Dealing with dollars, inflation and rates

Today’s baby boomers likely never thought that they’d be retiring in a world with historically low interest rates, nearly zero inflation and a plummeting dollar. But here we are.

The country’s overnight rate now sits at 0.5%, inflation is hovering at around 1% and the loonie has fallen by about 20% over the past two years. While the dollar may keep falling, rates and inflation will eventually rise and retirees need to be prepared.

While it’s not clear as to when our inflation rate will climb, we’re already experiencing higher prices thanks to that dropping Canadian dollar. Imports such as food, clothing, electronics and cars are typically brought in from the U.S., purchased in American dollars and then sold in Canada. Retailers usually pass on to consumers the money lost in the dollar differential.

Travel across the border — a favourite pastime among the retired set — is also now about 25% more expensive. If you have a client with a house in Florida, her winter expenses are far higher than they were even last year.

“Everything from property taxes to interest owed to fumigators is costlier,” says Evelyn Jacks, founder and president the Knowledge Bureau, a Winnipeg-based financial education institution. “You’ve just had a huge inflationary hit because of the value of the dollar.”

Inflation, rising rates and dollar fluctuations are factors that could derail even a carefully considered financial plan. Fortunately, there are a few things that advisors can do to prepare.

Use historical rates to help determine future rates

The first step is to consider the economic impacts that could affect a financial plan, says Jacks. Good advisors consider both life events and economic ones, she says.

However, now that people are living well into their 80s and 90s, it’s safe to assume that your 65-year-old clients will see inflation rise over their 20- or 30-year retirement. Jacks suggests using historical rates to determine what the future rate will be. Between 1914 and 2005, for instance, the average annual rate of inflation was 3%. Since 1990 it’s been closer to 2%.

Also look at how the loonie has typically compared to the greenback — it’s been well under par for most of the past 25 years. Then look at where economists think the dollar might be headed.

Every so often the government asks private sector economists where they think the dollar will go — that’s in the Federal budget and in economic updates, says Jacks. While you wouldn’t want to base a plan solely on what people think will happen — economist are often wrong — you can use those future numbers as a guide.

Take advantage of the TFSA

The only thing that matters is what money you have after taxes and inflation are taken into account. Right now, you’re losing money on inflation, especially when it comes to bonds, savings accounts and money market portfolios. In most of these cases, interest rates aren’t exceeding the inflation rate, even though it’s so low, so your clients’ purchasing power is being eroded.

Add taxes into the mix and those clients have even less money at the end of the day. Any interest generated from bonds and savings accounts is taxed at someone’s highest marginal rate, which could be upwards of 50% for high-net-worth individuals.

The TFSA is useful because it can shelter money from rising tax rates, and this annual tax-free compounding can lessen that pesky interest rate/inflation issue. Try to average the tax hit that comes with removing money from an RRSP before it converts into a RRIF, so you’re not pushed into the highest tax bracket when forced withdrawals come into effect. Then put that money into a TFSA.

This is useful for people who have already retired, but be sure to run the numbers with your clients to make sure that removing money before they’re 71 makes sense.

“The trick to planning into a greater inflationary environment going forward is to average the taxes from taxable pension sources and flip those investments over to a TFSA,” says Jacks. “Therefore, you’re building a completely tax-free future retirement.”

Ultimately, advisors can’t simply create plans using today’s economic numbers. They have to make projections and plan for rising inflation, rising interest rates and continued dollar fluctuations.

“A well-trained planner will take this issues into account,” says Jacks. “The biggest eroders of wealth are taxes, inflation and fees, and that becomes acute to someone who’s going into retirement.”