Of all the financial risks investors face in their lifetimes, perhaps the biggest is running out of money in retirement.
The average life expectancy of Canadians is steadily increasing, which is a good thing. But it also means investors today should plan to live longer than their parents or grandparents did.
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“For many people, retirement income will need to last 30 years or more – and it will need to cover a variety of expenses,” says Michael Banham, vice-president, wealth distribution at Sun Life Financial.
But how much is enough?
The 70% rule
The rule of thumb has long been that the average investor will need 70% of his or her working income each year in retirement. The idea is that you spend less in those years in large part because, by then, your mortgage is likely paid off and you’re no longer supporting your kids. You’re also spending less on commuting and other work expenses such as meals away from home and office attire. And you’re not saving for your retirement.
While this income guidance is helpful, the reality is different for everyone.
“It depends on your retirement plans and what you want to do,” says Banham.
For example, he says some people may decide to spend a lot on travel in retirement or use savings to help their children with a down payment on a house or cover a grandchild’s college or university tuition. On the other hand, some people might decide to live more frugally.
According to the 2016 Sun Life Retirement Now Report, retirees are typically living on 62% of what they earned before retirement. In that same report, retirees advised working Canadians to aim to replace 71% of their pre-retirement income.
Banham recommends investors plan to spend 70 to 80% of their working income in retirement, to be on the safe side.
The cost of retirement
You might spend less in retirement than in your working years, but there are still many expenses to consider, besides how long your retirement could last.
Adrian Mastracci, a portfolio manager at Vancouver-based Lycos Asset Management, says investors need to factor in rising healthcare costs, for example, especially as they get older.
“It is not unusual for a family requiring a retirement home facility to incur costs in the thousands of dollars per month for one spouse,” he says. “Medications can also add considerable cost burdens, especially if the family pays the entire cost.”
He also points to potential costs if you need to modify your home to make it wheelchair accessible, or for home-care services.
“They all place additional pressures on the retirement fund,” Mastracci says.
Inflation is another consideration
Assuming that inflation is 2% per year, a retirement income goal of $80,000 per year balloons to about $97,500 in 10 years, $118,000 in 20 years and $145,000 in 30 years, Mastracci says.
To reduce the financial impact, he recommends delaying, if possible, the start of annuity-type income streams such as an employer pension, Canada Pension Plan and Old Age Security until you’re closer to age 70.
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Another way retirees can stretch out their income is by ensuring their portfolio is tax efficient.
“No one likes paying more tax than they need to, especially in retirement,” says Banham. “Being tax efficient can help preserve wealth and maximize income potential.”
He recommends investors work with investment professionals, including financial advisors, accountants and lawyers, who can come together to properly structure a retirement income portfolio to maximize tax efficiency and ensure it meets their long-term needs.
Advisors will also help ensure you’re on track with your investment portfolio at each stage of your life. For instance, an investor with 10 to 15 years until retirement will likely be more focused on saving and building wealth, while someone closer to retirement may be more concerned with wealth preservation.
“Many Canadians put off saving for retirement to pay down debt, but the truth is, the earlier you start saving, the better prepared for retirement you’ll be,” says Banham.
Once retired, investors will need to consider how they’ll replace their paycheques and draw income from their investments. That usually means staying invested even when you’ve stopped working.
“It’s important that your money still has the opportunity to grow, to hedge against inflation and protect against longevity risk,” Banham says, adding that income and protection are both key in a retirement portfolio.
Products with guarantees, such as segregated fund contracts (also called guaranteed investment funds) and annuities, can help protect against unforeseen circumstances and market downturns, Banham says. The life insurance benefits of segregated fund contracts can also help transfer an inheritance to named beneficiaries, bypassing the time-consuming and often costly probate process.
“As part of an overall retirement income plan, these products provide benefits and increase confidence, and can offer peace of mind in retirement, not only during volatile markets, but also in the current low-interest-rate environment,” Banham says.