by Thomas Johnson
How much money is “enough” to retire? For such a seemingly simple question, the answer is anything but simple! “Enough” money for one person to retire successfully can be vastly different for another.
While I can’t give a single answer that applies for all; I can provide some guidance on the factors you need to consider
when calculating your own “enough.”
1. How much will you spend? This is the ideal starting point for retirement planning. If we begin with the end in mind, we can work our way backwards. This will allow us to figure out how much you need in savings in order to fund that expenditure goal. Think through what you want to do in retirement and try to estimate both your fixed expenses (housing, utilities, groceries, etc.) and your discretionary expenses (such as travel, entertainment, and gifts).
2. How long will you spend for? If only we had a crystal ball to know exactly how long we have to spend on this Earth. Since we don’t have that luxury, we need to do our best to estimate. There are plenty of online resources about longevity, such as from Stats Canada, to ballpark life expectancy. You should add on a few extra years to err on the cautious side! Also consider your ideal retirement start date. You can adjust this up or down later, but you definitely need a starting point for running calculations.
3. What income sources will you have already? Most Canadians will qualify for some combination of government
pensions, such as Canada Pension Plan and Old Age Security. The amounts you receive will be dependent on a number of factors, like career earnings, length of residency, and start dates. If you login to your Service Canada account, you can find accurate numbers for these benefits! Be sure to include other consistent incomes, like part-time employment, rental income or work pensions.
4. How much tax will you pay? Income tax doesn’t go away when you stop working! Factoring in an estimated tax bill on your income sources is a must in calculating an appropriate retirement figure. Ignoring taxes on your retirement income is a surefire way to ruin your plans.
Once you have an idea of your income need, its’ duration, your existing incomes and a tax estimate, you can run a calculator to determine what you need to fill in the gap! This can be done through a number of online Financial Planning Calculators or through retirement planning software accessible by Financial Security Advisors.
“Enough” retirement funds for you won’t match anybody else’s figures. The process to finding out how much you need is, however, the same for everybody! If trying to calculate your numbers in a spreadsheet or on the back of a napkin is too daunting, now is the time to ask for help!
by Thomas Johnson
“My sister/father/neighbour/co-worker told me that RRSPs are ‘bad,’ is that true?” This question has long surprised me in my career because of how often it comes up!
Registered Retirement Savings Plans (RRSPs) are a tool in your financial toolkit that, when used correctly, can be extremely advantageous. When used incorrectly, they can be extremely frustrating.
Think of RRSPs as income deferral. RRSPs operate by reducing your income when you contribute and increasing your income when you withdraw the funds. For example, if you had a salary of $80,000 and contributed $5,000 to your RRSP, you could deduct that contribution and pay tax as though you earned $75,000 that year. If you take that $5,000 out from the RRSP in a year where you’ve earned $25,000 already, you’ll add that amount to your income and pay tax as though you earned $30,000. The end result is you’ve deferred $5,000 of income from one year and claimed it in another.
Advantages of RRSPs include:
• They allow you to defer income from years where your income is high (your working years) to years your income is low (your retirement years).
• The money you contribute grows on a tax-deferred basis; you’re only taxed when you withdraw it.
• They provide the potential for you to increase your purchasing power, if the investments within your RRSP grow at a rate greater than the rate of inflation.
Considerations for RRSPs:
• If you buy RRSPs in years where your income is low, or redeem in years where income is high, the tax breaks don’t work in your favour.
• Not being aware of the details of the tax breaks could harm your retirement planning.
Let’s take a look at the context around tax breaks. For example:
Imagine a retiree who contributes $50,000 to their RRSPs over the course of their working career. At retirement, the value has grown to $100,000 and they’re shocked to find out that they would pay 30% tax on redemptions. That math leads to only $70,000 of purchasing power. Turning $50,000 into $70,000 doesn’t sound very exciting does it? On closer inspection, we find out that they earned a 40% deduction on all of their contributions. The tax break means the RRSPs really only cost $30,000 ($50,000 x (1-0.40)) net of taxes. Converting $30,000 to $70,000 sounds much better, right?
How should you use RRSPs to be successful?
1. Take advantage of the tax breaks as best you can! Save contributions for high earning years.
2. Consider re-investing the tax refund from your RRSP contributions, or apply it towards debt, to maximize the financial return on investment.
3. Invest your RRSP funds suitably for your retirement goals. If your account isn’t growing, at least with the rate of inflation, your purchasing power is being eroded each and every year.
