Four Common Retirement Planning Mistakes

Stock market returns are unpredictable. Budgets can be blown by unexpected expenses. And if we only knew how long we might live, it would make planning for retirement much easier. As a result, retirement planning can be more art than science.

There are several mistakes that retirees are prone to making. Here are a few of the most common ones.

Retiring Too Early (Or Too Late)

If you stop working too early, it is obvious that you may not save enough. But retiring too early is not just a matter of underestimating how much you need to save.

A 2015 Angus Reid Institute poll found that 48 per cent of respondents retired earlier than expected due at least partly to circumstances outside their control. Unexpected early retirement may be a result of a layoff, a disability, or even another family commitment like a sick spouse, parent, or relative who requires care.

Targeting an age 65 retirement may be well intentioned, but not everyone makes it there. It may be advisable to plan, budget, and save to retire early to allow a buffer just in case an unexpected situation arises.

Many retirees also underestimate their likely longevity. Commonly quoted life expectancies may be the age at which the average Canadian dies, and not necessarily the average age to which someone is expected to live.

The average Canadian who died in 2018 was 83 years old according to the World Health Organization, but that age is skewed downwards by people who have died young. This “life expectancy” is really the average age at death.

A 65-year old retiree who has lived that long in the first place has a 50 per cent chance of living to age 90 and a 25 per cent change of living to age 95 according to the Canadian Institute of Actuaries.

On the other side of the coin, retiring too late can also be a risk. Retirees may overlook the lower tax rates they will pay in retirement. Or they may not appreciate how much their expenses will decrease after repaying debt, no longer saving for retirement, and once their kids are independent. Inheritances or a home downsize may also supplement a retiree’s nest egg. People may think they need to save more than they really do.

Another risk of retiring too late is how many healthy years a retiree may have. There is a fine balance between saving enough for retirement and leaving enough youthful years to enjoy the fruits of your labour. Retirement planning can help determine financial independence and identify the financial considerations of a retirement timing decision.

Delaying RRIF Withdrawals

Nobody likes paying tax, and after a lifetime of paying it, many retirees do whatever they can to avoid it in retirement. A pain point for seniors is that most income sources like Canada Pension Plan (CPP), Old Age Security (OAS), minimum Registered Retirement Income Fund (RRIF) withdrawals, and non-registered investment income have no tax withheld by default. This differs from workers who have tax withheld at source on their main income source—their salary—and often have tax deductions or credits to generate tax refunds before retiring.

So, while retirees often have tax to pay on their income tax filing, it should be the level of tax that matters. Average tax rates can be particularly low in the early years of retirement, but retirees should strive to minimize lifetime tax. While it may be tempting to draw on non-registered savings or Tax-Free Savings Accounts (TFSAs) to avoid tax, financially modelling the sequence of investment withdrawals will often support early RRIF withdrawals. This can be advantageous to maximize retirement spending as well as an eventual estate on death.

If you defer RRIF withdrawals, you can end up in a much higher tax bracket in your 70s and 80s. If you tap your TFSA too early, you can miss out on tax-free growth, and have higher taxable RRIF withdrawals later in retirement. Retirees who die young could see more than half their RRIFs disappear to tax, reducing their estate value for their beneficiaries.

There are instances when starting RRIF withdrawals at 72—the latest they can be deferred—may be a better option. There is no one size fits all solution.

Starting CPP/OAS Too Early

You can start your CPP retirement pension as early as age 60 or as late as age 70. Taking a pension prior to age 65 results in a reduction of 0.6 per cent per month or 7.2 per cent per year, while deferring past age 65 results in a 0.7 per cent monthly or 8.4 per cent annual enhancement. CPP pensions are also adjusted each year in January based on the Consumer Price Index (CPI).

A 65-year old CPP recipient entitled to the 2019 maximum pension could receive as much as $13,855 this year. Compared to a maximum pension recipient starting their CPP pension at age 70, the early applicant would receive a cumulative $72,102 of payments after five years assuming a two per cent annual CPI inflation rate.

A crossover would occur by age 80, however, whereby a retiree starting CPP at age 70 instead of 65 will have received more cumulative CPP retirement pension payments. By age 90, an age 70 CPP application could generate 19 per cent more CPP income than applying at age 65. A retiree who expects to live well into their 80s could be better off deferring their CPP to age 70.

OAS pensions can start as early as 65 or as late as 70. There is a similar, albeit less generous enhancement of 0.6 per cent per month or 7.2 per cent each year the pension start date is delayed after 65.

So, if you’re on the fence, starting OAS at 65 and deferring CPP could be worth considering.

Another benefit of beginning government pension payments late is that you can draw down risky assets—your investments—earlier in retirement. This can maximize low-maintenance, safe, inflation-adjusted annuity income in your 70s, 80s, and 90s (your increased CPP and OAS pensions).

There are instances where starting CPP at 60 or OAS right away at 65 makes sense. There is no one size fits all solution.

Poor Asset Allocation

Reducing risk asset exposure too much in retirement can be risky. Many retirees going into retirement reduce their allocation to stocks in favour of bonds. Lower expected returns can increase the risk that you outlive your investments.

Wade Pfau and Michael Kitces did a 2013 study called Reducing Retirement Risk with a Rising Equity Glide-Path in which they suggest and support increasing equity exposure during retirement. This is contrary to the conventional approach of decreasing stock exposure with age.

Their logic is that if retirees experience a prolonged stock market downturn early in retirement—a risk that many retirees and near-retirees worry about—the low equity allocation early will help them avoid the risk of poor early retirement returns. And conversely, if returns are good early on, their portfolio will be off to a head start right out of the gates even if higher stock allocations later are subject to future losses.

The risk of poor asset allocation can take other forms. Many retirees and their advisors use similar or identical asset allocation across all accounts. Ideally, equities should be tilted towards non-registered and Tax-Free Savings Accounts (TFSAs), with a fixed income bias in registered accounts such as RRSPs, Locked-in Retirement Accounts (LIRAs), RRIFs, or Locked-in Retirement Income Funds (LRIFs.) This rule is not a hard and fast one, as asset allocation is also dependent on the sequence of withdrawals, and where you expect to draw down assets first.

Asset allocation can also run amok simply by forgetting to rebalance. As an example, the Toronto Stock Exchange was down 12 per cent (excluding dividends) in 2018. The S&P 500 was up two per cent (in Canadians dollars excluding dividends) last year. Developed markets outside of North American as measured by the MSCI EAFE were down nine per cent over the period.

A diligent rebalancing strategy would have seen an investor selling U.S. equities and buying Canadian and foreign equities. But portfolio drift, especially over several years, can see investors end up overweight a geographical region, stock market sector, or even an individual stock simply by not rebalancing.

Summary

Retirement planning is not easy. There are endless variables that need to be considered, and even the best laid plans can go astray for reasons beyond anyone’s control.

There is also no perfect set of rules to follow. Retirement planning is personal, and it is fluid. The four common retirement planning mistakes examined are hardly exhaustive, but hopefully can help you consider some of the impacts on your own retirement journey.

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.