Unfortunately, Canadians needlessly make a lot of mistakes with their retirement planning.
With so many conflicting messages from various financial institutions all shouting for your attention, it's no wonder there's so much confusion. Let us simplify this for you and show you the easiest retirement income strategy you can use.
Canadians fall into 3 main groups when it comes to retirement.
First, about 2 million Canadians are in the lower-income bracket with only government benefits (CPP, OAS, and GIS) and little savings to make it through retirement. They usually have low expectations for retirement, travel infrequently, and can live adequately on a low income. They pay little taxes and have simple planning needs.
The second group, which represents the smallest group of retirees, are the high net worth households that have well in excess of $2,000,000 in savings and have little risk of running out of money, however, this does tend to be their biggest concern. Other challenges are taxation, estate planning, divorce, business succession planning, cross-border concerns, etc. They require a great deal of planning with various advisors working collaboratively to achieve their long-term goals.
That leaves a third group which is probably the largest group. This may be the category you find yourself in. If so, you most likely earned a decent income throughout your life and worked hard to accumulate somewhere between $200,000 and $1,000,000 of retirement savings. This may be spread around in your RRSPs, TFSAs, work pensions, and maybe a non-registered account. The big investment firms may take you on as a client, but give you little attention because you do not have over $1 million of investible assets. You are the person that we specialize in working with and we have customized a process that will help you eliminate mistakes, maximize your income, and retire more confidently with peace of mind.
Consider having your own customized retirement income plan using this 3 step process:
The first step in developing a retirement income plan is to determine how much income you will need.
The second step is to calculate how much savings you need in order to create the income, and
The third step is to determine which financial products you should use to generate the income you need from your retirement nest egg to give you the most income and the most peace of mind. You want it to be sustainable, predictable, tax-efficient, and perpetual.
Take Bob & Jane Retirewell for example - Both aged 65 with no debt.
(Most people retire close to age 65 and will need between 50-70% of their pre-retirement income.)
Pre-retirement combined income: $100,000 (for the sake of easy math)
Retirement income target: $60,000
Government benefits: $35,000
Income shortfall: $25,000
Step 1: Let's assume the couple will each qualify for the full OAS of $614/month and about $862/month in CPP. (That's $35,400/year combined) Keep in mind that during retirement you should no longer have mortgage payments, work expenses, CPP and EI contributions, or retirement savings contributions and your income taxes will be much lower. This is why you can live well on less income than when you were working. Payroll taxes alone will be about $25,000 of savings in retirement. You will need to add in the cost of a health plan and travel insurance. So, in this case, Bob & Jane can determine that their post-retirement income target is $60,000/year.
Step 2: Determining how much retirement savings they will need in order to make up the difference. Bob and Jane have a combined income of $35,000 from government benefits, so they will need to create an additional annual income of $25,000 from their retirement savings.
We always start with the simplest solution and in this case, $550,000 of retirement savings can create an annuity with a lifetime annual income of about $25,986 for a 65-year-old couple (2020 quote). Once the first spouse dies the same payment will continue to the surviving spouse regardless of how long he or she lives. It will take 21 years for them to break even. If at least one of them is collecting these payments for 25 years then the annualized rate of return is 1.32%. If one of them is still alive at age 95, which is highly likely, the annualized rate of return is 2.42%. This is an excellent return on a 100% risk-free retirement income stream that is guaranteed for life. Remember, you are no longer in the wealth accumulation phase of life. You are now in the preserve, protect, spend without worry, and enjoy retirement, phase of life.
This annuity payout is based on interest rates at the time of writing this article, which is the Spring of 2020. These rates are subject to change, of course, and you need to get an up-to-date number at the time of your plan. As independent advisors, we work with multiple annuity providers and can search unbiased for the best rates and features available in the industry.
Step 3 is determining which financial products, or combination or (combo of an annuity and other strategies) Bob and Jane could use to generate the income they need from their retirement nest egg to give them the most income and the most peace of mind. Keep in mind that in order to have a worry-free retirement that income has to be sustainable, predictable, tax-efficient, and perpetual. Bob and Jane chose to use $550,000 of their retirement savings to create an additional guaranteed income for life of $25,000. This will guarantee that all of their living expenses and travel/entertainment budget is covered regardless of what happens in the markets. They have an additional $200,000 of savings which they can use at their discretion for other things such as home repairs, vehicles, helping family, and leaving an inheritance. They also still have their home which is another retirement nest egg that can be liquidated in the future for other expenses in old age, like long-term care.
3 options Bob & Jane considered for creating retirement income:
Option 1: The simplest retirement plan you can create with no investment decisions to make or worries about where your next dollar will come from is an immediate annuity, as described above. Basically, you are exchanging a lump sum of money for a guaranteed lifetime monthly income stream.
The pros:
You have no more investment decisions to make and longevity risks are totally eliminated as the income will be paid for as long as one spouse is alive.
Market volatility and watching your investment accounts fluctuate will no longer be relevant or of any concern. Peace of mind is very valuable. The annuity checks a lot of boxes in the list of creating retirement income - it is sustainable, predictable, tax-efficient and it's perpetual. (Perpetual, in that the income continues for life)
The cons:
The annuity income isn't indexed to inflation, meaning it loses some of its buying power over time. Government pensions are indexed so that will soften some of this impact of increases in the cost of living. Your income needs may change over time and you may require more income, but, contrary to what most people believe, your spending will most likely decrease over the course of retirement, which creates an inflation buffer within your planning. Also, if you have other assets, they will also increase in value with inflation.
