If you're at the end of your earning years, you and your spouse are probably wondering how you will manage financially in retirement. Even though you have both accumulated a fair amount of retirement savings and will benefit from income sources such as the Canada Pension Plan and a company pension, there is the issue of determining the proper withdrawal rate for those private savings. After all, with longevity becoming the norm, there is a worry that you might outlive your savings.
Unfortunately, there are no easy answers, according to experts in the field. There is no one-size-fits-all formula that will quickly provide a solution. That's largely because of the complexity of each person's financial circumstances, risk tolerance and expectations regarding retirement lifestyle and legacy wishes. As well, there's the challenging market environment, with fixed-income instruments that generate very low returns, and volatile equity markets.
"There used to be a 5% formula -- pre-2008," says Steve Parker, an assistant vice-president and head of guaranteed investment products for Manulife Financial Corp. "It's been used in the marketplace and was two-fold. One part says that individuals need to replace about 70% of their income. The second part said there was a 5% asset-consumption rate, starting at age 65."
The 2008 market crash changed things. "There is a new economic reality. Interest rates are low and people don't believe they are going up drastically any time soon," says Parker, who is based in Waterloo, Ont. "And there is choppiness in equity markets. The new reality has shifted our assumptions. Insurance products no longer pay out 5% -- they have moved down to 4.5% and then 4%."
Like Parker, Richa Hingorani agrees that a universal withdrawal rate is not satisfactory because withdrawal programs have to be tailored to each individual. "The 4% rule is a classic, but has become obsolete in today's market," says Hingorani, a Toronto-based senior manager, financial planning support, at Royal Bank of Canada. "The rule was put in place to get someone to save appropriately. Today, it's hard to predict where markets are going. More important, because everyone's retirement is different, you cannot guarantee that the 4% [withdrawal rate] will be enough for the first 10 years of retirement, or the next 10 years, and the last 10 to 15 years."
Hingorani says it's more practical to take a so-called hybrid approach during three phases of retirement. Generally, retirement expenses fall into three categories: living, lifestyle and legacy. At the same time, these expenses will vary according to the three phases of retirement. The first is the "active" phase when retirees fulfill dreams and spend a fair amount on travel and lifestyle expenses, followed by the "passive" or "homebody" phase when retirees generally stay closer to home and spend time with family. Finally, the "health-challenged" phase is when health becomes a dominant issue and physical capacity has declined considerably.
"At every phase you will need a different amount of money," says Hingorani. "But the 4% rule would not guarantee you won't run out of money. That rule may not fit your lifestyle spending or legacy wishes."
The hybrid approach takes into account sources of guaranteed retirement income, such as the Canada Pension Plan, plus employer pension plans, RRSPs or registered retirement income funds (RRIFs), tax-free savings accounts (TFSAs) and non-registered savings. The latter could come from home equity, should you decide to downsize and move into a smaller home, or from the proceeds of a business.
Take the hypothetical case of John, 61, and Mary, 59, who want to retire in the next year. Mary has accepted a $65,000 severance package from her employer, and has $108,000 in a defined contribution pension plan. John has $185,000 in a locked-in retirement account and $145,000 in RRSPs. They plan to downsize to a townhouse, investing the $250,000 from the sale of their home. Based on their combined retirement resources and non-registered savings, they expect to generate $50,194 in annual income, which will meet their annual expenditures.
As Hingorani points out, this scenario applies only to today's situation and is subject to change, given that the couple may live another 25 to 30 years. "A longer and healthier lifespan means you may need more years to plan for retirement income. That's why the 4% rule would be obsolete in most cases, depending how long someone lives," says Hingorani, adding that inflation is another consideration and will affect the purchasing power of your retirement income. "Health-care costs are also coming more to the surface. Usually, in the final health-challenged phase, there needs to be a plan for these expenses and a different withdrawal system to deal with them."
Another consideration is deciding if you would be better off first tapping your RRSP or RRIF or non-registered accounts, or vice-versa. "It will completely depend on what is the case in front of us, based on what do your expenses look like and what are the different income sources," says Hingorani, adding that it's important to conduct an annual review of your needs and income sources.
If the exercise sounds daunting, then for most people it's recommended that they get professional advice. And one of the main reasons is greater longevity, which puts demands on retirement savings. "A generation ago, people retired at 65 and life expectancy was 72. So they had to plan for about seven years in retirement," says Larry Moser, Ottawa-based regional sales manager, retail investments for Bank of Montreal.
"Today, people are retiring earlier and living well into their 80s," Moser says. "You have to plan for 25 to 30 years of retirement. The possibility of running out of money is very real. So it's important to start saving early, and make sure before your retire that you know how much money you will have to live on. If it's not enough, you may have to consider delaying retirement--if you choose to have a more lavish lifestyle than your savings will allow you."
Talking to an advisor will determine if you retirement plans can be supported by your savings, combined with company pension plans and government benefits. "A planner will put pen to paper for you and run the numbers. He or she will say, 'This is how much money you will have at retirement and this is how much you can spend each year, given a certain investment return, so that your money will last a specific period.' You don't want to guess," says Moser. "Among others, there is the challenge of very low interest rates. How do you get more investment income when interest rates are only 1.5-2%? Retirement-income planning is very complex. You need an expert to guide you."
Manulife's Parker also recommends speaking to an advisor to determine how much money you might need to live on, and then decide if your retirement savings are adequate. "If you need $70,000 a year, for example, that's $5,800 a month. Will your capital support that?" says Parker. "Then we look at what products will give you that income -- knowing your risk tolerance and how much equity versus fixed-income product that you are comfortable with. One key question is: Do you want to take some risks or hold mainly guaranteed products? There is no general rule, given that each person has different answers."
Not only should the advice be tailored to your needs. It's also wise to start the planning process long before you retire, even 10 years, or more.
"Ten years before retirement gives you some flexibility," says Peter Drake, vice-president, retirement and economic research, at Toronto-based Fidelity Investments Canada. "If you do the calculations, you will have some notion of your living expenses and discretionary expenses, and what you want to do in retirement." Moreover, he adds that you might discover that a certain withdrawal rate may not be sufficient to support your planned-for expenses.
"At 10 years before retirement, you have enough time to do something about your savings," says Drake. "You might need to increase your savings rate or change your asset allocation. If you wait until you start retirement, you have what you have. There isn't enough time to make adjustments."
