Myodicy, Issue 22, December 2004

Well Endowed

by Theodore Plantinga

Redeemer University College, where I have taught since its inception in 1982, recently inaugurated its first endowed chair or professorship, and it happened to be in my own department -- Philosophy. An anonymous donor stepped forward with the offer of such a chair, and it was gratefully accepted. Now, it happens that Redeemer's philosophy department was at the point of needing a second full-time member when the offer came along: the timing was just right. And so Redeemer is now in the position of being able to rely on outside sources to fund at least part of the teaching done within the philosophy department. This happy circumstance takes some pressure off the overall instructional budget.

Endowment funds are nothing new in the university world, and Redeemer had already established a small general endowment fund of its own, even though it also carries capital debt. Older universities -- especially those with great prestige and international recognition -- boast of huge endowment funds, some of them running in the billions of dollars. Those funds not only support the primary mission of such universities but also guarantee considerable financial stability.

When Redeemer was in its infancy, we had very little in the way of capital debt and lived largely off current revenues, which consisted mainly of tuition fees and donations from our primary support community. I remember those days vividly, for just as Redeemer was young, so was I. As I look back on those years, I am struck by the parallels between university finance and personal finance. The concept of an endowment functions in a central way in both situations, even though we do not normally use "endowment" terminology in connection with household economics. Part of my reason for writing this essay is to suggest that the term "endowment" should be introduced into the world of personal finance. (No, this essay is not about attractive women, and it offers no illustrations.)

When a young man and women start out in life as a married couple, they often have a hard time making ends meet: it may be quite a struggle to get all the bills paid at the end of the month. It would be possible for some generous donor to confer upon such a couple an endowment fund of a million dollars or so, with the provision that the principal was to remain untouched while the interest or investment return would be available to subsidize day-to-day living. Something of that sort, of course, is what one aims for in retirement, although the amount of the endowment fund or "retirement nest egg" is normally far below a million dollars, and its source is not a mysterious stranger but one's own disciplined efforts to save money.

Now that I have passed the age of 55 and am formally eligible to retire and ask for the title of professor emeritus, I find myself reading a fair amount of literature concerned with financial planning for later life. And it occurs to me that what happens in retirement, assuming that the financial picture is reasonably sound, is a good deal like what happens in university financing: one draws on investments to subsidize day-to-day operations. And so the proverbial "retirement nest egg" could well be called an endowment fund.

Some retirees have been so successful in saving and investing that they can live entirely off the interest or return on their investments. Such folk need never concern themselves with what sort of pension or income support their government may provide for seniors. But for most retirees, the endowment fund they have managed to scrape together for their old age represents one of four primary sources of revenue. The other three, of course, are the company pension plan (although not everyone goes into retirement able to draw on such a plan), the government pension plan and/or income support for seniors, and the equity in the home they occupy (assuming that the retiree is a homeowner).

One way to understand retirement planning is to regard it as a process of nurturing and building up an endowment fund. Retirement becomes feasible once you are "well endowed." Books on the financing of retirement provide estimates on how large that fund needs to be in dollar terms in order to make retirement possible. Frightening figures are printed in some of the books. Of course the actual dollar amount that will be needed in the endowment fund will depend in part on how much revenue the prospective retirees are able to derive from the other three income sources mentioned above. How lavishly they will spend when retired is also a contributing factor in how large their endowment fund needs to be. In short, "well endowed" is a relative term.

People in mid-life, with children at home in need of clothing and an education, tend not to think in terms of an endowment fund as they plan their financial future. If they are prudent, they save some money (and reduce their income tax) by way of Registered Retirement Savings Plans (RRSPs, used in Canada) or Individual Retirement Accounts (IRAs, used in the USA), but because the money in such accounts remains untouched (otherwise it becomes subject to income tax), its only effect in the short run is to lower the amount of income tax to be paid, which is to say that the folks in question get a little additional money in their pockets early in the year in the form of an income tax refund. And so the money in the retirement accounts is left to accumulate and has little impact on financial operations in the short run.

