Retirement Income Planning is a speciality in the world of financial advice. There are specific risks that are different from simply saving for retirement. It requires a different skillset for the advisor to be able to plan for the specific risks when developing an income plan that will last a family’s entire lifetime.
From my experience, helping retirees develop and implement lifelong income plans, the most common goals and concerns among retired or soon to be retired clients are:
- They don’t want to run out of money during their lifetimes (and/or are worried about investment losses).
- They are concerned about everything costing more each year.
- They want to pay less in taxes.
- They are worried about health issues as they age, such as taking care of their spouses or parents, and what happens if they can’t take care of themselves (especially Alzheimer’s).
- They wish to leave something for their family.
In order for the retiree to feel comfortable in their retirement income plan, all of the above items need to be taken into consideration as well as the very specific risks to retirement income planning as outlined below.
The Non-Negotiable Risks of Retirement Income Planning
An advisor’s job is to review and plan as much as possible for the key risks when transitioning from the saving phase of your life to providing a lifetime income from the assets you have accumulated (deaccumulation stage). These risks are very different from when you are saving for retirement. A non-negotiable is something that you can’t change, and many of the key risks to retirement are non-negotiable.
The key non-negotiable risks of retirement income planning are:
- Longevity Risk – unknown time horizon
- Inflation Risk
- Taxation Risk
- Investment Risk
- Sequence of Returns Risk
- Health Care Risk
- Cognitive Risk
A risk that you may have some control over:
- Withdrawal Rate Risk
A detailed review follows:
- Longevity Risk – Unknown Time Horizon
No one knows how long they will need their income to last, but they are certain they don’t want it to run out. In general, people are living longer today, so most people will have to plan for their income to last a longer time period than previous generations. One of the biggest fears retirees have is outliving their assets, and one of the biggest fears of financial advisors is the same, having their clients outlive their assets.
The below chart shows the probability of a healthy 65-year-old living to various ages.
|Current age is 65||25% survival||50% survival|
Source: FP Canada Projection Assumption Guidelines 2021
So, if you are a couple who are both 65 today, there is a 25% chance one of you will live to age 98, and a 50% chance one of you will live to age 94. As you can see, you will need to plan for 30 years of retirement income.
A White Paper from the World Economic Forum, entitled, “We’ll Live to 100 – How can We Afford it?” estimates that 50% of the babies born today (2017) in Canada, can expect to live to 104. (2121) Just think what this will do to retirement income planning if you have to plan to live to age 100?
Source: Human Mortality Database, University of California, Berkeley (USA) and Max Planck Institute for Demographic Research (Germany)
- Inflation Risk
Inflation risk is the risk of not being able to maintain your purchasing power during retirement. As you know, over time everything seems to become more expensive.
What does $1,000 today buy in…?
|Inflation||1 %||2 %||4 %|
|20 years||$ 820||$ 673||$ 456|
|30 years||$ 742||$ 552||$ 308|
To maintain your purchasing power, you need to be able to increase your income in retirement, much like an annual pay raise while you were working.
3. Taxation Risk
Taxation Risk is the risk of your tax rates increasing over time and also paying more in taxes than you otherwise might have if you had organized your investments in the most tax-effective manner.
Everyone has to pay taxes, and as taxes seem to be increasing each year, everyone needs a tax plan. One of the best ways to increase your income (and to make your money last longer) is to reduce the amount of taxes you have to pay by structuring your income sources tax effectively.
This is needed because retirees can have numerous sources of income that need to be coordinated to reduce current and potential future taxation. For example, a retired couple may have the following sources of income that have to be coordinated:
- Government Benefits
- Old Age Security each
- Canada Pension Plan each
- Company Savings Plans
- Defined Benefit Plans (guaranteed income)
- Defined Contribution Plan
- Individual Savings
- RRSPs (RRIFs)
- S-RRSPs (SRRIFs)
- LIRA (LIFs)
- Non-Registered Savings
- HOLDCO with investment assets (for business owners)
- Rental Real Estate Income
In my experience, it is not uncommon for a retired couple to have 10 or more sources of income that have to be coordinated with regards to:
- Timing (when to start the income)
- Taxation (where to place the investment and types of investments)
- Withdrawal (where to draw the income from)
Different investment incomes (interest, dividends, capital gains) are taxed at different rates, therefore you will want to ensure you place the investments in the proper locations (TFSA, RRIFs, Open Accounts) to reduce your taxes, and to maximize any potential government benefits.
