for retirement benefits.

All monthly benefits are based on your Primary Insurance Amount (PIA), which is the amount you would receive if you retired at your full retirement age (FRA). The FRA is age 65 for people born before 1938, gradually increasing to age 67 for those born in 1960 and later. You can choose to take it as early as age 62, resulting in a 25% reduction in benefits. At a more granular level, the monthly PIA is reduced by 5/9ths of 1% for each of the first 36 months before your FRA. You can also choose to earn delayed retirement credits (DRCs) for any month from FRA up to age 70. DRCs increase the benefit for the retired worker but not the spouse (if utilizing the spousal benefit). If you were born in 1943 or later, you earn 8% DRCs for each full year (prorated for months) up to age 70 for a maximum increase of 32%.

Individuals have the opportunity to take a SS benefit on the greater of their own record or 50% of their spouse’s SS benefit.

Canadian Old Age Security (OAS)
The rules to qualify for full OAS benefits under the Canadian system are centered on residency in Canada beyond the age of 18, not employment history. A full benefit is received when an individual has accumulated a Canadian residence history of 40 years. The pension can commence as early as the month following one’s 65th birthday or be delayed as late as age 70. By deferring one’s OAS, the benefit increases by 0.6% per month/7.2% per year, which equals a 36% increase if OAS is deferred to age 70. Partial OAS benefits may be available in certain situations. Let’s review a few scenarios:

Let’s assume you’ve lived in Canada less than 40 years and you are currently residing in Canada. As long as you are 65 years or older, a legal resident of Canada or Canadian citizen, and have lived in Canada at least 10 years since the age of 18, you are eligible for a prorated OAS benefit.

To take it a step further, let’s assume the same scenario with a bit of a twist. Instead of currently residing in Canada, you are now living in the U.S. These circumstances dictate you must have resided in Canada for a minimum of 20 years since the age of 18 in order to receive a partial benefit.

If neither of these examples apply to you, there may still be an opportunity to collect on the benefit if the country in which you currently reside has a social security agreement with Canada.

One final item on OAS; if one were to reside in Canada at the time of receipt of the OAS benefit, the individual may be subject to the OAS clawback. This would be created when your income exceeds certain threshold levels. For the 2019 tax year, the OAS clawback kicks in when income exceeds, $77,580. On the other hand, if OAS payments are made to a physical resident of the U.S. – and not a Canadian physical or tax resident – the clawback provisions are eliminated, and the entire benefit is paid to the recipient. No OAS clawback would apply.

Canada Pension Plan (CPP)
Unlike Old Age Security, CPP is based upon your pension contributions through your employment record, subject to certain maximums. As long as you’ve made at least one contribution to the plan, you are entitled to receive a CPP benefit. This benefit is available at age 65, but one can opt for a reduced benefit as early as age 60 (reduced by 7.2% annually) or a delayed benefit as late as age 70 (increased by 8.4% annually). In addition, the CPP benefit is not subject to any clawbacks.

How then do these benefits tie in with the Windfall Elimination Provision (WEP)?

Understanding the Windfall Elimination Provision
Under Title II of the Social Security Act, the Windfall Elimination Provision was born. It authorized the Social Security Administration to reduce an individual’s Social Security benefit in the event the recipient was also receiving a foreign pension (e.g. CPP). To understand the “why” behind the WEP, it’s important to comprehend how the SS benefit is calculated, specifically the Primary Insurance Amount (PIA).

A worker’s PIA is based off their average monthly earnings separated into three amounts. These values are then multiplied utilizing three distinct factors. Here’s an example:

For a worker who turns 62 in 2018, the first $895 of average monthly earnings is multiplied by 90%, earnings between $895 and $5,397 by 32%, and the balance by 15%. The sum of these three amounts equals the PIA, which is then either increased or decreased depending on when a worker decides to draw SS. This is how the monthly payment is determined.

Social security was meant to replace part of an individual’s pre-retirement earnings. With the previous calculation in mind, one can conclude that workers with lower average monthly earnings have a higher percentage of their pre-retirement earnings replaced via Social Security than those with higher average monthly earnings. For example, a 62 year old worker with average earnings per month of $3,000 could receive a benefit at FRA of $1,479 (49 percent of their pre-retirement earnings), increased by cost of living adjustments. For a worker with $8,000 of average earnings per month, the benefit starting at FRA could be $2,636 (32 percent of their pre-retirement earnings) plus cost of living adjustments.

For those individuals whose primary job wasn’t covered by Social Security, yet had their benefits calculated as if they were a long term, low-wage worker, they would end up receiving a benefit that would cover a higher percentage of their earnings, plus a pension from a job for which they didn’t pay Social Security taxes. This is true for someone who spent time working for an employer in Canada, earning CPP credits.

Under the Windfall Elimination Provision (WEP) the calculation for a worker’s Social Security benefit needs to account for the CPP payment. The 90% factor on the first $895 of monthly average earnings (when estimating PIA), could be reduced depending on the number of years of U.S. earnings history. The WEP is eliminated once a worker has 30 or more years of substantial earnings in the U.S.

The U.S. Social Security Administration has an Online WEP Calculator that is available here.

Despite the current provisions of WEP, a U.S. Class Action lawsuit has been filed on behalf of Canadians who receive SS benefits and have been impacted by WEP.  The suit was recently filed in the State of Indiana against the SSA. The crux of the lawsuit is whether the application of WEP against individuals who also receive the same benefits in Canada is lawful.  The Plaintiffs in the Class Action are claiming that the application of WEP to U.S. benefit recipients is unlawful and presents a violation of the plain meaning of the U.S. Social Security Act, U.S. Social Security Act Regulations and the Social Security Agreement (1983-1984) between United States and Canada (the “Social Security Agreement”). The Plaintiffs are seeking retroactive payment of the amounts that have been deducted through the application of WEP and the ending of the application of WEP moving forward.  The claim has been certified but has yet to move forward at the trial court level.

In Summary: Although a worker’s Social Security is potentially reduced by CPP, the good news is that OAS does not factor into the WEP calculation. Whether the WEP impacts your Social Security depends on the uniqueness of your individual circumstances and the potential result of the Class Action Lawsuit. If you think you might be impacted by WEP, we recommend you have a cross border financial planner such as Cardinal Point analyze your situation.

 

 

 

Terry Ritchie in “Weak loonie, competition from U.S. home buyers work against Canadian snowbirds”

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In past years, with a strong Canadian dollar, Canadian Snowbirds were able to pick up investment properties or vacation homes in popular locations such as Arizona, California and Florida. With a softer Canadian dollar, snowbirds are finding some competition for these types of homes. Cardinal Point Capital Management’s Terry Ritchie discusses the current state of the U.S. real estate market for snowbirds in this Globe and Mail article.