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Retirement savings

January 17, 2012

How to handle the unexpected on a fixed income

If the furnace in your home fails in January and you have to suddenly buy a new one, will you have a way to pay for it?

An Ipsos Reid survey for the Canadian Institute of Actuaries, Retirement Risk: Defining Retirement Horizons, pointed out last year that 72% of pre-retired Canadians are concerned about maintaining a reasonable standard of living in retirement, with a majority also worried about depleting their savings and having enough money to pay for adequate healthcare.

Even those who are confident they’ll be able to cover their basic retirement living expenses worry about what they’d do in the case of an emergency.

So, how can you successfully prepare to handle unexpected retirement expenses that arise from health-related events, home repairs and tax bills for example? Canadian financial expert Gail Bebee, author of No Hype — The Straight Goods on Investing Your Money, provides the following tips:

1. Build contingency income needs into your plan: Part of planning for retirement is to allow for contingencies, says Yih. Try to ensure you have a monthly income that is above the amount you need to cover your basic expenses. This will help you to create a cushion to deal with the variability of life.

2. Save in a TFSA (Tax-Free Savings Account): Yih explains that TFSAs make better contingency accounts than RRSPs, because of the ramifications associated with withdrawing money from an RRSP. Bebee agrees, saying almost everyone should have a TFSA. “If the furnace fails in your house in January and you have to buy a new furnace, you need a way to pay for it.” If you’ve got limited cash, she advises keeping an emergency fund inside a TFSA.

3. Consider a line of credit: If you’re a disciplined person who tracks your expenses and is good at knowing where your money is being spent, Yih says a line of credit can also be good for covering contingencies. Rather than keeping money in an account where the interest rate is low, he suggests you can do something more productive with your money. When an emergency comes up, you can then use the line of credit to pay the unexpected expense and use your other assets to pay off the line of credit. “The line of credit becomes the emergency fund,” he says.

4. Plan to retire with little to no debt: When you’re on a fixed income, ideally you don’t want to have debt such as a mortgage, explains Bebee. “You want to make sure that the basic expenses you have to pay each month are as low as possible, and one obvious way is to make sure the mortgage is paid off before you retire.” This also includes avoiding outstanding balances on credit cards.

5. Prepare for possible tax-related expenses: One potential surprise in retirement relates to the tax that can arise when you start to receive multiple sources of income from CPP, OAS and possible part-time employment, rather than just the one paycheque you may have received before retirement, explains Yih. The problem is each of these new cheques will only withhold the minimum amount of required tax based on that specific source of income, which may not be enough to cover the overall amount of tax you owe. This can result in additional tax being owed. To help avoid this, Yih says you need to figure out your overall tax rate. You can then arrange to either increase the withholding tax on some of your income sources or make installment payments to the Canada Revenue Agency.

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