4. Investment Risk
a) Interest Rate Risk
With the current low-interest-rate environment, most people can’t only invest in “safe investments” to fund their lifestyles, such as GICs and Bonds. For example, the yield on Government of Canada 10-year bonds declined from approximately 8.5% in 1991 to about 1.65% currently (source: Bank of Canada.) As a result, most people have to invest in assets or investments that do not have a guaranteed rate of return and are market-based (i.e., can go up and down in value and are not guaranteed).
b) Market Performance
Retirees must develop an asset allocation (investments) that provides them with the ability to meet their income requirements over their lifetime, and also fits their risk profile. A key concern once retired is, if the markets have poor performance several years in a row, it can dramatically affect your income. For example, a 20% market decline could mean a 20% reduction in income. Also, poor investment performance just prior to or just as you retire can dramatically affect your long-term goals.
5. Sequence of Return Risk (also known as Black Hole Risk)
The years just prior to retirement and after retirement are the key times when planning to create retirement income. If you have poor market performance just prior to and just after retirement, it can dramatically reduce long term income.
As an example, if you had $1,000,000 of investments, the market dropped 20% and you withdrew $40,000, the market value would be $760,000.
If the following year, you withdrew another $40,000, the new withdrawal rate would be 5.2% which may be too much over the long term. Just think what would happen again for a few years in a row…This is called the “Black Hole” as you can never climb back out of it.
As a result, your retirement income can be determined by luck, which can be either good or bad depending on if you start withdrawals during good or bad investment markets.
The following example involves investing $1,000,000 at each of the below start dates, with an initial withdrawal rate of 4% per year, and increasing this by 2% per year for inflation, utilizing the Morningstar Global Canadian Balanced Index.
|Start Date||Investment Amount||Initial Withdrawal Amount||Value September 30 2021|
|January 1, 2008||$ 1,000,000||$40,000||$ 881,891|
|January 1, 2009||$ 1,000,000||$40,000||$ 1,568,667|
|Start Date||Investment||Initial Withdrawal Amount||Value September 30 2021|
|January 1, 2001||$ 1,000,000||$40,000||$ 407,961|
|January 1, 2002||$ 1,000,000||$40,000||$ 659,728|
Each of the above examples uses the Morningstar Global Canadian Balanced Index (a globally diversified portfolio) so the investment had the same returns in each. However, the difference in a starting date of only one year had a huge difference in the end value as of September 30, 2021.
6. Health Care
A survey by Ledge Marketing for the Canadian Life and Health Insurance Industry indicates that 74% of respondents haven’t included long term health care planning in their retirement plans. Health care can be a significant cost for retirees, and yet many retirees have not included long term care costs into plans or have even considered it. From my perspective, every retiree should account for the potential cost and have a plan for this.
The estimated rates for a government-subsidized long term care home in Ontario Long-Term Care Home is:
|Type of Accommodation||Monthly Rate|
|Basic/Standard (usually 3-bed ward)||$1,891.31|
|Preferred (semi-private room)||$ 2,280.04|
|Preferred (private room)||$ 2,701.61|
|Short Stay Program||$ 40.24/day|
Fees for nursing homes in Ontario are set and subsidized by the Ministry of Health and Long-Term Care. The amounts on the above chart are what is billed to the residents. If the individual can’t pay for the basic accommodation, a subsidy is available.
Another option is private retirement homes and residences, and you would have to pay the entire amount yourself. Private retirement homes often have a few different living options such as:
- Independent living
- Assisted living
- Memory care: these provide some health care for challenges such as dementia. Often this option may be used while waiting for a Long-Term Care facility.
The average cost for a senior’s space in Ontario is $3,999 /month according to the CHMC Senior Housing report in 2021, however, this will vary depending on the level of service (as above) and amenities provided. The price range for private facilities has no upper limit and varies greatly depending on the city you live in.
7. Cognitive Risk:
This is related to health care and is the risk that as people (and their spouses) age, they may not be able to make sound financial decisions and/or health decisions for themselves. With increasing life spans this is becoming a more common issue.
