If you are like most Canadians and don’t have a defined benefit pension plan and don’t have the financial capacity to self fund your retirement for your entire life you are probably going to run out of money at some random point in retirement.
Here’s a basic reason why. Let’s say you have $100,000 saved for retirement. You’ve invested in a basket of balanced medium risk mutual funds in a contribution pension plan at work and some RRSP funds at your bank. You decide to retire at age 65. You convert your plans to a Registered Retirement Income Fund (RRIF) and take out 4% right away. Then the stock market has a correction. Market corrections can’t be forecast but you can expect that if you’re retired for a couple of decades or more it’s bound to happen few times.
You had $96,000 left in your savings after your first withdrawal but the correction made it worth $80,000. So the next year, at age 66 you need to take out 4.17% of $80,000 leaving you with $76,664. (You must take out a minimum amount from your RRIF every year and that minimum increases until you’re 94 where it max’s out at 20% of the RRIF’s value per year).
To keep this example going, your savings don’t grow the next year because it’s a flat market. So now at age 67 you need to take out 4.35% leaving you with $73,329.
Age: Starting Balance Savings Balance
65 $100,000 – 4% = $96,000
65 $96,000 – 16.7% = $80,000 (example market correction)
66 $80,000 – 4.17% = $76,664
67 $76,664 – 4.35% = $73,329
This is essentially what happened to most retirees savings in 2008 and 2009 and in many cases the losses were much worse than this. It’s painfully obvious that if you are underfunded in retirement, to be financially happy depends on being lucky with good markets. Planning on luck in this case would mean that in three short years your nest egg would be down 26.7%! Even worse, the market has historically not been able to catch up to losses like these so at some point in retirement you’re going to either spend less than you need to or run short on money sooner than you’d like. It’s a treacherous spiral and anyone caught in this trap won’t be happy when they retire.
A good rule of thumb is that if the value of your assets can sustain you in the lifestyle you want to at least age 100 you’re probably going to be ok. Keep in mind that new mortality tables indicate that our median lifespans are ever increasing so the younger you are, the longer you’re likely to need to plan for.
If in your case you can’t see how you can self fund your retirement to at least age 100 you would be very wise to move some of your savings into pooled income solutions. Pooled income solutions will give you a guaranteed income for life so you’ll never run out of money. These products are only offered by insurance companies and typically include such things as Variable Annuities and Annuities.
Variable Annuities are a solution that’s very popular with people who don’t have access to defined benefit plans. Variable Annuities can be described as self directed defined benefit pension plans and can be excellent solutions both during savings years and at retirement because you’ll know up-front the guaranteed minimum income you’ll receive for life. Variable annuities also give you the upside potential of mutual funds so over time your guaranteed income for life can ratchet upwards and will be contractually locked in for the rest of your life. Joint accounts can be set up and you always have access to your money at any time, a great feature that’s bound to make you happy.
When you use savings that are not in RRSP’s or RRIF’s to buy an Annuity your income is almost all non-taxable so you’ll need significantly less upfront money than alternately deciding to take income from bonds or GICs (which are taxed at the very highest rate). Often an annuity is used to bump up retirement income using only a portion of your savings because once you buy an annuity you no longer have access to that money. You decide what makes the most sense in your circumstances.
Also, at retirement age Annuities normally give you a much higher income than other guaranteed income products. If you outlive what you paid for your annuity, your income continues for the rest of your life anyway. You’ll be happy. If you don’t outlive your initial investment your beneficiaries will get what’s left over. It’s a very good deal.
Almost everyone will tell you that retirement isn’t all about money. There’s family, friends, activities, travel and everything else we’d like to get more involved with. Pooled income solutions give you a guaranteed financial foundation so no matter how stormy the weather gets, you know that your lights will always be on and there’s always going to be food on your table.
It’s not surprising then that in most cases, switching some of your savings into guaranteed for life pooled income solutions is an ideal step you can take today to be on the road to be happy when you retire. Quite frankly, nothing beats comfort and peace of mind.