But if young families with children do not, in any functional sense, depend on an endowment fund, it should be noted that they may well be operating with what we might call a negative endowment fund. Many books on financial planning stress that the first thing to do to put yourself on the road to a successful retirement is to get rid of the sort of debt that people often carry on credit cards. The folks who find themselves unable to pay off credit card balances at the end of each month are often not even aware of just how high their debt level is, since it is money owed to a number of separate companies and financiers. What they should do is total it up and look upon it as a negative endowment fund, for it subtracts money from their monthly income that should be used for living expenses (to say nothing of saving for old age).

In effect, such people are in the same position as the many governments that must use their revenue from taxation first of all to pay interest on the massive amounts of debt that have been accumulated in the past. (Canada's province of Alberta is a notable exception.) And so governments are most familiar with the dynamics of a negative endowment. In recent years, many governments have therefore made Herculean efforts to stop running deficits and have even begun to produce small surpluses which they can use to reduce the national debt, thereby shrinking the negative endowment fund that hangs like a millstone around their necks.

My picture of personal finance is still incomplete insofar as little has been said about home ownership. I am among those who advocate home ownership as a valid part of a sound, long-term financial plan leading to retirement. In the early days of owning a home and making massive mortgage payments, one pays very little principal and can be said in effect to be renting a home that is owned by the bank holding the mortgage. But once some years have passed and one's level of equity in the home has grown, the equity can be regarded as an endowment fund that serves to subsidize one's standard of living. The homeowner may not be aware of this continuing subsidy since the amount of money he must come up with each month remains about the same as it was when he was paying off almost no principal.

In a conventional mortgage, the proportion of principal to interest gradually grows with each payment made. In effect, an endowment fund is being built up: with each mortgage payment, saving for the future gets a little easier. But to get a proper sense of what is going on, bearing in mind that we are thinking in terms of long-term retirement planning, the monthly mortgage payment should be broken down into its two components: the interest portion represents an unavoidable expense that has no long-term benefit, but the money paid toward the outstanding principal is ultimately an investment. In other words, the principal or home equity functions as a sort of endowment fund. Of course the aim is to have one's home paid off before embarking upon formal retirement. At that point, the equity in the home represents a substantial endowment fund that serves to subsidize one's day-to-day living expenses.

These factors in personal finance are often overlooked when schemes are devised to decide who is eligible for financial assistance or perhaps a reduced rate in relation to some government program. The same dynamics may be present when decisions are being made about the amount of tuition a given family should be expected to pay to the private Christian school in which their children are enrolled. During my years of serving on the boards of directors of Christian schools, I can remember much discussion of "tuition geared to income." There were many who thought this was the fairest way to run a Christian school: those who were able to pay more in virtue of having a higher annual income would then be obliged to do so. I was always reluctant, because I understood that one's income level is not necessarily a fair reflection of one's overall financial position and ability to pay. The problem, in brief, is that endowment funds -- both negative and positive -- were not being taken into account.

Part of the reason why the notion that income level is the best indicator of people's ability to pay proved popular is that income level can be ascertained in a fairly objective manner, assuming that people are willing to be honest. The usual requirement was that one was to report line such-and-such of the previous year's income tax form. Of course it would have been conceivable to base Christian school tuition or one's entitlement to some government benefit on a mixture of income and assets, but it is widely understood that assets are notoriously hard to assess. Even the value of an RRSP or IRA account is hard to assess, because the dollars in such an account have not yet been exposed to income tax. In other words, $100,000 in such an account is not be regarded as a straight $100,000 of future purchasing power. How much cash in one's pocket the $100,000 will eventually become will depend in good measure on the annual income level of the person withdrawing the money. That income level may fluctuate from year to year, and with it will fluctuate the proportion of the original amount that must be paid in income taxes. Therefore the value of a retirement account must be reckoned as less than the value that is reported by the company holding one's investments. Similar considerations apply to unregistered investments, for there are also potential income taxes to be paid on growth or profit in such accounts, although the proportion of tax that is owing will depend somewhat on the nature of the securities involved. So-called capital gains are normally taxed at a lower rate.

