What is Retirement Income Planning?
The Financialist • Issue 101 • April 2009
BY CLAY GILLESPIE BBA CFP CIM FCSI
Retirement income planning is a process, not an event. To effectively deal with it, there needs to be a strategy or “game plan” that can adapt to changing market conditions as well as to personal needs, goals and objectives, any of which may change dramatically over time.
LIFE EXPECTANCY
A couple who is 65 years of age has a life expectancy of approximately 26 years. Most people assume that life expectancy is the same as lifespan. This is not correct. Instead, life expectancy is a median number of years - such that 50% of a particular age group will die before this number of years, and the other 50% will die after this.
Thus, when planning for retirement, it is important to look beyond your life expectancy – because there is a 50% chance you will exceed it. In this example, a couple aged 65 has a 30% chance that one of them will live beyond their 95th birthday.
INFLATION RATE
As demonstrated above, there is a high probability that your retirement will exceed 30 years. Therefore, it is important to understand how inflation can affect your ability to maintain your desired lifestyle.
Let’s say, for example, that you require an after-tax, after-inflation net income of $50,000 / year. If inflation averaged 3% (well below the historical long-term average), you would require $90,306 in 20 years time and $121,363 in 30 years time to maintain the same lifestyle that costs you $50,000 today.
HOW MUCH DO I NEED?
To generate $50,000 / year in net spendable (after-tax, after-inflation) income today, you would need an investment portfolio of approximately $890,000 at age 65.
This example assumes that you earn a constant 4% real rate of return (actual gross return minus inflation). It also assumes that you will live until you are 95 years of age and are entitled to full CPP and OAS benefits.
Is this enough income? This is a very difficult question to answer. There is a “general principle” that indicates you will need 60% to 70% of your income immediately preceding retirement in order to maintain your standard of living during retirement. The rationale behind this “rule of thumb” is that in retirement, you are no longer saving, nor would you have employment-related expenses.
It goes without saying that this number will be different for everyone.
STOCK MARKET RISK
When you are working and accumulating retirement savings over a long period of time, stock market volatility is not a huge concern as long as your portfolio is properly diversified. In fact, volatility will likely increase your return if you are investing on a monthly basis (i.e. dollar-cost averaging).
One of the greatest risks in retirement income planning, however, is having the stock market drop substantially just before or just after you retire, forcing withdrawals (for income) from your investment assets once they have declined in value.
You need to implement an investment and income strategy that will allow you to deal with extreme market volatility like what we have been experiencing since 2008.
INCOME INTEGRATION
When you are working, you typically have only one source of income – employment income. In retirement, you will have a mixture of different income sources that need to be integrated. You will probably be entitled to some type of government benefit (e.g. OAS, CPP, etc.), you might have a company pension plan and you may have your own investment assets (RRSPs, real estate, savings accounts, etc).
It is important that you use these income sources in the most effective manner to generate the highest possible spendable (after-tax, after-inflation) income in your retirement years.
HEALTH CARE COSTS
As the baby boomer generation retires, our health care system will continue to be under increasing strain. It is very possible that you may have to spend a substantial portion of your retirement income on health care costs.
LIFESTYLE
During your retirement years, your lifestyle will change over time. We encourage people to retire slowly and not suddenly in the initial retirement years. For many individuals, much of their social life revolves around their career. If possible, it is advisable to work a few days per week until you can start developing a retirement lifestyle.
Your first two years of retirement will also be some of your most expensive years as you will have “pent-up demands” which could include projects around the house, long vacations, family reunions, etc. It typically takes at least two years to settle into a retirement lifestyle. In addition, retirees are typically healthier in their first 10 or 15 years of retirement; this should also factor into your retirement income planning strategy.
Please call your advisor at Rogers Group Financial to discuss your retirement income strategy in further detail.
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