A day does not go by without my having clients express their concerns about approaching retirement. I feel their angst. I, along with an estimated 14 million other Canadians, will transition into hopefully blissful retirement over the next 16 years. In the process we will convert an estimated $3 trillion in wealth to fund our retirements. A key question to answer is whether we approaching retirement with confidence or uncertainty?
All previous generations have faced unique risks and challenges and true to tradition we Canadian “baby boomers” have our shopping list of challenges that differ from previous generations. For one we are living longer and this longevity risk creates the fear that we may have to fund our retirement for 25 years or longer, perhaps outliving our retirement savings.
What we are doing, or plan to do, in retirement is also dramatically changing. We may live as long in retirement as we worked and retirement presents us with a diversity of unique goals, from travelling, to outdoor adventure pursuits, to going back to school, to the traditional golf and gardening, to even going back to work.
The first thing we need to do in our planning is to sit down and map out what we’re looking for in retirement. That can be a lot more difficult than it first sounds. Then we’ve got to figure out how to pay for it. This is when retirement planning becomes particularly challenging. Many risks have to be taken into account as we begin our serious preparations. For example inflation may erode our savings, lousy and volatile market returns early in retirement can quickly deplete savings, unexpected health care expenses and emergencies may necessitate our access to some liquid funds and of course many of us would like to leave an inheritance for our kids. When you add to this mix the reality that during down markets investors make wrong decisions 75% of the time you end up wondering how people can develop a successful financial plan. But, this is our challenge and in the last 10 years leading up to retirement we should at least consider a few simple ideas as part of our planning:
1) Have You Really Saved Enough? Do you know what you need to live now and do you know what you will need in your retirement?
A starting suggestion is to save 10 per cent of your gross income. Registered tax saving vehicles such as registered retirement savings plans (RRSPs) and tax-free savings accounts (TFSAs) are two simple and useful vehicles to use for savings accumulation.
RRSPs provide a deferred tax break and allow your savings to compound free of tax during your working years. Withdrawals in retirement are taxed as income but usually at tax rates lower than during your working years. TFSAs, by comparison, are invested after tax is paid and provide no upfront tax benefits. They do however allow savings to grow free of tax. Capital withdrawals are not taxed.
2) Expect Modest Market Returns. Given recent market volatility it is prudent to plan based on an assumption of a conservative rate of return in the years leading up to retirement and during retirement. This provides a safety cushion. You can feel pleased if the markets perform better than assumed.
3) Use Product Allocation Retirement Strategies. Asset allocation strategies alone, shifting towards less volatile and less risky assets, may be inadequate to ensure that your savings will last. This shift away from accumulation strategies towards preservation and retirement income generation strategies can help ensure people do not outlive their savings. Product Allocation is one strategy aimed at placing a retiree’s assets in the right proportion into three distinct product categories to help ensure sustainable retirement income. Although there is a cornucopia of product choices available three product classifications are Systematic Withdrawal Plans (SWP), Guaranteed Minimum Withdrawal Benefits (GMWB) and Immediate Annuities (IA). A systematic withdrawal plan (SWP) allows investors to receive a regular income while still maintaining their investments’ growth potential. A GMWB is a type of option that protects retirement investments against downside market risk by allowing the withdrawal a maximum percentage of their entire investment each year until the initial investment amount has been recouped. An Immediate Annuity contract is purchased with one payment and has a specified payment plan which starts immediately.
4) Calculate Retirement Income and Expense Streams. Include income from pensions, non-registered investments, Old Age Security and Canada Pension Plan benefits when calculating your retirement income. Typically you want annual retirement income that is a minimum of 70% of your pre-retirement income.
5) Estate Planning. For some people an important aspect of retirement planning is leaving a financial legacy. Recent market downturns have demonstrated how volatility can deplete a planned inheritance as individuals realize they’ll need to use all their savings to fund their retirement. Life insurance is one way to provide a degree of certainty for those who want to achieve their estate goals and legacy desires.
Here is a final recommendation. Retirement comes with many unknowns. You will want to work with your advisor to understand the retirement income products that best suit your retirement goals and income needs.