Why separating planning for retirement income and estate goals can lead to better outcomes

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Retirement represents a significant shift in a person’s lifestyle that spans beyond finances and brings a unique set of challenges. The way advisors manage clients’ investments during their working years, focused on saving and accumulating wealth, fundamentally needs to change as clients enter the decumulation stage.

Taking a holistic wealth planning approach for someone in retirement is much more critical and more time-consuming than it is for someone in their working years. After all, it’s easier for a younger person who is still working to make the necessary adjustments if something goes wrong with their finances than it is for someone in their 70s, 80s or 90s, who is already well into their retirement.

Reports suggest more than 40 per cent of advisors’ clients are in decumulation – a figure that is expected to continue rising. Advisors need to supplement their practices with a financial planning lens to meet clients’ retirement goals.

A fundamental question clients must address through the financial planning process is whether their primary goal is to generate a sizeable income to meet their lifestyle goals or to leave a substantial estate for their heirs.

For most Canadians, it’s a delicate balance between these two objectives. Without careful planning, there’s a high risk of a disconnect between clients’ financial goals and the outcomes their investments are likely to deliver.

Once their financial circumstances and personal preferences regarding income and estate goals have been identified, it will become easier to apply investment opportunities and models to meet clients’ goals.

How to separate income goals

When constructing a portfolio for a retired client, the income goals can be divided into two primary investment sleeves – basic needs and wants and wishes.

Clients’ basic needs encompass essential expenses such as housing, health care, and everyday living costs. The investments designed to fund the basic needs sleeve should be lower risk, offer income protection and must provide a consistent and sustainable cash flow that lasts their entire lifetime.

A mix of investments that meet these specific income solutions includes life annuities or longevity-risk pooling mutual funds, cash and cash equivalents such as money market funds.

The wants and wishes sleeve covers aspirational spending on non-essential items or experiences such as travel, hobbies, or gifts. Clients can take on more risk for these discretionary expenses than the basic needs sleeve.

So, this part of their portfolio could include a higher allocation to growth-oriented assets that offer higher expected returns but come with more variability and a relatively lower allocation to lifetime income solutions.

Benefits of lifetime income solutions

Lifetime income solutions are not widely adopted in advisors’ practices; that’s due mainly to the limited redeemability and benefits for clients’ estates. This approach, though, distinguishes between the investments they expect to spend while they’re alive versus what they intend to pass on to their estate, enabling lifetime income to be applied selectively where appropriate.

The benefits of lifetime income solutions include their ability to provide a protected income stream for life while indirectly helping retirees overcome psychological tendencies to hoard savings, allowing them to meet basic needs and wants and wishes objectives.

The estate sleeve, on the other hand, can typically take on a higher level of risk and requires less liquidity for someone entering retirement because of its longer-term investment horizon.

This portion of the portfolio should be earmarked for clients’ heirs and can include a set of investments designed for this purpose with no allocation to cash and cash equivalents or lifetime income solutions.

Life insurance can also play a significant role in tax-efficient estate planning and should be considered as part of the client’s full financial picture.

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Every advisor will differ in what investments they use for the basic needs, wants and wishes, and estate sleeves, and how much to allocate to each investment. What’s critical is that they first identify clients’ goals across each of these sleeves and use outcome-oriented investments designed to reach each of the specific sleeve’s objectives.

Simon Barcelon is vice president, Longevity Pension Fund, at Purpose Investments Inc. in Toronto.

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