Will your retirement funds be enough?

Many Canadian investors worry about outliving their retirement savings.  Planning for retirement can be very intimidating, but with the right advice, the process can be less overwhelming.

There are key areas to consider

Changing investment objectives from growth to income

When working there is usually no requirement to withdraw funds from your investment accounts.  These are considered the growth years when the focus should be on building up your net worth.  In the early years, paying down debt on a mortgage may be a priority.  In the middle income years the focus may be on paying for educational expenses for children and building up investment savings as employment income increases. Contributions into an RRSP during the higher income earning years will result in a greater deferral of income into retirement.  People should focus on growth related investments in their earlier years and shift to more conservative income generating positions as they approach retirement.  This should result in less volatility in the later years and will increase the available cash flow.

Medical advancements mean people are living longer

It is very realistic for some people to be in retirement for as long, or longer, than they have worked.  This is becoming a challenge for some defined benefit pension plans – and one reason they are slowly disappearing.  Retirement plans should factor in your family health history, lifestyle, and retirement date. Actuarial studies have proven that the earlier you may retire, the longer your life expectancy.  Your advisor can calculate the required savings given a life expectancy date, along with other assumptions like inflation and rates of returns.   The required savings numbers are considerably different when looking at different life expectancies.   A useful first step is to run the numbers at five year increments, such as age 80, 85, 90, 95, and 100.

Not factoring in inflation

Canadian inflation numbers this past month surprised to the upside at an annualized increase of 3.3 per cent.  We feel that changes in inflation rates should be monitored. It is important when factoring the future cost of living into retirement planning as this will impact cash flow requirements.  Below we have inserted a table illustrating the impact of inflation purchasing power.

Annual Inflation Rate Value Today Today $ Value in

5 Yrs

Today $ Value in

10 Yrs

Today $ Value in

15 Yrs

Today $ Value in

20 Yrs

1% $1,000 $951 $905 $861 $821
2% $1,000 $906 $820 $743 $673
3% $1,000 $863 $744 $642 $554
4% $1,000 $822 $676 $555 $308
5% $1,000 $784 $614 $481 $377

More people retiring without a company pension

Even those people who have a company pension are finding their pension reliability may be suspect.  The issue of underfunded pension liabilities has been a greater concern in the past decade as those companies under financial stress may not be able to meet their obligations to retirees.  The onus has shifted more to the individual to ensure that they are a member of a sustainable plan. People are often faced with several career changes over their working life which may result in additional decision requirements regarding various severance options.

Working part-time during retirement

Many people may find sudden retirement a challenge both psychologically and from a cash flow perspective.  Continuing to work part time may be a more suitable transition for some.  People may decide to do something unrelated to previous experience as a welcomed change.  Your retirement plan should factor in whether you “want to work” or whether you “have to work”.  It is easy to illustrate how pulling large lump sums out early in retirement materially stresses long term planning.  Working part-time can keep the mind active, is social for many people, and can cover immediate expenses allowing your investment savings to compound for a longer period.

Communication with parents is often ignored in retirement plans

As you’re approaching retirement, your parents are likely beginning to require more help in their latter years.  This may be in the form of time or financial assistance.  In other cases, parents are financially well off and your retirement plan may factor in the possibility of an inheritance.  In some situations we encourage parents to gift assets to children early. This may lower their taxable income and help out the younger generation.

Families are more distant

We are getting more inquiries about people who say they have no children or that their children live in another part of the country or outside the country.  They are concerned about their long-term care should they become incapacitated or require assistance as they age. People should consider the potential cash requirements if there is this eventual need.  Downsizing personal residences is also a factor as their house becomes a significant component of net worth.

Insurance policies are often not understood

Not all insurance policies are equal and many people will focus on the lowest premium when first taking out a policy.  There are many things to look out for, including whether or not the policy has a level cost of insurance.  The policies that do not have a level cost often become a thorn in the side for many people at retirement.  Prior to purchasing an insurance policy, we recommend that you read the fine print and determine if premiums could change, even in your retirement.  The inflation table up above can also be used to illustrate the future real value (in today’s dollars) of a $200,000 life insurance policy.  If in 20 years the policy is paid out (assuming 3 per cent inflation), the equivalent amount in today’s dollars is $110,800.

Seeking advice early

For many people it makes sense to start working on a retirement plan in advance.  One of the most important things to consider is what your lifestyle will look like in retirement and the necessary cash flow requirements to make it happen.