Why Your Retirement Plan Requires Flexibility

Ross McShane Over the years I have had individuals say to me, “Why bother with a plan as it doesn’t work out in the end anyway?” They claim that the rate of return assumption falls short of what was anticipated or that job loss, a divorce, or other factors can derail the outcome of a long term plan. I agree that the further you are from retirement, the greater the probability that your projected net worth will deviate from what we project today.

I have also found that those without a plan discover later in life that there were missed financial opportunities that would have been uncovered with thorough planning.

I hope that many of you have a written holistic financial plan in place, one you review and monitor annually. Some of you start the planning process sooner than others depending on your level of concern over your financial affairs. Understandably, building in time to work through the planning process is not always at the top of the priority list as other daily events take over. In fact, vacation planning takes priority for some over financial planning. Those who don’t have a plan hope they will achieve their goals as they move along, and try to adapt to the situation at hand. Most of us however need a game plan and structure.

This is the first article of a three part series on planning for the unexpected life events that could disrupt the successful outcome of your plan.

A 2015 report published by the Brondesbury Group entitled Financial Stages of Older Canadians identified two key overall findings through their research that have major implications for both planning and managing retirement:

Unexpected financial crises that disrupt savings and planned retirement spending are far more common than anticipated, especially in pre-retirement years.
The financial ramifications of personal health become increasingly important as Canadians age.

Their study determined that 6 of 10 people experienced major life events that challenged their financial plans. Flexibility needs to be part of financial planning.

Events cited in the study that, from my experience, challenge a retirement plan include:

Lost income or benefits
Providing financial support to an adult family member
Paying significant health care costs for self or a family member
Divorce or loss of a spouse
Investment portfolio underperformance or investment fraud
Unanticipated major home expenses after a disaster
Changes in tax rates

John Klaas, Adjunct Professor, Rowe School of Business, Dalhousie University and long-time financial planning coach and educator feels that risk mitigation is key. “Plan for the normal and layer on risk mitigation,” says Mr. Klaas. Over the course of his coaching career (which has involved observing and critiquing over 12,000 advisor/client consultations), Mr. Klass has found that knowing which questions to ask the client is crucial.

Let’s examine two events in this first article.

Lost Income Or Benefits:

The days when we worked for one company for life and retired with a defined benefit pension plan are largely over. These days it is fair to assume that we will not be with the same organization for life and that defined benefit pension plans are not nearly as abundant as they are being replaced (if you are lucky!) by defined contribution pension plans and group RRSPs. With self-employment more common these days and the fact that the variable component of a salaried employee’s remuneration can form a larger share of his/her income, planning can be challenging.

Start by running your retirement projections based on your current income and see where you end up. If you are self-employed, be careful not to be over-confident as there can be a tendency to assume that the bottom line will continue to grow at the same rate when it may not be sustainable in the long run. I have found that business owners prefer to use more conservative numbers to allow for possible future downturns. Retirement planning for physicians is more unpredictable these days given cuts to their remuneration. Building in a reduction in their current practice income and projecting income in constant dollars is often a more realistic option.

If your plan counts on eventually realizing the value of your business, be sure to obtain a sound valuation and seek tax counsel that maximizes the net after-tax proceeds. Business owners are understandably proud of their business but can also be overly optimistic of its value and contribution to their retirement plan. A sound succession plan is crucial.

Lost income might include forced retirement for health reasons. Risk mitigation includes ensuring adequate disability and critical illness insurance coverage. I have seen examples of situations where coverage was insufficient to allow for continued savings to achieve your retirement goals.

How would your retirement plan be impacted if, as an employee, you lose your job to due to company downsizing? Do you have the skills and marketability to find employment elsewhere? Would you be able to generate the same income with another employer or would relocation to another city be necessary? If there is any doubt about the stability of your income, a second scenario could be run based on a lower salary to determine the impact on your plan. A plan ‘B’ will be critical for your peace of mind.

Then there are those who feel they are invincible. Instead of ensuring adequate sources of retirement capital are available at 65, they aim to work until 70+ to cover the gap. This is fine as long as you remain in good health. But what if suddenly your health deteriorates to the point where you are no longer able to work at the same pace and income level? Or, not at all? Does your disability coverage end at 65?

Providing Financial Support To Family Members:

This can come in all different shapes and sizes whether support is to an adult child or an aging parent.

You find yourself in your peak accumulation years (mortgage is paid off, rate of savings has increased, children have moved out) when—surprise!—a child loses his/her job, goes through a messy divorce, or has a major health crisis. They are forced to return home and require financial support. Your disposable income and hence savings could be reduced if he/she needs funding for retraining and day-to-day expenses. Perhaps they had purchased a home and are now in need of your financial support to carry the mortgage. A permanent life insurance policy could be considered to ensure that your dependent child is financially sound when you are no longer around to provide support.

As life expectancies increase, aging parents may require expensive long term care or medical support. If you are part of the ‘sandwich generation’ that is dealing with adult children returning home as well as aging parents who need support then you are facing a double whammy that could seriously impact your retirement plans.

When modelling a retirement plan, I often ask the clients about their grandchildren and how they intend to assist them. Any gifts such as RESP funding should be factored into the plan. Says Mr. Klaas, “It is imperative that the right dosage of probing is administered during a client meeting.” For instance, “Tell me about your children and grandchildren and what are the chances they will need support? What contingency has been made for that support?”

In the event one of these life challenges threatens your retirement goals, it is critical that your financial planner has built in contingencies. Your financial plan is not a static document—it will have to be updated regularly in order to keep it relevant and ensure that you are still on track. Your plan needs to be flexible and as Mr. Klaas says, “be designed with the appropriate level of thoroughness and due diligence”.

In our next article we will look at other events that can challenge your plan.

Ross McShane, CPA, CGA, CFP, RFP, CIM is Director, Financial Planning at McLarty & Co Wealth Management in Ottawa, Ontario.