Funding your retirement with RRSPs isn’t right for everyone! However, RRSPs are a core component to many retirement strategies, as long as they’re used correctly. If paying less tax today and increasing your income in retirement are among your goals, keep your mind open to using RRSPs! To learn more about how RRSPs could fit into your retirement or financial security plan, give me a call!
by Thomas Johnson
Almost everyone approaching retirement will, at some point, ask the question: “will I run out of money?” It’s completely understandable to feel this kind of concern. You’ve worked hard to amass resources for your retirement years and returning to the workforce in your 80s or 90s is unfathomable. What can a person do to improve the longevity of their retirement savings without sacrificing their lifestyle? Can a strategy be put in place to help reduce the risk of outliving your money?
In 2006, two financial researchers by the names of Jonathan Guyton and William Klinger conducted a study in Financial Planning Association Journal titled “Decision rules and maximum initial withdrawal rates,” where they modeled four rules for a perfect retirement against a litany of market and economic conditions. These rules were designed to enable retirees to maximize withdrawals (especially in the early years of retirement), reduce the probability of running out of money, maintain purchasing power and avoid income cuts. Their methodology specifically aimed towards a retirement income pattern that could last for a minimum of 40 years! The rules are:
- Optimize Your Portfolio Management. When constructing your retirement income portfolio, Guyton and Klinger suggest a range of possible allocations, varying in level of diversification and equity/fixed income splits. They found, historically, more diversified portfolios allowed for higher early withdrawal rates, but fewer pay raises throughout retirement. Higher equity portfolios enabled higher withdrawal rates but decreased the probability of success. Ultimately, they leave the portfolio selection up to the retiree, based on their own personal investment objectives and comfort with risk. When deciding how to structure your portfolio, consulting with a professional Financial Planner can ease the decision-making process.
- Optimize Your Withdrawal Strategy. Guyton and Klinger offer a variety of initial withdrawal rates (dependent on portfolio selection) and some guidance on withdrawal strategy. For example, using their 65% multi-class equities, 25% fixed income, 10% cash portfolio, they were confident that an initial withdrawal rate of 5.3%, increasing with inflation, is a good investment strategy. Individuals with $500,000 at the start of retirement could comfortably withdraw $26,500 ($500,000 x 5.3%) in the first year. Choosing “where” to get that $26,500 from is important too! The authors recommend taking income, in order, from: 1) overweight equity holdings, 2) from overweight fixed income holdings, 3) from fixed income holdings, and lastly 4) from remaining equities, in order of prior year’s performance. While a great baseline, these rules do not account for taxation and potential investment fluctuations, making it imperative to consult with your Tax Accountant and Financial Planner, prior to executing on these orders.
- Apply the Capital Preservation Rule. This is the first guardrail for protecting your portfolio against over-redemptions in poor market conditions. In years where your portfolio has depreciated in value, Guyton and Klinger recommend an income freeze. Essentially no increase to match inflation. If your withdrawal rate is already 20% higher than you started, they implement a 10% income cut in these years to preserve your portfolio’s capital. The good news? If you are within 15 years of the end of your planning period (example year 25 out of 40), you can ignore the Capital Preservation rule!
- Apply the Prosperity Rule. Nobody wants a pay cut, but how about a pay raise? If market conditions have bolstered your portfolio such that your withdrawal rate would be 20% less than you started, the authors advise you can take a 10% income increase without jeopardizing your retirement!
The academic article itself contains lots of financial planning and statistical jargon that can make it difficult to decipher. The moral of the story is that proper portfolio management and sound redemption guidance can help produce the financial security of not outliving your assets. While investments are not guaranteed, having guardrails in place, going into retirement, can give you confidence you’ll be able to weather any financial storm.
The information provided is based on current laws, regulations and other rules applicable to Canadian residents. It is accurate to the best of our knowledge as the date of publication. Rules and their interpretation may change, affecting the accuracy of the information. This information is general in nature, and is intended for informational purposes only. For specific situations you should consult the appropriate legal, accounting or tax advisor.
by Thomas Johnson
The vast majority of retirees will, one day, sell their longtime residence in favour of something more conducive to their retirement lifestyle. If you spend summers at the lake and winters snow-birding somewhere warm, maintaining the home you raised your family in might feel like an incredible amount of work. Perhaps a place with less grass to cut, sidewalks to shovel, or bathrooms to clean is calling your name!
