The risk of a long life
How to make sure your money lasts as long as you do
The "risk," in this case, refers to a concept called longevity risk. The risk comes from not knowing how long you and your spouse are going to live. Because that's an unknown, you have no upfront certainty about how long your retirement savings need to last.
Hope for a long life also means preparing for it financially.
"The economic impact of longevity risk is actually larger than the stock market risk," says Moshe Milevsky, a York University finance professor and the author (with Alexandra Macqueen) of Pensionize Your Nest Egg.
Living longer than you anticipated is good news, to be sure. But it can also be a financial shock if you're not prepared for it. "We all expect to live into our 80s," Milevsky says. But he points out that a quick perusal of the local death notices will quickly show the wide variation in how long people actually live. A few don't make it to retirement age while some live past 95 or 100.
'What if I run out of money?'
That's when you worry: "If I live to 100, I'll run out money." Milevsky says the reality isn't quite that bad.
"Running out of money in retirement is a bit of a fallacy," he says.
Milevsky points out that the Old Age Security pension, the Guaranteed Income Supplement and CPP retirement pensions — all guaranteed and all fully indexed — ensure that today's and tomorrow's seniors won't ever "run out of money."
Which is not to say that they won't have to reduce their standard of living in retirement.
"What people are really worried about is that the retirement they've dreamed of won't materialize," he says.
As for how much that dream retirement is going to cost, the experts say it's essential to get a handle on spending.
"Almost no matter what the level of assets or income, if you don't have a handle on spending, you start to feel things are tight," says Warren Baldwin, regional vice-president at T.E. Wealth, a fee-only financial planning firm.
"You have to sit down and analyze your budget."
He points out that if the mortgage is paid off, the kids are through school, the house renovations are done and you're not putting any more into your RRSP, your spending requirements in retirement may be quite different from your working years.
|RRIF payout schedule (assuming 6% return and opening balance of $100,000)|
|Year||Age on Jan. 1||Balance in RRIF||Minimum withdrawal (%)|
You can use a good retirement calculator to project the growth of your retirement nest egg. "People should assume conservative returns over time," says Baldwin. "We use six or seven per cent, which is appropriate for a balanced portfolio." Don't forget to take inflation into account, he adds.
Taxation in retirement is also a lot kinder. There's a federal age tax credit for those over 65 with modest incomes. Seniors can also reduce taxes by splitting CPP retirement payments and pension income (like RRIF and annuity payments). There's also a federal tax credit on the first $2,000 of eligible pension income for each spouse.
Baldwin suggests each spouse prepare an expense sheet detailing what they spend now and then knock off things they won't be paying for after age 65. They should then "compare notes on what they spend today with what they think those expenses will look like in retirement." This exercise can be a useful way of arriving at a suitable structure for the portfolio, given their evolving spending needs.
The experts advise people not to put too much stock in the one-size-fits-all solution that says people must aim for a retirement income of 70 per cent of what you made in your last year of work. The reality is, it will depend, and the percentage likely won't stay the same.
Cherith Cayford, a financial educator at CMG Financial Education in Victoria, suggests that people try living on their retirement income before they actually "pull the plug." If that's difficult, they may have to adjust their expectations.
"In the first stage of retirement, people don't necessarily spend any less, but they spend it in different places," she says.
She calls the first stage of retirement — up to roughly age 75 — the "go-go" phase. "People are embracing those extra 2,000 hours of freedom," she says, and that can get expensive. "You need to be careful. It's one thing to budget for the 'trip of a lifetime'; it's another to go out to lunch several times a week."
You're retired, not on vacation, she says. "You need to track living expenses."
The second stage of retirement — roughly age 75 to 85 — is the "slow-go" phase. People aren't travelling or going out as much. This is the least expensive phase of retirement, Cayford says. This is the time to set yourself up for the final phase of retirement by, say, trading down to a smaller home.
The last phase — the "no-go" stage — may require extra money to hire people to help with personal care. For women, who are more likely to outlive their partners, there are extra financial challenges. Once widowed, their spouse's pension may be cut by 50 per cent when it becomes a survivor pension and their spouse's OAS cheque also disappears. Unfortunately, many living expenses like rent or mortgage payments, utilities and operating a vehicle remain unchanged.
For those seniors who don't own their own homes, Cayford suggests people look into rental co-operatives, which charge rents based on income. Most have long waiting lists so sign up early.
Because most Canadians don't have defined benefit pension plans — the kind that guarantee a certain pension payout for life — Moshe Milevsky suggests people use some of their nest egg to generate a personal pension that will last as long as they live.
Purchasing life annuities is one possibility. So is a hybrid annuity instrument known as a Guaranteed Lifetime Withdrawal Benefit (GLWB) product. As with life annuities, these are sold by insurance companies. These typically pay a guaranteed annual return of five per cent for life, even if the underlying investments decline.
Warren Baldwin says portfolio managers can easily come up with an investment structure for retirement assets that will spit out an automatic payment in retirement. Many companies also offer monthly income mutual funds that do much the same thing. While not guaranteed, they're usually conservatively managed and well diversified to limit risk.
Retirement is not a time for people to be worried about income. Getting some trusted advice can really help — the earlier the better.