Key considerations when financial planning for retirement
There are three primary considerations to take into account when determining whether your savings last through your retirement years: inflation; the timing of returns on your investments; and life expectancy.
Most of us think of inflation as the ever-increasing cost of goods and services over time. Governments encourage inflation because it provides them with tools to help smooth out the effects of economic cycles. Like it or not, inflation is unlikely to go away.
According to Statistics Canada, Canada’s inflation rate over the past 20 years has been 1.89% per year so a basket of goods that cost you $100 in 1992 will cost you $144.89 today. So if you want to maintain your standard of living, ongoing inflation requires that you have an increasing salary to during your earning years and in retirement, your pensions, savings, and any alternate income streams also need to take inflation into account.
2. The timing of returns on your investments
Many people keep their savings are primarily in bank accounts, GICs, mutual funds or the stock market. During the years you are adding to your savings, you may not worry too much about these investments and what return they will deliver in your retirement years.
Bank accounts and GICs are often considered safe bets, but don’t earn much interest. The value of funds in mutual funds and the stock market fluctuate daily. During savings years, financial advisors often suggest adding to your savings when market values fall, with a general understanding that there will be a market recovery in the future and the returns overall will be higher than bank account interest and GICs. However, it requires a crystal ball to know when markets will recover, which becomes a concern in later years if you are forced to begin drawing upon your savings while their value is still low.
Over the past decade, investing in the markets has generally provided lower rates of return, causing serious financial obstacles for savers and retirees alike, increasing tension levels. For those who are saving, low or no growth puts people years behind in their ability to accumulate enough savings from which to retire on. For retirees withdrawing money from savings that aren’t growing it lead to financial disaster, as dwindling funds make it more and more difficult to keep up with inflation and worse still, the base capital is likely to erode faster than it can be replenished. If this happens to you, you’ll run out of money before you die. That’s pretty scary.
3. Life expectancy
Better health care is allowing Canadians to live longer, and although this can be a reason to celebrate, it is also leading to more worrying about how to finance our retirement years. According to Stats Canada, the life expectancy for Canadian males now aged 65 is 83.5 (an additional 18.5 years); life expectancy for females now aged 65 is 85.2 (another 20.2 years).
The term ‘life expectancy’ is often misunderstood. It expresses an average age, meaning half of all people will die on or before their life expectancy age and half will live past that age. Your lifespan most likely won’t be the exact average but can supply general guidelines when working with your independent financial advisor for financing your retirement.
As a financial planner, I’m always asked, “How far ahead should we plan for our nest egg to last?” Many planners will advise you to use the age 95 as a baseline when planning to self fund your retirement. If you do live longer, that means there is some risk, but 95 is a good place to start, to help you sleep at night.
I recommend that your plans take you well into the future because your financial capacity may change unexpectedly. You have to keep in mind your personal lifestyle needs and wants, and also anticipate changing health care needs which can dramatically increase your cost of living.
When you are in your saving years, you may be able to afford higher risk investments that could possibly deliver higher rates of return. But as you approach retirement, higher risks lead to greater worries and may be inappropriate. This should be a key topic of discussion with your financial advisor. Keep in mind that independent advisors can generally offer you a much broader range of options.
To ensure you won’t run out of money, ensure you are putting money aside on a regular basis. Products like annuities and variable annuities are insurance products that generally offer a greater return than GICs, and offer fixed, guaranteed income for the rest of your life, even if you outlive the capital. This can be a good place to your discussion with your financial advisor to find the best solutions for your situation.
Please feel free comment if you would like to share your experiences, would like to see a specific topic covered in future blogs or have any questions around these issues.
Next: My home is my nest egg… What do I do now?