As ever larger numbers of the boomer generation start to retire, fixed income options, once the staple of retirement cash-flow planning, are no longer delivering the way they used to. Add to this that we’re living longer, although a welcome development, means those of us planning to rely on Registered Retirement Income Funds (RRIFs) for income may need to take on more risk to generate the returns we need to cover our retirement income needs.
Consider three main risks:
1) Market fluctuations: could lead to a sequence of negative returns, and once retired there may not be enough time to recoup the lost investment value.
2) Inflation: The erosion of the purchasing power of your savings accelerates as inflation rises.
3) Longevity: Our longer life spans increase the risk of running out of money, so people should plan for income to last to age 95 for men, and 97 for women.
Using average life expectancy of 79 for men and 83 for women, there’s a 50 per cent chance people will still be alive when their money runs out, which is far too much risk.
Wealthier investors who don’t rely on RRIFs typically take one payment at year’s end. This allows them to grow their money tax-free as long as possible. But for those who prefer to treat a RRIF like a monthly pension payment, consider equities that produce monthly cash flow, such as balanced funds or publicly traded REITs. Alternatively for those wanting the entire RRIF payment at the beginning of each year, they should consider a five-year laddered bond strategy, as one will come due every year as needed.
While risk tolerance usually decreases in the drawdown years, being too conservative in the current environment may not be the best strategy. Recent changes help a bit. Under the old rules, an investor turning 71 was required to withdraw a minimum of 7.38 per cent from her RRIF. But the 2015 Federal Budget plans to lower that mandatory RRIF rate and moved the age at which retirees reach the top 20 per cent withdrawal rate from 94 to age 95.
Still, if a large percentage of your investments are stuck earning 2 per cent, there is big risk you’ll encroach on your principal too quickly.
The annuity option: Combining today’s longer life spans and less-than-stellar fixed income yields may make annuities a good option for some investors. Here’s a simple way to determine if this is right for you. Take for example someone with $425,000 of retirement savings, with annual supplemental income needs of $15,000, and a 30-year-time horizon. The yearly withdrawals will drain their savings around year 20, a decade shy of their 30-year target. Even at today’s low interest rates an annuity can be a good option here to meet or supplement one’s lifetime income needs.
RRIF nuts and bolts:
1) We Canadians are legally required to convert our RRSPs into RRIFs by December 31 of the year we turn 71, though we can do it earlier. This transfer is not a taxable event.
2) RRIFs are subject to yearly withdrawal minimums. The younger one retires, the lower the RRIF minimum.
3) An investor with a younger spouse or common-law partner can use their spouse’s age to calculate the minimum withdrawal. This would enable them to shelter more income in the RRIF.
4) An investor must be committed to withdrawals after setting up the RRIF.