What considerations should a retiree make when it comes to downsizing? How do you pull off the transition with minimal disruption to your life and finances?
Start by consulting with professionals. Downsizing may sound straightforward in theory, but in practice there are a number of moving parts that benefit from professional guidance. Your Financial Planner is a great starting point for developing a strategy, but he or she can only work off so many assumptions. You’ll want a real estate agent to give you an appraisal on your existing house, advice on how to maximize the sale price, and listing prices for your next destination. You’ll need a mortgage professional to understand any penalties on your existing mortgage (if you have one) and the best financing strategy for the new home or condo. You may even need to consult with your tax accountant, if you own more than one property, to get a handle on your Principal Residence Exemption.
Build a game plan for the cash flows. Are you going to fund the down payment for a new home from cash, savings, or investments? How big of a down payment should you make? Should you carry a mortgage on the new residence or pay cash? How should you invest surplus proceeds from your house sale? These are all important questions that your Financial Planner can help answer. If the borrowing costs are low today, you may find it advantageous to carry a larger mortgage and invest more of the proceeds. If borrowing costs rise in the future, you should have a plan for tackling that mortgage balance. Developing a solid roadmap for how you will handle future changes will give you the peace of mind that your downsizing decision won’t derail your retirement plans.
Organize and write out the details. If you’re planning to hire movers or do it yourself, make sure you create a checklist. Packing boxes, check. Cleaning time, check. Vehicles for transport, check. If your new home could be delayed by builders or contractors, create a Plan B for where you and your belongings can stay. If your lender requires a down payment on the new place, prior to the first one selling, be sure you know exactly where you’re getting the money from and where you’ll put money back.
Leaving your family home can be daunting and is not a decision to take lightly. Downsizing in retirement is a BIG change. Your lifestyle over the past decade (or two, or three, or more) will certainly be disrupted, but not necessarily in a bad way. By getting yourself organized and prepared, both physically and mentally, you can be assured of a less stressful transition.
by Thomas Johnson
I can’t even begin to count how many clients have told me “when I retire, I’m going to get $X per month from my work pension, guaranteed!” However, when we review their statements together, they’re quite surprised to find out the income figure in their minds IS NOT guaranteed at all. What gives? Why so much confusion about the benefits an employee will receive?
Many statements include illustrations, not guarantees. There’s a big difference between an income guarantee and an illustration. A guaranteed income means that your employer, or an insurance company, is vouching that your income stream will be paid and maintained. An illustration is a hypothetical scenario based on a broad set of assumptions. The two can look eerily similar at first glance, making it difficult to tell them apart.
If your statement shows an income amount, followed by fine print about how that result can be achieved if you maintain the same contribution rate for X number of years and earn Y% per year, that’s an illustration. Illustrations are great for a quick assessment; but the number of variables in play means your end results might vary wildly.
We’re conditioned to think of Defined Benefit pensions. Defined Benefit pensions are an employer-sponsored pension plan that guarantees a retirement payout based on a formula. That formula is most often driven by career earnings and the number of years with that employer. This pension type tends to be the kind most Manitobans think of when we hear the word “pension” and we naturally associate it with guaranteed income for life. But Defined Benefit pensions aren’t the only option out there and they’re quickly disappearing in popularity.
According to CNN Money research, 60% of employees in the private sector had Defined Benefit pensions in the early 1980s in the US. Nowadays, that number is only 4%! That’s a dramatic drop-off in Defined Benefit pensions among private sector workers. Defined Benefit pensions are often being phased out and replaced with Defined Contribution pensions and Group RRSPs. These retirement plans have set contribution schedules, with retirement income dependent on investment performance, rather than guaranteed by the employer’s pocketbook. The end result is many Manitobans know they have a retirement plan from their employer but they have yet to be educated on how it works or why it’s different from the “pension” they’ve been conditioned to think of.
How to tell what you own. If your retirement plan statement shows you a monthly income at “early retirement age” and “normal retirement age,” you likely have a Defined Benefit plan. If your retirement plan statement highlights investment growth/loss or names the underlying holdings, you likely own a Defined Contribution plan or RRSP. If you can’t make heads or tails of what your statement reads, you likely need to consult with a professional Financial Advisor!
Retirement plan statements can appear very complex, because they are! There are tons of rules around contributions, reporting, taxation, and redemptions. Understanding what your employer provides, what’s guaranteed, and how it fits into your retirement vision is paramount to your long-term financial success.
Recent Comments