Your investment portfolio, despite the market ups and downs of the past few months, looks tantalizingly large. Government benefits will provide a surprisingly high percentage of your basic income needs.
Maybe retirement is more doable than you thought, sooner than you thought.
Those happy thoughts are likely cycling through the minds of many 50- and 60-somethings these days, thanks in large part to a bull market that has lasted the better part of six years. What seemed like a distant dream in the wake of the financial crisis--a financially comfortable retirement--is starting to look eminently possible.
But don't limit your retirement readiness check to an assessment of your account balances and your CPP/QPP payments. Make sure that you're considering the whole gamut of financial-planning considerations in retirement--especially new expenses and costs that you might not have had to contend with when you were working--when determining whether you're really ready to hang it up.
What follows are some of the financial realities of retirement that have the potential to blindside new retirees who don't plan for them.
You could encounter a down market early on in retirement: Retirement-portfolio balances are way up at the moment, but the past few months have provided a reminder that that can change in a hurry. And encountering a bum market, especially early in retirement, can change the math on the viability of retirement in short order. If your $1 million portfolio were to drop by 25% next year, your $40,000 annual withdrawal would jump from 4% to more than 5% in the space of a year. That might not be catastrophic, but financial planners usually advise pre-retirees to build in some variability in their in-retirement spending programs so that they spend less in down markets, especially if those down markets happen early in their retirement years. I also like the idea of "bucketing" --holding enough cash and bonds to ensure that you're never going to have to sell stocks to meet living expenses when they're in a trough.
Your healthcare costs may go up: Because healthcare is a provincial responsibility, the percentage of healthcare costs covered by the government varies across Canada. A 2014 Leger Marketing survey found 56% of Canadians are "entirely unfamiliar" with how much long-term care costs in their province, and two-thirds do not have a financial plan for these costs. Health care expenses like prescription drugs, mobility aids, accessibility renovations, home care and medical tourism often need to be paid out of pocket. Some retirees may be covered by an employer-provided plan, though that segment is shrinking; a 2014 Aon Hewitt survey found that 44% of Canadian employers do not offer healthcare benefits for retirees, while a further 10% closed existing retiree programs on account of high costs.
Inflation will take a bite out of your withdrawals: Gas prices provide a regular, visible gauge of whether costs are going up or down. But most price changes are far more subtle and easy to ignore: The pasta box that was 16 ounces shrinks to 14, or the cable bill (don't get me started on the cable bill!) jumps by $20. Over time, those minor cost increases, both direct and indirect, mean that you'll need to spend more to maintain a steady standard of living. That's why it's so important to make sure that you're factoring in the role of inflation when assessing the viability of your plan--an amount that you can live on today may not be enough to get by on in 10 years. Spending guidelines like the 4% "rule" factor in the role of inflation by assuming the retiree spends 4% of her portfolio balance in year one of retirement and then gives herself a small raise annually to account for inflation; this article discusses how to properly inflation-adjust your withdrawals. It's also valuable to make sure that your portfolio has a fighting shot at out-earning inflation via direct inflation hedges like real return bonds as well as indirect hedges such as stocks.
You'll owe taxes on your withdrawals from tax-deferred accounts: Balances for RRIFs and LRIFs are a bit of an optical illusion, in that they look fatter than they actually are. While you enjoyed tax-deductible contributions and tax-deferred compounding while you were accumulating money there, you'll owe ordinary income tax on each and every one of your withdrawals. That underscores the importance of making sure that you factor in the bite of taxes when crafting your retirement-spending plan, as well as the merits of tax diversification--making sure you come into retirement with accounts that will enjoy varying tax treatment, including TFSAs and taxable assets.
You'll be responsible for managing your own tax outlays: Self-employed individuals know well the importance of setting aside enough of their earnings to cover taxes. But for retirees who spent most of their lives receiving a paycheque that took taxes out automatically, covering their annual tax bills on their own may take some getting used to. RRIF minimum withdrawals are not subject to withholding tax, so retirees may want to manage their ongoing tax obligations by setting aside a percentage of these withdrawals at the time they take them. If your income is predictable, paying your taxes in quarterly installments--rather than as an annual lump sum--is also an option; a tax advisor can help you make sure that your ongoing tax outlays during retirement aren't so low that you'll incur a penalty, and aren't so high that you're giving the government an interest-free loan.
You'll be on the hook for required minimum distributions: Wealthy retirees may find themselves in the enviable position of not needing their RRIFs; they can draw their income from other sources and continue to take advantage of tax-sheltered compounding that the RRIF wrapper affords. That's a fine strategy in the early retirement years. But required minimum distributions begin in the year in which you turn age 71, and if the RRIF is a large one, your tax bill may well go up right along with those distributions. Here again, tax diversification can come in handy, as withdrawals from TFSAs and some taxable assets may help retirees offset the tax bills from their RRIF withdrawals. Retirees should also bear in mind that the proceeds of minimum RRIF withdrawals don't have to be spent; you can reinvest them in your taxable account or even in a TFSA if you don't need the money.
You might not be able to continue to work: While a 2015 Sun Life poll found that 60% of Canadians expect to work past the age of 65, the average age of actual retirement is 61. Some early retirees were forced to stop working by their employers, while others were compelled to leave because of their own healthcare difficulties or those of a loved one. However, 44% of working Canadians are satisfied that they have enough savings for retirement, up from 33% in 2012, and 63% of retirees are satisfied with their savings.
