News

It's not widely understood, but at age 71, they yank away your retirement investing safety net.

So be prepared. Arrange your registered retirement income fund (RRIF) so that you're protected as much as possible against the kind of stock market drop we've seen in the past six months.

By the end of the year in which you turn 71, you must convert your registered retirement savings plan into a RRIF. With RRSPs, you have some protection if the markets go wrong. You can toss in some extra cash if you have the contribution room, and for many people there's the comfort of knowing they have years to go before they dip into their retirement savings.

With a RRIF, however, you can't put any new money in and you must withdraw a set minimum amount of money every year. Investing mistakes matter more with RRIFs, which means it's crucial to build them properly at the beginning. Let's look at some smart ways to do that.

The foundation of a RRIF portfolio is enough ready cash to cover three years' worth of living expenses. If you want to withdraw $40,000 a year from your RRIF, keep $120,000 in something safe and liquid.

Financial adviser Peter Andreana said the three years of cash is a cushion for times such as these, when investments in the stock markets have tanked. By dipping into your cash, you avoid selling beaten-down stocks and equity funds to finance your RRIF withdrawals.

“Whether markets are good or bad, it doesn't matter,” said Mr. Andreana, a partner at Continuum II Inc. in Burlington, Ont. “The cash is there and you can always live on that.”

Mr. Andreana uses a high-yield savings account to hold his clients' three-year cash supply. Offered by National Bank, B2B Trust and Dundee Bank of Canada, these accounts can be held within a RRIF, an RRSP or another type of account.

Money market funds, especially supersafe T-bill funds, are also an option for the cash in your RRIF. But while returns for these funds are below 0.6 per cent in many cases right now, high-yield savings accounts pay as much as 1.6 per cent.

An alternative for keeping a safe pool of money in an RRIF is to use government strip bonds with maturity dates of one, two and three years. Strip bonds are basically bonds that don't make semi-annual interest payments. You buy them at a discount to the amount you'll get at maturity, and the difference is computed into annualized yield. You can buy strips through any broker, and they're best held in registered accounts such as RRIFs because otherwise you'll have to pay tax annually despite receiving no interest.

As with any investment portfolio, building a RRIF requires that you first decide upon an appropriate mix of fixed income – bonds or guaranteed investment certificates – and stocks. A basic rule is to base your percentage in fixed income on your age, said Winnie Go, an associate portfolio manager and senior wealth adviser with ScotiaMcLeod.

This suggests having 30 per cent of your assets in stocks if you're 70 years old, and 70 per cent in fixed income (this would include money set aside for your three years' worth of living expenses). However, Ms. Go said clients with more of a tolerance for the ups and downs of the stock market might have as much as 50 or 60 per cent of their RRIFs in the stock markets.

Risk tolerance is important in setting your mix of stocks and bonds, but there's another consideration as well. If you've got ample retirement savings, you can afford to be cautious in your RRIF investing. If not, then you may want to modestly increase your exposure to stocks to try for higher returns than you can get with bonds.

“This isn't suitable for some people,” Ms. Go warned. “Although they may need to take more risk, they can't sleep at night.”

For fixed income, Ms. Go uses government and provincial bonds, as well as high-quality corporate bonds. “We can also use GICs if it turns out they have the best rates. There was a 5-per-cent GIC available last December and that seemed like a good rate at the time.”

Ms. Go said she has some clients who make their RRIF withdrawals annually; for them, she might arrange a five-year ladder of strips to cover these amounts. A bond ladder means investing equal amounts for terms of one through five years, then taking the money that matures every year and putting it into a new five-year term. The benefit is that you never have to renew everything at low rates, and you always have a chance to get a least a little benefit from rising rates.

For clients who make monthly RRIF withdrawals, Ms. Go might use monthly-pay GICs as well as a mix of bonds and stocks that pay dividends. In fact, dividend-paying shares are her preferred investments for getting exposure to the stock markets.

“We're looking for companies that have consistently paid dividends over time, and that have raised dividends over time,” she said.

Mr. Andreana's approach to building an RRIF hinges on the idea of having a bulletproof source of living expenses and keeping it replenished as much as possible. To do this, he divides a RRIF into three parts:

Segment One: A high-interest account with three years of living expenses.

Segment Two: A somewhat riskier mix of cash, bonds and stocks.

Segment Three: Mostly stocks, but some bonds.

As time goes by and a client starts to use up his or her cash to cover living expenses, Mr. Andreana moves some money from Segment Two into Segment One, and from Segment Three into Segment Two.

His goal is to balance the long-term growth potential of the stock market with short-term security. “The closer we are to needing the money, the more conservative we must be.”