If both spouses die prematurely, there is no estate value for your heirs. The probability of this happening is rather slim. There's a high probability with a 65-year-old couple that one of them will live into their 90's. The lack of estate value upon premature death is of greater concern for a single person but you can add a feature to the annuity to mitigate that. Keep in mind that the main purpose of retirement savings is to turn it into retirement income, not creating an inheritance. You cannot try to accomplish too many goals with one source of funds. Many retirees see their principal residence as the last asset to be liquidated and spent and therefore is the main source of inheritance for their children.
Option 2: A Cashable annuity of $750,000 will give the same amount of guaranteed income. The difference between this type of annuity and a straight annuity as previously described is that you still have access to your money at any time, you can still be fully invested in the markets, and the balance of your investment account is distributed to your beneficiary upon your death. If you live a long life and the account balance goes to zero, your income stays at the same amount of guaranteed level until you die.
Pros:
Guaranteed income for life with estate value for your heirs if you should die before all the money is paid out to you as income. Also, you always have access to your money should you need it. This option provides predictable, sustainable, tax-efficient and perpetual life-long income and, unlike the straight annuity, it is flexible. It checks all the boxes.
Cons:
You do have to make some investment decisions, and you'll need extra savings to generate the same income as the joint-life annuity. There will be slightly higher fees and more tax implications than with a straight annuity.
Option 3: Fully invest your retirement savings portfolio in the stock markets and take $25,000 each year, which is 5% of your balance. If your market returns are at least 5%, theoretically, you will never run out of money.
Pros:
You have access to your money anytime so you can withdraw more or less in any given year as you have the need. If markets perform strongly enough you could possibly have more of an estate to leave to your family. You can defer your income until a future date and continue to grow your money. With the right asset mix, you can have predictable, sustainable and tax-efficient income, however, one significant market downturn can set you back and take many years to recover from.
Cons:
The downside risk is constant market volatility and the loss of sleep often associated with that. You also have no guarantees of what the market returns will be for the next 30 years and you run the risk of running out of money before you die (longevity risk). You also cannot create "guaranteed lifetime income" with this option. If your savings are in RRSPs you will eventually have to convert to RRIFs and may be forced to take out more than you want, as the RRIF minimum withdrawal amount increases every year. This creates taxable income that is beyond your control if strategic planning is not done well before you turn 71. Most importantly this option does not check many boxes on the list of criteria for creating retirement income. It does NOT provide predictable, sustainable, or perpetual life-long income, unlike the straight annuity or the cashable annuity.
** More on annuities: These products are only available from a life insurance company and a life licensed advisor. This is how guarantees are possible.
Retirement income planning is all about managing risk.
You need to decide how much risk you want to carry and how much of the risk you wish to share with a financial company. An annuity allows you to shift all of the market risk and longevity risk to an insurance company. Many people will divide their retirement savings into "buckets" by using a combination of the 3 options above thereby reducing the risk they carry on their own.
Here are some key points to ponder:
1. Statistically speaking, if you take a sample of 20 adults age 50 and look at them 20 years into the future, this is what will have happened by age 70.
- 10.5 will be healthy
- 1.5 will have died.
- 8 will be dealing with a life-threatening illness like cancer, stroke or heart disease. *Source: 2008 Critical Illness Tables
If you reach age 70 the odds increase greatly, every year, that you will also reach 90.
Our experience and the research shows that the best years to enjoy a retirement lifestyle is between the ages of 55 and 75. After that, the enjoyment of life gradually decreases for various reasons. If you are in a relationship, there's a 50% chance that one of you may have a premature death or a serious health crisis by age 70. Be careful saving all of your money for the years of least enjoyment. Spend more of your retirement savings in the early years and use what's left, along with the equity in your home, for the latter years.
2. There are no two plans alike and although we talk about the average couple statistically, there is no average couple. Your plan needs to look at your own probabilities and possibilities and then be created for the best outcome. Not everyone retires at 65 - some earlier and some later. Not everyone gets to choose their retirement date and are often forced into it with little notice. Levels of stress, eating and exercise habits, hereditary, smoking are all major contributing factors to vitality and longevity.
3. You don't know how long you'll live or how healthy you are going to be. You don't want to be the richest person in the cemetery. Additional reading: "All The Money in the World"
4. There are 3 major contributing factors to a happy retirement: Something to do, someone to do it with, and not having to worry about money. Annuitizing a chunk of your retirement savings is the best way to achieve the third factor. Not having to worry about money will allow you more peace of mind and the ability to focus on your purpose and social connectivity.
5. The research shows that cognitive abilities decrease with age, however confidence increases. We think that we can handle more, but in reality, we can't. We will struggle to make decisions relating to our health and financial well-being. This leaves many seniors vulnerable to being taken advantage of and there are many news stories to verify this. Link to this research.
With this in mind setting up a retirement income plan as early as possible makes the most sense, but also setting up a plan that is easy to follow for many years, especially in the later years, makes even more sense. For example, it's a good idea to have a Will, Power of Attorney, and Personal Directive early in retirement before your cognitive abilities start to diminish. The same applies to financial matters, such as banking and investments, as well as funeral arrangements and life insurance requirements.
It's important in retirement to have a trusted advisor that you can work with for many years to come. 55% of pre-retirees will change advisors when they transition to retirement because they realize they need specialized planning with a focus on income protection.
Learn more about our planning process to help you get your total financial house in order and keep it that way for life. We can ensure you have enough money to fund your current lifestyle, a plan in place that will ensure you reach your future goals, and the confidence to handle whatever comes your way.
Willis J Langford BA, MA, CFP
Nancy Langford CRS
Retirement Income Planning,
Willis is a Certified Financial Planner. 
- You can check our credentials at FP Canada, and at Alberta Insurance Council.