A closely related risk is elder fraud and abuse. This is more prevalent today with the aging population, and it is imperative this risk is planned for well ahead of time.
Summary of the Non-Negotiable Risks of Retirement Income Planning:
The reason the above risks are called “non-negotiable” is you really can’t control or change them. You can’t determine how long you will live, or your future health care requirements (although by staying fit you may live longer and/or be healthier), interest rates and investment returns are beyond your control, as are taxes and inflation. However, with a sound plan in place, you can adjust as required.
Retirement Risk You May Have Control Over:
The final risk to retirement income planning is under your control, and this is spending too much, which is called Withdrawal Rate Risk. Quite often we see this risk when people haven’t saved enough in order to fund their desired lifestyle, they have underestimated how much they require in retirement or have not planned for extra health care costs as they age.
8. Withdrawal Rate Risk (Spending Too Much)
This is the risk of withdrawing too large a dollar amount, each year from your capital, and as a result, your capital will erode over time. Your withdrawal rate is the amount of money you need from your investments each year, divided by the total value of your investments.
For example, if your total investments equal $1,000,000, and you need to withdraw $30,000 a year to cover all of your expenses and taxes, your initial withdrawal rate would be 3.0% ($30,000/$1,000,000= 3.0%)
The following charts are from research by Morningstar Canada, and they are the projected safe withdrawal rates in Canada today. The below summary is based on asset allocation and initial safe withdrawal rates that provide the retiree with an 80% chance of sustaining that rate over a 25-, 30- or 40-year period (potential time in retirement).
(Note: 80% success rate means that 80% of the time your money would last for the time period, and 20% of the time, your capital would be depleted by the end of the time period)
25 Years with a chance of Success of 80%
|Equity Allocation||Safe Withdrawal Rate|
|0 %||3.2 %|
|20 %||3.6 %|
|40 %||3.8 %|
|60 %||3.9 %|
|80 %||4.0 %|
|100 %||4.0 %|
30 Years with a chance of Success of 80%
|Equity Allocation||Safe Withdrawal Rate|
|0 %||2.7 %|
|20 %||3.1 %|
|40 %||3.3 %|
|60 %||3.4 %|
|80 %||3.5 %|
|100 %||3.5 %|
40 Years with a chance of Success of 80%
|Equity Allocation||Safe Withdrawal Rate|
|0 %||2.1 %|
|20 %||2.4 %|
|40 %||2.7 %|
|60 %||2.9 %|
|80 %||3.0 %|
|100 %||3.0 %|
Source: Safe Withdrawal Rates for Retirees in Canada Today, Morningstar January 2017.
As an example, if you were 65 years old today and wished to plan to age 95 (30 years), and had a $100,000 investment account, this safe withdrawal rate with an allocation of 60% to equities would be 3.4% of $100,000, which is $3,400 per year.
(For the full report see: Safe Withdrawal Rates for Retirees in Canada Today)
The above is a good guideline, but in reality, retirees don’t spend the same each year and often can adjust spending based on the current market conditions. For example, in 2008 when the market declined, retirees were able to delay some of their discretionary spendings for a few years until the markets rebounded. As well, spending can decrease once retirees reach ages around 80 as they tend to be less active. However, this can be offset by increased health care costs as they age.
While all of the above sounds like a tremendous amount to overcome and to consider, the issues can be addressed with an advisor who specializes in retirement income planning. That advisor understands the specific risks and utilizes robust financial planning software to review the “what if” scenarios.
Once you are aware of the non-negotiable risks, and your personal spending rate risk, you can begin to craft a plan to suit your needs. However, this plan needs to be continually updated and monitored over your entire life.
For more information, you can refer to Preserving Wealth: The Next Generation – The definitive guide to protecting, investing, and transferring wealth by Jack Lumsden, MBA, CFP®
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Jack Lumsden, MBA, CFP® Financial Advisor, Assante Financial Management Ltd.
This material is provided for general information and is subject to change without notice. Every effort has been made to compile this material from reliable sources however no warranty can be made as to its accuracy or completeness. Before acting on any of the above, please make sure to see me for individual financial advice based on your personal circumstances. The information provided is for illustrative purposes only. Commissions, trailing commissions, management fees and expenses, may all be associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated. Please read the Fund Facts and consult your Assante Advisor before investing.
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