Pre-Retirement Planning
The Financialist • Issue 97 • April 2008
BY ALAN KOTAI CFP CIM CFA
A person’s financial life cycle is comprised of three phases:
Accumulation Phase, Retirement Phase and Estate Phase.
Naturally, pre-retirement planning falls into the accumulation phase. For many, retirement seems far off and, thus, is not a priority. This does not mean retirement planning should be ignored.
HAVE TARGETED RETIREMENT GOALS
The definition of "retirement" varies. Some people do not want to retire in the conventional sense and instead target a "financial security" date at which time they have the option of working or not.
Others wish to retire from full-time work and work part-time or start their own business. Some never want to retire.
Irrespective of how you define retirement, we suggest that you:
- Have a targeted retirement or financial security age to focus on. The younger you are, the more likely this "target age" will change over time. The closer you are to retirement, the more fixed you will likely become on a specific date.
- Have a targeted net retirement income you would like to achieve. If you have no idea of what the figure should be, assuming 70% of current net income, adjusted for future inflation, is a good start.
We also suggest that you take into consideration the potential for major early retirement expenditures. It is at the early stage of retirement that lifestyle changes occur which require spending money.
COMPETING OBJECTIVES
The problem that most people encounter in the accumulation phase is that there are multiple objectives competing for their limited resources.
Besides the "cost of living", the two most common competing objectives we see in this phase are:
- Debt elimination – The early part of this phase is punctuated with major purchases such as a first home. For most, debt elimination extends over the entire accumulation phase.
- Education funding – With both the increased need for post-secondary education and the introduction of the 20% federal grant for RESP contributions (up to certain limits), this objective has become a greater priority.
The challenge is that debt elimination and education funding typically have shorter time horizons than retirement planning.
Our approach is to not look at retirement planning in isolation. Rather, we look at all your objectives together and determine what is required to achieve them.
Specifically for retirement planning, we run accumulation and income projections to determine what you need to save to meet your retirement goals, and whether or not you are on track.
The projections take into consideration all of your potential income sources, the effects of inflation, taxation, and potential life expectancy.
PRE-RETIREMENT PLANNING GUIDELINES
We are often asked questions like:
- Is it better to contribute to RRSPs or pay down our mortgage?
- I have an employer pension, why do I need an RRSP?
- What do I need to do to ensure that I will meet my objectives?
Of course there is no one right answer to each of these important questions. Rather, the answers are dependent upon your unique circumstances.
However, here are some guidelines you can use:
- Besides the tax deferral, contributing to RRSPs and paying down your mortgage at the same time makes sense. RRSPs can be used as “savings of last resort” in the event that you run into financial difficulty. Also, by making RRSP contributions you free up "tax dollars" that otherwise would have been paid now. These freed up tax dollars in the way of a tax refund can be applied to your mortgage.
- By making RRSP contributions in unison with defined benefit pension contributions, you will build up a pool of money that can be used to augment your eventual pension income, or be used for major expenditures in your retirement. Otherwise, the vast majority of assets will be tied up in your home and pension.
- Managing financial risk through insurance to protect your income earning ability; diversifying your investment portfolio and other financial holdings; and allowing for a certain level of flexibility in your financial circumstances will increase the likelihood of success, and reduce the risk of failure.
If you start planning early enough and stay committed to a plan, it is likely that you will experience a retirement with greater financial security and choice.