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Should you have a savings plan that's similar to having your own Defined Benefit Pension Plan?

As the Canadian postal workers union  (CUPE)  continues to negotiate with Canada Post over their contract and in particular t he issue of ph...

Thursday, 12 December 2013

Will You Be Happy When You Retire

There are always some risks in life but if you have a decent defined benefit pension plan through work, or otherwise have done the math and know that you can guarantee that you have enough money to self-fund your own retirement for the rest of your life, your financial pillar is probably reasonably well taken care of and you'll be happy when you retire or at least won't have financial worries.

If you don't have a defined benefit pension plan and you don't have the financial capacity to self fund your retirement for your entire life you are probably going to run out of money at some random point in retirement.

Here's a basic reason why. Let's say you have $100,000 saved for retirement. You've invested in a basket of balanced low or medium risk mutual funds in a contribution pension plan at work or some RRSP funds at the bank.  You decide to retire at age 65. You convert your plan to a Registered Retirement Income Fund (RRIF) and take out  4% right away.  Then the stock market has a correction. Market corrections can't be forecast but you expect that if you're retired for a couple of decades or more it's bound to happen sometime, maybe even a few times.

You had $96,000 left in your savings after your first withdrawal but the correction made it worth $80,000. So the next year, at age 66 you need to take out 4.17% of $80,000 leaving you with $76,664. You must take out a minimum amount from your RRIF every year and that minimum increases until you're 94 where it max's out at 20% of it's value per year.

To keep this example going, your savings don't grow the next year because it's a flat market. So now at age 67 you need to take out 4.35% leaving you with $73,329.

Age:  Starting Balance                         Savings Balance
65       $100,000                 - 4%          = $96,000
           $96,000                   - 16.7%     = $80,000 (sample market correction)
66       $80,000                   - 4.17%     = $76,664
67       $76,664                   - 4.35%     = $73,329

This is essentially what happened to most retirees with RRSP's and RRIF's in 2008 and 2009.  In many cases the losses were much worse. With this example you can see that in the first three withdrawals during retirement your savings would already be down 26.7%. Unfortunately the market has historically not been able to catch up to losses like these so at some point in retirement you're going to either spend less than you need to or run short on money sooner than you'd like. It's a treacherous spiral and anyone caught in this trap won't be happy when they retire.

A good rule of thumb is that if the value of your assets can sustain you in the lifestyle you want to at least age 100 you're probably going to be ok.  New mortality tables indicate that our median lifespans are increasing so the younger you are, the longer you're likely to need to plan for.

If in your case you can't self fund and sustain your lifestyle in retirement to at least age 100 you would be very wise to move some of your savings into pooled income solutions.  Pooled income solutions will give you a guaranteed income for life so you'll never run out of money. They are only offered by insurance companies and typically include Annuities and Variable Annuities.

When you use savings for an Annuity that are not in RRSP's or RRIF's they are extremely tax friendly so your take home income will be need much less upfront money than if you decide to take income from a bond or GIC (which are taxed at the very highest rate).  Often an annuity is used to bump up retirement income using only a portion of your savings because once you buy the annuity you no longer have access to that money. You would decide what makes the most sense in your circumstances.

At retirement, Annuities normally also give you a much higher income than other guaranteed income products. If you outlive what you paid for your annuity, your income continues for the rest of your life anyway. You'll be happy. If you don't outlive your money your beneficiaries will get what's left over. It's a very good deal.

Variable Annuities are another solution that's very popular with people who don't have defined benefit plans. These are also described as self directed defined benefit pension plans and can be excellent solutions both during savings years and at retirement because you'll know up-front the guaranteed minimum income you'll receive for life. Variable annuities also give you the upside potential of mutual funds so over time your guaranteed income for life can ratchet upwards and  be contractually locked in for life. Joint accounts can be set up and you always have access to your money at any time, a great feature that's bound to make you happy.

Almost everyone will tell you that retirement isn't all about money. There's family, friends, activities, travel and everything else we'd like to get more involved with. Pooled Income Solutions give you a guaranteed financial foundation so no matter how stormy the weather gets, you know that the lights will always be on and there's always going to be food on the table. It's sure to give you invaluable comfort and peace of mind.

In my experience, for most people, moving some of your savings into guaranteed for life pooled income solutions is the perfect step you can take today to be on the road to be happy when you retire.