I recall that in my school board days, we were told that farmers are particularly hard to assess in terms of ability to pay. They tend to be low in income as reported on tax forms, but wealthy in other respects. Sometimes their alleged wealth was understood in terms of their prospects for selling their farm one day for "development." Some farmers do become wealthy in just this way and thereby fund their retirement. It makes some sense, I suppose, to judge farmers as potentially wealthy, assuming that the anticipated "development" is a sure thing. But there are many farmers for whom the ship never does come in. Zoning and other government decisions play quite a role in these matters. And so the financial position of our farmers is to some degree a matter of speculation.

With all of these considerations to be borne in mind, it did seem to me that young families with children in Christian schools are hard to assess in terms of their ability to pay tuition. One could simply say: You reported an income of X thousand dollars on last year's income tax return, and therefore we judge that you are able to afford a tuition of such-and-such an amount. Such a judgment does not take into account the possibility of a negative endowment fund that may be dragging down the family finances. Or in some cases it may be that the young family has already built up enough house equity to be benefiting from a positive endowment fund. Of course, in the latter situation there is not much implication for monthly cash flow; nevertheless, the long-term picture in terms of such a family's buildup of capital intended to support retirement is significant.

Although I am not qualified to engage in formal financial planning, I have gradually reached the conclusion that money is too important to be left to experts. And so, in the years in which I have begun to look ahead to my own retirement, I have become quite deliberate in terms of tracking my personal financial position. Naturally, I have kept a close eye on the growth of my own endowment fund, the fund that will one day supplement my company pension and government pension to sustain me and my wife in our old age. In the course of my planning and calculating, I have reflected on the role of the family mortgage. Can the principal that has been paid off (the equity in the home) truly be considered an endowment fund?

Originally I was of the view that one can speak formally of an endowment fund supporting one's pending retirement only when the family home is completely paid off. And so one's retirement nest egg, so to speak, would consist of the full value of the house (the assumption here is that the mortgage has been paid off) plus whatever money may have accumulated in RRSP or IRA accounts, plus non-registered savings or investment accounts. And in the years when the mortgage is not yet paid off, the amount that remains to be paid on the principal needs to be subtracted from the registered and unregistered investments. In other words, the outstanding principal serves to reduce the retirement nest egg.

More recently I have come to the conclusion that this kind of thinking is too negative. Instead of subtracting the money still owing on the house from the endowment fund to support retirement, I would propose to add the equity that is already in the house to the other funds. Remember that in any long-term mortgage, a house must be considered as partly paid off, unless there has been a serious slump in real estate values. I know that such calculations can be difficult to make in absolute dollar terms because house values are a matter of speculation. I suggest the use of some conservative figure, plus an indexing of that figure.

My reason for making the switch toward a more generous endowment figure is partly psychological. The motivation one needs when it comes to saving for old age cannot be taken for granted.

From time to time I discuss retirement and financial issues with people who are about my age. I am sometimes shocked at how little planning some have done -- indeed, how little awareness of financial issues pertaining to retirement seems to exist in the heads of some of them. Part of the reason, I suspect, is a sense of hopelessness that settles over many people when they read in some book or other that one needs to have half a million dollars saved in order to retire. They think to themselves that to amass such a sum of money without visiting Las Vegas is an utter impossibility, and so they put the whole business out of their minds and begin joking that they cannot afford to retire and will simply keep working until they drop dead one day. My own involvement in financial planning for retirement has convinced me that many people who have been prudent throughout their working lives are actually in better shape when it comes to retirement than they realize. And so I would like to see the home equity added to the endowment fund on which retirement is based rather than subtracting from it.

And in the same upbeat vein I would point to a parallel between the life of many retirees and the newly endowed chair at Redeemer. The endowment fund subsidizes the activities of the holder of the chair; in other words, the chair or professorship does not generate its own revenue and is not self-supporting in a business sense. The holder of the chair does a fair amount of teaching, an activity that generates tuition revenues, but he is also given two course releases per year for purposes of research and publication. Hence the anonymous donor can be said to function as a patron in relation to the endowed chair. (I hardly dare make such a comment: today "patronizing" is a pejorative term, as though it were an activity to be strictly avoided.)

