Retirement planning is the process by which an individual plans for life after their working career is over. After years in the “rat race”, you look forward to the day when you can start living under your own schedule and your own rules – you are the boss! But, the one question that mystifies many of us is knowing whether you will have enough assets to enjoy your desired lifestyle in retirement.
When considering a proper retirement plan, it is crucial to think about the three phases of retirement planning:
- Pre-Retirement; and
Retirement planning also incorporates several aspects of portfolio analysis and insurance analysis and is the precursor to Estate Planning.
Why is retirement planning important?
For most Canadians, retirement is their most significant financial goal that requires a considerable financial commitment. With increasing life expectancies, and regardless of your desired retirement date, the biggest questions remain “will I have enough assets to retire?” and “will I outlive my assets?”. These questions often remained unanswered until you reach retirement, which can be an unnerving feeling.
Phase 1 – Accumulation
This phase cannot start soon enough for anybody and begins on the first day of your working career. The earlier that you can start saving, the more your money will have a chance to compound throughout the years. There is the Rule of 72 that illustrates the power of compounding, and it goes like this:
Take 72 and divide it by your compounded rate of return – the result is the number of years that it will take to double your money.
For example, $10,000 earning 6% compounded annually will take 12 years to double (72/6 = 12)
Taking this example further, that $10,000 deposited when you are 25 years old will be worth $81,473 at age 61. Imagine making $10,000 deposits to your RRSP every year from age 25-34 (10 years) – you will save:
at 8% – $1,157,196
at 6% – $640,844
at 4% – $346,180
Unfortunately, for most young people, they do not have sufficient incomes to save in this manner, particularly if they intend to start a family, buy a house, and so on.
But the power of compounding is undeniable.
Phase 2 – Pre-Retirement
This period usually starts 5-10 years before retirement. During this period, you will make the most money in your career. The problem is that there is less chance for it to have time to compound. But that should not discourage you. If you have started some level of savings during the accumulation phase, then any further savings in this phase will only augment the savings you have accumulated to date.
Phase 3 – Retirement (or Decumulation)
At retirement, you will be more concerned with income and wealth preservation. Taking greater short-term risks with growth investments will be replaced with a desire to preserve your capital in more secure fixed income investments. It is time now enjoy the fruits of your labor.
Depending on how successful you have been, and with careful planning, you can make sure that your money outlasts you.
Proper asset allocation is critical for a successful long-term financial strategy and is especially important for retirees. Ideally, your investments should produce sufficient income without drawing down on your principal. However, this cannot always be achieved in which case one can look at purchasing a series of annuities, a life annuity and/or segregated funds (also known as “individual variable insurance contracts”) that contain death and maturity guarantees.
One thing is for sure, risk-taking can no longer fit into the plan. Many retirees experienced drastic reductions in their retirement assets that were invested in equities during the last market downturn in just over a one-year period. This scenario is a nightmare for a retiree, but it was a reality to many hard-working people.
At this phase, you will also apply for government benefits in the form of CPP/QPP, OAS and whatever other benefits may be applicable to your situation.
This is also the point where you will convert RRSPs to RRIFs, begin drawing company pensions and/or converting them to LIRAs or LIFs, and start the implementation of other strategies planned for during your working career (drawing dividends from your company, using borrowing strategies with the cash surrender value of your permanent insurance policies, and even reverse mortgage strategies using the equity in your principal residence).
At SPARK, our representatives can assist you in developing a comprehensive retirement plan that considers all of your options and incorporates the best options for you.
Seven KEYS to Success
- Determine your retirement income needs – preparing projections of income needs as a percentage of current income adjusted for inflation is the starting point to determining how much in assets will be required in retirement to produce the desired income.
- Remember the Three “S”s – save now, start now, and stay invested. Start saving now – whatever amount that you can spare. Then increase the amount you save in regular intervals. Use pre-authorized deposit plans that allow you to make regular contributions to retirement savings plans that go ‘unnoticed’. Remember to stay invested – the longer you hold your investments, the more they will benefit from compound growth.
- The importance of diversification – this is the process of spreading your risk by investing in several different investments, thereby reducing the impact of a poor performer in your portfolio. Avoid “putting all of your eggs in one basket”.
- Start early – as has been shown, starting early can have a dramatic impact on the amount of available assets during retirement.
- Contribute regularly – it’s akin to the tortoise and the hare, slow and steady wins the race. Regular contributions to a savings plan also helps to offset fluctuations in the markets by ensuring dollar-cost averaging of your investments.
- Contribute the maximum – whenever possible, try to contribute the maximum allowable amounts to your RRSP and TFSA.
- Consider your RRSP/TFSA untouchable – this can be the most difficult rule to live by as you see the value increase while you have unfulfilled wants or needs. Often people will draw down from their retirement savings as a safety net in times of financial crisis but try not to touch these accounts unless it is absolutely necessary. It goes without saying that funds you withdraw today will not be there when you need them at retirement.
Other considerations/final thoughts
Your retirement plan should always be reviewed after any major life event – such as a birth, death, or divorce – to ensure it reflects your new reality, and then adjust it as necessary.
Products and services used in estate planning
- RRSPs, RRIFs, LIRAs, LIFs, TFSAs
- Investment funds
- Life insurance – permanent