Retirement Planning 101

As a financial planner, my job is never boring. Except for tax time, which is a necessary evil, I love my job. My clients are varied and so are their needs. I have clients who have been transferred abroad who need advice; I have clients who need help with their estate planning, insurance planning, divorce issues, cash flow planning etc. After 28 years of experience one would think that I have seen pretty much everything, but there is always a client who shows up with a new wrinkle—that’s why my job is never boring.

The one thing that always comes up is retirement planning, and the questions: Will I have enough savings for my retirement years? Am I saving enough for my retirement? These questions come up more and more often, so we spend a lot of time doing retirement projections for new and existing clients.

I believe that many people are becoming concerned about their retirement savings because the media keeps sounding the alarm bells that Canadians are not saving enough for their retirements and that X% of Canadians will not be able to retire at age 65, hence, they have to delay their retirement.

I’m not entirely in agreement with these dire warnings. Yes, I see a lot of clients who should save more, but in most cases these people can retire with just a bit of tweaking of their budget and some tax planning advice.

My retirement plans start in the current year and run to the client’s age 90, because that is the industry norm and I don’t want to start using mortality tables as these are averages. If there is a large age difference between husband and wife, I will use younger spouse’s age 90.

It is also important that clients realize that 30 years or so of cash flow and asset projections are road maps; they show the big picture. It is always good to take them out and dust them off and check every few years to see if the client is still in line with their road map. But they should not be concerned if income or expenses are off by a few hundred dollars.

Some planners will do Monte Carlo projections to see the probability of their clients’ funds outlasting them. In 28 years, I have never done a Monte Carlo projection, even though my software has the ability to do them. I do not find them useful and it is a tool to scare people in my opinion. The idea of retirement planning is to help clients achieve their goals, not to scare them. In my experience, if you give a client too great a mountain to scale, he will give up and not bother trying. That’s not my role as a financial planner. I need clients to realize that their goals are achievable with a little bit of fine tuning.

Of course, savings come into play, but if you make clients save so that they can’t enjoy their current lifestyle, they will give up and not save at all. I am not recommending doing a budget and trying to maintain it. Usually, if you’ve never budgeted, it’s not going to happen. Most people live paycheque to pay cheque; if the money is there, they will spend it. It’s human nature, but with a little discipline, the idea of paying yourself first works very well. Just decide what you can afford to set aside every month and make sure it is withdrawn from your account regularly like a bill payment. It becomes easier after a while. Where to direct these savings will depend on the clients’ situations and maybe that can be the subject of another article altogether.

So what should one do to achieve retirement goals aside from saving?

First, be debt-free or as close to debt-free as possible by retirement age. So the first goal, while still earning income, is to get rid of debts, especially the expensive ones like credit cards. Once these are paid off, attack the next expensive debt and so on, until all debts are paid off by retirement date, or nearly paid off. Be aware that debt repayment is a form of saving as well.

Second, do not look to replace income; what should be replaced are expenses. What do you anticipate your expenses to be at retirement? Usually, if debts are paid off, and children’s schooling is done, you will need 100% of current expenses, at least for the first 15 years into retirement. You have established a lifestyle that will not change overnight. Some expenses that were related to working life will be replaced by other expenses, i.e. hobbies, travel etc. So don’t expect that expenses will be drastically reduced at retirement. After 15 or so years, I find clients become more sedentary or they get used to a routine and expenses usually decrease. I’m not saying that is the case for everyone, but it is true for a good portion.

Third, look at what your sources of income will be in retirement, i.e. QPP/CPP, OAS, and RRSP. If you have a defined benefit pension plan, that is worth its weight in gold. If your employer allows you to withdraw the present value of these funds, do not do it, unless there is a risk that the employer will not be around in the future, or the pension plan is underfunded. Basically, if you withdraw these funds in order to manage them yourself or have them managed by someone else, you are shifting the market and longevity risk from the employer to yourself. Bad idea! If you want to take the risk in order to get greater growth do it with your other funds – RRSPs, TFSAs, non-registered savings etc. Even if you take a gamble and lose everything, that pension income stream will always be there.

If your income falls short of expenses, then see where you can cut expenses. If you can’t cut expenses for various reasons, look at how to generate revenues – part-time jobs, selling a big property to purchase a smaller one, thereby generating an asset base that will provide income or capital to supplement other pension income.

Fourth, do some tax planning. If you retire early or your income is low, consider withdrawing from your RRSP prior to age 71. This will depend on your income and your spouse’s income. If you each withdraw an equal amount from RRSPs, you will likely pay less tax. If only one spouse has an RRSP, consider converting to a RRIF at age 65, in order to do some pension income splitting. Keep track at what level of income the OAS clawback begins; this changes every year. Most importantly make sure that you do not pay more tax on your RRSP/RRIF withdrawal than the benefit you received when you made the RRSP contribution in the first place. This is not always possible, but it is recommended.

This part is tricky, pension income splitting will allow you to reduce taxes and keep more for your retirement expenses. In many cases that alone will help with covering your retirement expenses. Careful planning is required if this strategy applies to you. You may want to talk to your accountant or, if you prepare your own taxes, use a software to run “what if” scenarios.

Fifth, look at your investment allocation. In retirement you will be in a withdrawal mode. I normally recommend that clients be far less aggressive with their investments at this stage, even if they have to give up some returns. Manulife has an analysis that they made entitled “Why the Sequence of Returns Matters”. It’s an extremely useful tool and I show it to clients who want to take more risk.

Basically they have put two portfolios together with the same beginning value and the same total return. If you are in accumulation mode, market returns do not matter as you have time to recoup your losses. However, the picture changes when you are in a withdrawal mode; same portfolio, same total returns, but the sequence of the returns has been altered. Portfolio A starts with negative returns, while Portfolio B has positive returns; even if the returns turn positive for Portfolio A in later years and negative for Portfolio B, because the owner of Portfolio A was in withdrawal mode, it’s a double whammy. The portfolio is in catch-up mode, and needless to say, it never catches up. So, being too aggressive while in withdrawal mode is not recommended, unless you have other sources of income.

In a nutshell, this is Retirement Planning 101. Every case is different and I don’t want to put everyone in the same boat, but the above five points are what we repeat more often than not in our retirement plans.

Caroline Nalbantoglu, BAA, CFA, RFP, President, CNal Financial Planning Inc, 514-798-4895 x301, cnalbantoglu@cnalfp.com ; www.cnalfp.com