In similar fashion, people who are successfully retired and have built up enough of an endowment fund so that they can be relatively active can be regarded as patrons in relation to their own activities. Many of them, especially in the Christian world, engage in useful work for a number of years after retirement. In some cases the work is entirely voluntary and unpaid, and in other cases there is a modest level of payment that amounts to no more than an honorarium. Either way, the person doing the work may in addition have to pick up expenses associated with the work. How is all of this financially possible? The answer is simple: through the subsidy provided by the endowment fund. Such retirees are "well endowed." Through their volunteer activities and self-subsidized work they share their endowment with their community. This sort of thing can even be done in the university world. Although I've never heard of a professor endowing his own chair, it is certainly possible to work for a dollar a year, or to teach after formal retirement for a token part-time salary.

Here a beautiful picture begins to emerge. By saving for retirement and building up an endowment fund, a person is looking out for himself and seeing that he does not become needlessly dependent on others. And if he is successful, he has the opportunity to use the modest amount of capital he has accumulated for the benefit of others as well.

There are a great many activities in our society -- I think especially of church activities, since that's the social world in which I am most active -- that are only possible through the volunteer labors of many people, some of whom are retired. If all of that work had to be paid for at wage rates that are considered competitive nowadays, with fringe benefits built in, many of the programs in question would simply collapse.

When we add all this together, we see that the financial world of a successful retiree is a little more complicated than we might have thought at first. Some retirees like to create the impression that they are very badly off financially. They may state their annual income (their company pension plus whatever support and pension they may receive from government sources), and it may seem paltry in comparison to what many younger people earn. But the annual income does not tell the whole story, for if the retiree has paid off his house, he is being subsidized by an endowment fund which consists of the equity in his home.

Not to be forgotten is the fact that the subsidy derived from his home equity is tax-free. In other words, it is not a housing allowance which he must report as income; it is money saved, i.e. money that he refrained from spending in the first place. We sometimes say that a penny saved is a penny earned, but even this is not quite true. A penny earned needs to be reported as income, which means that it shrinks once the taxman has taken his share, and so it is less than a penny in terms of actual spending power, but a penny saved does not count as income for income tax purposes. And so it is better to save $15,000 (by not needing to make mortgage or rent payments) than to earn an extra $15,000, for it will shrink to considerably less once the income taxes have been paid.

In this regard, a retiree's financial position can be hard to assess in roughly the same way as the financial position of a minister may seem a bit murky. At a congregational meeting one may read on a sheet outlining next year's proposed budget that the minister's salary is X thousands of dollars, which is a figure well below that of many of the members of the congregation. But then someone pipes up: "He gets free housing." True, let's say that he lives in a parsonage or a manse. Or perhaps there is a separate line in the budget statement reporting a fairly substantial housing allowance for the minister. If that allowance were added to the minister's salary, he would be more in line with others in the congregation. But if he occupies a parsonage owned by the congregation, one could calculate roughly what it would cost to rent such a home and add that sum to his salary. And so ministers can join farmers and retirees as people whose financial position is not easily summed up.

It is often said that God helps those who help themselves. If possible, we should be self-supporting, even in our old age. But the money we save for retirement should also serve, if possible, to benefit others, and this is what an endowment fund has the potential to do.

In concluding this little essay, I should point out that there are much more sophisticated ways to work out these ideas in practice. The ways and means available go beyond my own competence to explain since I am far from being a professional in the financial field. Charitable institutions are keen to show older folks how, on the one hand, they can use their savings to supplement their income during their retirement years, while on the other hand they can set aside money for charities and churches or for the eventual support of some other good cause. The details of such a plan may involve an annuity of one sort or another. I urge all readers who are interested in approaching financial planning for retirement in such a spirit to contact a financial officer of a charity or a church that is dear to their hearts, so that in endowing themselves they may also endow others with what God has been pleased to give them. [END]

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