Where’s your retirement income hiding?
Golden Girl Finance | R. Thompson
Where will my retirement income come from? A worryingly large number of higher-tax-bracket individuals I talk to these days ask me that very question. After looking at their Canada Pension Plan payment, perhaps some employer sponsored pension funds accumulated over the years, a hodge-podge of RRSPs, TFSAs, and non-registered investment at various brokerage firms, some of these folks are surprised to discover they have a retirement nest-egg of $1 million or more. But how do you convert that into a steady – and above all, safe – income stream?
It’s a really important question, and one that can’t be left to the “shoe box” method of planning. The need for a coherent, well-planned retirement income strategy has never been greater. Here’s why…
Threats to your retirement income
- We’re living longer. Canadians are living longer, raising the possibility of running out of money in retirement. A significant decline in health, sudden critical illness, and a need for quality long-term care are risks we all face as we age.
- Government pension stress test. With an aging population, government pension plans are becoming increasingly stressed. The average monthly payment for Canada Pension Plan and Old Age Security is less than about $1,200 per month. With governments under pressure to curb runaway spending, there’s very little appetite for those in the workforce to increase pensions to those who have retired.
- Private pensions changing. The long-popular defined benefit pension plan has become increasingly exposed to systemic risk. Some plans may become underfunded or insolvent if the employer faces financial difficulty, meaning severe reduction or even total loss of pension benefits. Defined contribution plans, which let individuals choose contribution levels and pension management options, are becoming more popular.
- Inflation. Inflation is always a threat because it erodes the purchasing power of your savings.
- Investment risks. Interest rates are at historic lows and traditional interest-bearing investments like GICs are currently not even keeping pace with the annual rate of inflation. Yet stock market returns, while higher than fixed-income over the long term, are far riskier.
What you’ll really need
A rule of thumb is that in order to maintain your lifestyle during retirement, you will need 60% to 70% of the average annual income for the last five years of your employment before your retirement.
A report from the Organisation for Economic Co-operation and Development (OECD) noted that an average of only about 39% of income replacement needs for Canadian seniors at retirement comes from government pensions and plans. The remainder must be made up from private pensions and personal funds.
Building your retirement income stream
At retirement, creating a stream of stable, reliable income becomes a paramount consideration. After all, you’ve spent perhaps 30 years carefully building a considerable nest-egg that you now need to use to create a steady income for perhaps another 30 years.
To begin with, look at proven income-producing products and potential income streams to create the best cash flow for your retirement needs and to comfortably meet contingencies as you age into retirement.
But simply creating a reliable income stream isn’t enough. Without careful planning for tax efficiency, the tax man may take a big bite out of your annual income. So you’ll have to consider a combination of sources to produce the most tax-efficient income-portfolio possible, one that’s built for income security, asset growth, and inflation-protection.
Here are the top income-producing assets that are likely to form part of your retirement income portfolio, categorized by tax rate payable:
- Top-tax assets: bonds; interest income; pensions; employment earnings; registered annuities; GICs; RRSP/RRIF; real estate rental income.
- Mid-tax assets: mutual fund distributions; insurance policy cash value; corporate class mutual funds; prescribed annuities; stock dividends.
- Low-tax assets: home; personal capital; Tax-Free Savings Account withdrawals; leveraged insurance policy cash value.
The good news is that as you read this list, you may discover you already own many of these assets. Others, like annuities, might be a total mystery to you. The challenge is to turn this stew into a safe, reliable, tax-efficient long-term income stream that lasts as long as you do. Most of us don’t have the training or expertise to make the objective choices needed to achieve this goal. But Certified Financial Planners do, and if you’re at this stage in your life now, that’s where I’d recommend you begin.
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