As you transition from your working years to retirement or optional work years, creating a cash flow stream from your investments is critical to retirement planning.
There are five main retirement investment options to consider when developing a prudent plan for retirement cash flow: Income Only Investing, Income Focused Investing, Guaranteed Income Products, Total Return Investments, and a combination of these.
TYPES OF INCOME
The three main types of investment income are:
- Interest Income: Income earned from investments such as High-Interest Savings accounts, GICs, Bonds, and Bond funds.
- Dividend Income: Income earned from equities that pay dividends.
- Capital Gains: Income earned from selling investments which have increased in value.
RETIREMENT INVESTMENT OPTIONS
To create a retirement portfolio for your cash flow plan, there are five main options to consider:
- Income Only Investing
- Income Focused Investing
- Guaranteed income: Life income annuity/guaranteed products
- Total Return Investing: a globally diversified portfolio
- A combination of the above.
Let’s Review them in detail:
- INCOME ONLY INVESTING
This would involve only investing in products like GICs and Bonds and living from the interest they provide. While interest rates have increased recently, most people have yet to save enough capital to invest and for the interest income to provide enough cash flow for their needs and allow for increases over time as inflation is considered.
- INCOME FOCUSED INVESTING
This is similar to income-only investing, but it does add dividend-paying investments. The main issue is similar to the above in that, over time, the growth of the assets may not be enough to allow an increasing income in retirement to keep up with inflation.
- GUARANTEED INCOME PRODUCTS: LIFE ANNUITY
A life annuity isn’t an investment but a tool to create income. It is like purchasing your own pension. With this option, you would buy an annuity from a life insurance company and then receive a guaranteed income for life or joint life with your spouse or partner. Annuities can be purchased with registered investments (RRSPs and RRIFs), and the payment is fully taxable each year. Annuities purchased with non-registered funds may have a tax advantage.
A key advantage of annuities is that they eliminate the risk of outliving your savings and market risks, which are transferred to the life insurance company.
However, with annuities, you exchange your capital for the income stream. Some people don’t like using their capital to purchase an annuity, so another option for guaranteed income is guaranteed income products offered by life insurance companies through segregated funds, which are pooled investments like mutual funds. These products provide a lifetime income guarantee regardless of how the underlying investments perform within the segregated fund contract.
Most often, the guaranteed income will be less than what an annuity would provide; however, you have full access to your capital at any time at the current market value. If you redeem your money, you no longer have the income guarantees.
- TOTAL RETURN PORTFOLIO
A total return portfolio is a strategy that utilizes all four types of income:
- Capital gains
- Return of Principal
Rather than relying on only one type of income, it provides a diversified approach among the various income sources, which can help reduce risk. Different types of investments do better in different years.
This strategy can provide for cash flow today and allow for longer-term growth over retirement. A predetermined dollar amount is often deposited into your bank account to create a monthly income.
Often a total return portfolio strategy is used with a bucket approach, a retirement cash flow planning strategy that divides retirement savings into different categories or buckets based on the time horizon when you will need the money.
This approach balances having enough income and cash for your current needs and allows for growth to increase cash flow over your retirement, which is needed due to inflation.
Typical buckets used are:
- Income Bucket: these are typically cash and income investments for the first several years of retirement spending.
- Balanced Income Bucket: this bucket provides for the intermediate term and can consist of income investments and equities in a balanced approach.
- Growth Bucket: this bucket provides for longer-term growth and typically consists of equity investments. This bucket offers growth to keep pace with inflation over retirement.
Often the buckets are rebalanced at the end of each year if the growth has been positive.
Over the years, a few clients have taken advantage of annuities and guaranteed income products to provide a base source of guaranteed income. This has often been used in conjunction with a total return portfolio.
A total return portfolio helps to protect against the unique risks to retirement, such as inflation risk, longevity risk, and sequence of return risk. It also allows retirees to develop a retirement cash flow plan to:
- Provide a consistent and steady cash flow during retirement.
- Have the ability to increase income, like a raise while working.
- Provide funds for emergencies and contingencies.
For more information, refer to Preserving Wealth: The Next Generation – The definitive guide to protecting, investing, and transferring wealth by Jack Lumsden, MBA, CFP®.
For your FREE E-Copy of Preserving Wealth, CLICK HERE
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 regarding 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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