Canadians focus for most of their working lives on accumulating assets, but an even tougher challenge is deciding how to draw down those assets in retirement – decumulation, as financial planners call it.
The decumulation challenge arises because retirement planning hinges on two massive unknowns: how markets will perform and how long you will live. Since nobody can accurately predict either variable, retirement planning becomes an exercise in risk management. Spend too much in the early years of your retirement and you may wind up running out of money at 85. Spend too little and you deprive yourself of years of pleasure for no good reason.
Public policy is slowly moving to address the issue. For instance, the federal government has recently opened the door to variable payment life annuities (VPLA), a plan that would allow participants to pool risks in a professionally managed, actuarially sound investment fund that would guarantee them a monthly cheque for life. This is not just theory: The University of British Columbia faculty pension plan has been running such a plan, quite successfully, since 1967.
To be sure, devising such plans is not a simple job, but it’s not an insurmountable task either. “The detail devils involved in designing workable decumulation back ends can be conquered,” Keith Ambachtsheer, director emeritus of the Rotman International Centre for Pension Management at the University of Toronto, asserted in a report this week. “The time has come to do so on a much broader scale.”
Mr. Ambachtsheer hopes that the VPLA notion and other alternatives for retirement planning will gain ground over the next few years. Until then, we have to do our best to ensure we’re not sabotaging our own decumulation plans.
In my opinion, the three most common decumulation mistakes include:
Taking Canada Pension Plan too early: The simplest way to ensure you won’t run out of money in old age is to defer your CPP payments for as long as possible. The standard age to start is 65, but every year you put off collecting swells the monthly amount you will collect. Defer to 70 and your payout grows by 42 per cent compared with the amount you would otherwise collect at 65. This, by itself, can go a long way to giving you financial security in your later years.
Paying excessive fees: If market returns over the next few years are lower than normal – as many forecasters believe likely – it will be more important than ever to watch the fees you’re paying for financial advice. Mutual funds that charge more than 2 per cent in management expense ratios are nearly always a questionable notion.
Look instead at the low-cost all-in-one diversified exchange-traded funds (ETFs) from providers such as Bank of Montreal, iShares and Vanguard. These may not fit your exact needs, but they do provide a good basis for comparison.
Not having a plan: Improvising is fun if you’re playing a musical instrument. But with retirement? Not so much. If you want a better handle on how to draw down your assets in a systematic fashion, check out Frederick Vettese’s recent book, Retirement Income for Life: Getting More Without Saving More. This online calculator is based on Mr. Vettese’s book and offers a handy way to calculate how much income your savings can reasonably be expected to generate.
Finally, keep an eye on what is happening both in terms of public policy and in terms of products. The sheer number of retiring boomers is likely to put pressure on governments and financial companies to offer better ways to practise decumulation. “It will take time, but changes are coming,” Mr. Ambachtsheer says.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.