Income alternatives for young retirees

By Dale Jackson
Globeinvestor Magazine Online, Aug. 5, 2008

Dale Jackson is a producer at Business News Network.

Every retirement strategy boils down to one question: Will my money outlast my life?

It’s a gut-wrenching subject in the best of times but the current stock market malaise and low fixed-income yields are forcing soon-to-be and young retirees back to the drawing board.

What many don’t realize, according to Toronto-based TriDelta Financial Partners president and CEO Ted Rechtshaffen, is that retirees living on non-RRSP investments while waiting to crack open their registered retirement savings plan nest-eggs at age 72 have a treasure-trove of income alternatives.

He says roughly 80 per cent of the typical retiree’s net worth goes untapped. “They only focus on non-registered and pension assets. That represents 20 per cent of their net worth.

Here are four income alternatives for young retirees.

Home sweet home

Mr. Rechtshaffen says the largest untapped source of retirement income is home equity – typically about 40 per cent of a retiree’s net worth. Most retirees own their homes and most homes have appreciated in value. He considers home equity dead money. “It’s guaranteed to earn zero per cent as long as it’s within the house.”

Retirees can establish a secure line of credit or a second mortgage against the house at the going rate of 4 to5 per cent. The cash can be used to enjoy life or generate income.

It’s suggested the amount borrowed stay below 30 per cent of the total value of the home in case house prices plunge or interest rates soar. “When you sell in five, 10 or 15 years you’re just going to pay off the debt anyway,” he says.

The good old RRSP

The government demands registered retirement saving plan holders withdraw a minimum amount of funds in the form of a registered retirement income fund at age 72, but in some cases it’s more prudent to dip into you tax shelter early.

Mr. Rechtshaffen considers RRSPs – typically 30 per cent of a retirement portfolio – the second largest untapped source of retirement income for young retirees. “There are certain strategies where you can effectively take your money out of your RSP tax free.”

RRIF withdrawals are fully taxed and an overloaded account could result in a hefty tax bill and possibly an Old Age Security clawback. If a young retiree’s income is low, the funds will be taxed at a lower rate and the cash can once again be used at the retiree’s discretion.

Insurance for income

One unlikely source for retirement income is insurance policies, which Mr. Rechtshaffen says typically make up about 10 per cent of net worth in retirement. “We view insurance as an asset class because it doesn’t move with the stock market or real estate prices.”

One strategy requires investors in their mid-30s to early 50s to take out a policy on their parents. They pay the premiums and when the parents die, the payout becomes their retirement income.

Policy holders can often access cash by withdrawing assets from the cash surrender value of the policy without impairing the coverage terms.

Some policies also have a contractual provision that includes a policy loan that is only payable after death and subtracted from the payout.

In addition, most banks offer collateral loans against life insurance policies where the bank holds the policy and pays out the balance minus the outstanding loan.

Non-RRSP tax advantages

When young retirees tap alternative income sources the funds can be used for anything. If they choose to generate more income by reinvesting in their non-RRSP portfolios TriDelta suggests high-dividend paying stocks, which can pay out yields in the 8-per-cent range but also carry risk.

Unlike bond yields companies are not obligated to maintain dividend payouts and dividend stocks could decline in value. The most popular dividend stocks in Canada are the big banks, which have never missed a dividend payout. The U.S.-based credit crisis knocked many Canadian bank stocks off their highs but retirees who enjoy the dividends only realize those losses when, or if, they are sold.

Bond returns are fully taxed while dividends are taxed at a rate of two-thirds or less. If the stocks are sold at a profit the capital gains are taxed at only 50 per cent. If they are sold at a loss the capital loss can be used to cancel out capital gains from other investments.

Mr. Rechtshaffen says a good tax strategy in a non-RRSP portfolio is an income source in itself. “If you have significant money outside an RSP you should not have a penny in money market funds, GICs or high interest saving accounts.”

TriDelta estimates 90 per cent of retirees with a sound financial plan will have more money left over at the end of their lives than they think.

Investors are advised to speak with a qualified financial planner but to give retirees a better idea of where they stand financially many companies, including TriDelta, offer online calculators on their websites. Investors can input various income scenarios and the calculators take into account extenuating circumstances such as life expectancy, inflation, interest rates, investment growth and Canadian Pension Plan and Old Age Security payouts.

But even with an arsenal of facts, figures and historic data Mr. Rechtshaffen says basic psychology most often wins out in a retirement plan. “There are a lot of people that wind up dying with two or three million dollars who aren’t rich. In the end they get taxed a ton.”

Special to The Globe and Mail