Work hard, build up your registered retirement savings plan, and retire in your 50s or 60s to a life of travel, beaches and hobbies. Sounds good, but then there is the nitty-gritty of managing your nest egg to ensure you have enough income to keep the show on the road.
Given the wondrous complexity of the Canadian retirement system, pitfalls lurk. Many retirees pony up for financial advisers. Some are good, but the sales culture of the financial industry has its pitfalls, too. Moreover, just about everyone’s situation is different in terms of health, wealth and goals, so the “last thing you want to do is make decisions based on a column in a newspaper,” to quote York University finance professor Moshe Milevsky.
In short, financial advisers and journalists (and professors) may offer guidance, but retirees shouldn’t blindly follow the first thing or two they hear or read. Gather input from a variety of sources to become better informed. Get second and third opinions.
Beware the registered retirement income fund
“RRSPs are tax bombs, liable to go off and blow the hell out of your retirement plans,” warns Garth Turner, a former Member of Parliament who now blogs at GreaterFool.ca. Colourful language, but he may have a point.
When retirees turn 71, they are compelled to roll their registered retirement savings plan into an annuity or registered retirement income fund. Most choose the latter, which has a minimum withdrawal requirement of 7.4 per cent at age 72, rising to 20 per cent by age 93.
Such high withdrawal rates push retirees into higher tax brackets. They also may claw back benefits such as the Guaranteed Income Supplement, Old Age Security, Age Credit, and means-tested services such as long-term care.
When one spouse dies and their income defaults to the surviving spouse, there can be further jumps in tax burdens. When the surviving spouse dies, the estate can end up paying the top marginal tax rate on the bulk of assets.
Minimizing taxes and fees
“Prolonged deferral of RRSP money can lead you into a tax trap,” argues Daryl Diamond, a financial adviser and author of Your Retirement Income Blueprint. A balanced approach of withdrawing from non-registered and registered funds may be best for some retirees under 71. His book provides guidelines on how much should be taken from each silo under the “Topping up to Bracket” and other rules.
Withdrawals from a plan can be used to help fund living expenses. Or they can be deposited into tax-efficient vehicles such as tax-free savings accounts, dividend stocks, return-of-capital vehicles, growth stocks (for capital gains) and corporate class investment funds.
Fees and withholding of taxes apply to withdrawals from registered retirement saving plans. To avoid them, retirees and semi-retirees like Ron Watson of Thunder Bay, Ont., and blogger Jean Lesperance (Canadian Financial DIY.com) move money from their plans into registered retirement income funds (which can be opened before 71 and have no fees or tax withholding on withdrawals). After 65, up to $2,000 can be tax sheltered under the pension income credit (and income splitting is possible).
Dialling down risk
Investment risk can be reduced by the manner in which withdrawals are done. One step is to keep the withdrawal rate from climbing too far above investment returns. Another step is to rebalance. For example, when aggressive assets (such as stocks) are doing well, take funds from them to replenish cash reserves or return to strategic asset allocations (which should be reset to more conservative levels as a retiree ages).
Watch the temptation to reach for yield when interest rates are low. Consider ladders of bonds or guaranteed investment certificates in lieu of, or in conjunction with, preferred shares, real estate investment trusts and other high-yield securities. The staggering of maturities in a ladder allows income holdings to roll into higher yields when interest rates rise (and provides some inflation protection since inflation and interest rates tend to move in the same direction).
For do-it-yourself investors, a simple investing approach minimizes errors and leaves more time for recreation. Simplicity also helps in the event the investing spouse becomes incapacitated or passes on: “I had no idea where to start after my husband passed away,” discloses Ottawa, Ont., resident Avril Davies. Consolidate accounts in one place, lighten up on investment styles that require time and effort (market timing and stock picking), and bring your spouse into the loop.
Outliving your nest egg
For retirees without defined-benefit pension funds, anxieties over outliving retirement funds can be addressed by rolling part of a registered retirement savings plan into annuities, as Mr. Milevsky and Alexandra Macqueen discuss in their book, Pensionize Your Nest Egg. Payouts are currently rather low, so people in their 50s and 60s might delay major commitments, Mr. Milevsky suggests (but still make sense for those 75 and older because the pricing of annuities are less affected by interest rates at that age group).
Guaranteed lifetime withdrawal benefit (GLWB) products can also supplement investment portfolios to insure against the possibility of outlasting savings. They also have a growth component that complements the inflation protection provided by equities and real-return bonds. However, “it remains to be seen … whether insurance companies will continue to offer GLWB products – or just call them GLWBs and offer watered down payouts with high fees,” Mr. Milevsky cautions.
Managing a registered retirement savings plan involves maximizing tax efficiency, controlling risk and covering off the possibility that you and your spouse may outlive your funds. It is also worth keeping in mind that solutions vary according to the circumstances of individuals.
For example, if you expect to live a long time, an aggressive “meltdown” of a registered retirement savings plan may not turn out to be as optimal as letting the funds compound tax-free in a registered plan. A column like this can only touch on the issues broadly; consultations with advisers and/or self-education are needed to find tailored solutions.