Financing my retirement living. Part one. Some risks to look out for when planning for retirement

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There are three primary considerations to take into account when determining whether your savings last through your retirement years: inflation; the timing of returns on your investments; and life expectancy.  

1. Inflation

Most of us think of inflation as the ever-increasing cost of goods and services over time. Governments encourage inflation because it provides them with tools to help smooth out the effects of economic cycles. Like it or not, inflation is unlikely to go away. 

According to Statistics Canada, Canada's inflation rate over the past 20 years has been 1.89% per year so a basket of goods that cost you $100 in 1992 will cost you $144.89 today. So if you want to maintain your standard of living, ongoing inflation requires that you have an increasing salary to during your earning years and in retirement, your pensions, savings, and any alternate income streams also need to take inflation into account.

2. The timing of returns on your investments

Many people keep their savings are primarily in bank accounts, GICs, mutual funds or the stock market. During the years you are adding to your savings, you may not worry too much about these investments and what return they will deliver in your retirement years.

Bank accounts and GICs are often considered safe bets, but don't earn much interest. The value of funds in mutual funds and the stock market fluctuate daily. During savings years, financial advisors often suggest adding to your savings when market values fall, with a general understanding that there will be a market recovery in the future and the returns overall will be higher than bank account interest and GICs. However, it requires a crystal ball to know when markets will recover, which becomes a concern in later years if you are forced to begin drawing upon your savings while their value is still low. 

Over the past decade, investing in the markets has generally provided lower rates of return, causing serious financial obstacles for savers and retirees alike, increasing tension levels. For those who are saving, low or no growth puts people years behind in their ability to accumulate enough savings from which to retire on. For retirees withdrawing money from savings that aren't growing it lead to financial disaster, as dwindling funds make it more and more difficult to keep up with inflation and worse still, the base capital is likely to erode faster than it can be replenished. If this happens to you, you'll run out of money before you die. That's pretty scary.

3. Life expectancy

Better health care is allowing Canadians to live longer, and although this can be a reason to celebrate, it is also leading to more worrying about how to finance our retirement years. According to Stats Canada, the life expectancy for Canadian males now aged 65 is 83.5 (an additional 18.5 years); life expectancy for females now aged 65 is 85.2 (another 20.2 years).  

The term 'life expectancy' is often misunderstood. It expresses an average age, meaning half of all people will die on or before their life expectancy age and half will live past that age. Your lifespan most likely won't be the exact average but can supply general guidelines when working with your independent financial advisor for financing your retirement.

As a financial planner, I'm always asked, "How far ahead should we plan for our nest egg to last?" Many planners will advise you to use the age 95 as a baseline when planning to self fund your retirement. If you do live longer, that means there is some risk, but 95 is a good place to start, to help you sleep at night.

I recommend that your plans take you well into the future because your financial capacity may change unexpectedly. You have to keep in mind your personal lifestyle needs and wants, and also anticipate changing health care needs which can dramatically increase your cost of living. 

When you are in your saving years, you may be able to afford higher risk investments that could possibly deliver higher rates of return. But as you approach retirement, higher risks lead to greater worries and may be inappropriate. This should be a key topic of discussion with your financial advisor. Keep in mind that independent advisors can generally offer you a much broader range of options. 

To ensure you won't run out of money, ensure you are putting money aside on a regular basis. Products like annuities and variable annuities are insurance products that generally offer a greater return than GICs, and offer fixed, guaranteed income for the rest of your life, even if you outlive the capital. This can be a good place to your discussion with your financial advisor to find the best solutions for your situation.

Please feel free comment if you would like to share your experiences, would like to see a specific topic covered in future blogs or have any questions around these issues.

Next:  My home is my nest egg… What do I do now?

Will I have enough income?

For those of us who don't have a defined benefit plan to rely on when we retire (or have a plan that won't be enough to satisfy our financial needs) we require different investment strategies to fulfill our family's financial needs that will last throughout our retirement years.

In addition, low interest rates are making our investment decisions even more challenging because it takes significantly longer for our savings to grow and a much larger savings base from which to pay our expenses. Some people can afford to take more risk by investing in assets like mutual funds that are not secure, but if you are relying on this money to pay your way as you approach your retirement years is this really a good idea?

The short answer is a qualified maybe. Here's why.

For years we've been told by people who sell riskier investments that taking on a 'balanced approach' or just a little more risk means you'll get a higher return on your investments. They also tell us that when the market goes down it's a buying opportunity because the markets will recover and in time we'll get better over-all returns. The idea is that the longer you are invested, the higher the probability you will end up with above average returns.  In general this is good advice when you have a time horizon of many many years and/or you have invested excess money you won't need to depend on.

In his book Pensionize Your Nest Egg, Moshe Milevsky calls the five years before retirement and the five years after retirement the Retirement Risk Zone. During this time the most basic problem with risky investments is that there are no rate of return guarantees. Market corrections will occur at various random times before, during and after the risk zone years and these corrections will decrease the value of your nest egg. As you take money from your savings and your capital erodes at the same time, it becomes a very serious negative compounding problem that can spiral to zero values extremely quickly. 

In a very basic example of this, let's say you've just retired and have $100,000 in savings which then grow to $105,000. You then start withdrawing an expected $5,000 a year. The market corrects by 20% and your savings become worth $80,000. Do you stop taking income and wait for the market to recover? How long will that be for? Can you afford or even want to wait?  (Today the S&P/TSX60 is about at the same level it was in 2008!)

Though the future is unknown you know that the average return of the S&P/TSX60 over the past 10 years or so has been a little under 5%. If that rate of return continues your savings would grow to somewhere around $78,500 before you take out another $5,000. Leaving you with $73,500.  And so on until the next correction. I'm sure you can see that, unless you stop taking income for a period of time, it's unlikely your savings will ever catch up and you'll run out of money much faster than you'd care to worry about.

If you wish to avoid this kind of risk or this has already happened to you what are some of the more common solutions available?

Like with most things financial, unfortunately there are no one size fits all solutions because everyone's family, finances, current and future needs and wants are quite different from each other so proper solutions really depend on the outcomes you want and can afford. 

In general though, if your retirement income is too low for your needs, or you'd prefer a higher after-tax income, it's time to explore whether your nest egg should be rearranged somewhat to provide a higher after tax income stream and to do so without taking on any risk.  

In my practice, I find that it often makes sense to initially explore whether it makes sense to create a core income that's guaranteed for life. When it is appropriate, guaranteed income for life is really something that you can rely on and can effectively plan around.

Next...Financing your retirement living.

Jack Bergmans, Certified Financial Planner/Founding Partner
Bequest Insurance
Personal financial planning for life!™
jack@bequestinsurance.ca
Books:
Ripple Effect
Multiplying Generosity