For people who are their own pension manager, the challenge is building retirement income that’s steady, sufficient and tax-smart.GETTY IMAGES
Workplace pensions can be the backbone of retirement, but only for a minority of Canadians. Just 37.5 per cent of all paid workers are covered by a registered pension plan, according to Statistics Canada. Of those, about two-thirds of plans are defined benefits where the pension payout is pre-determined.
Any retiree might grapple with decumulation, the period when they’re unwinding the assets they’ve accumulated while working to create their new income stream. For do-it-yourself (DIY) investors without a pension plan, it can be even more challenging to produce retirement income that’s sustainable.
Doing so often involves a ‘floor and upside’ strategy, says Daryl Diamond, a certified financial planner and chief retirement income strategist with Dynamic Funds in Winnipeg.
This typically involves using Canada Pension Plan (CPP), Old Age Security (OAS) and perhaps a life annuity for a portion of retirement income to cover necessary expenses. That’s the floor.
“It’s always good idea to have enough money in guarantees where, irrespective of market returns, you’ll be okay,” says Mr. Diamond. “From there, income from personal investments is used to fund discretionary expenses,” says Mr. Diamond.
If CPP and OAS fall short of covering essential costs, annuities can often be a key part of guaranteed income. You can purchase this financial product with a lump sum or series of payments, and in return the annuity pays out a regular income for either a set period or for life.
But many investors are leery of giving up a large chunk of capital to buy annuities, says Ian Wood, a certified financial planner with Cardinal Capital Management in Winnipeg. Consider that $250,000 used to purchase a life annuity at age 65 will provide about $15,000 in pre-tax income, based on estimates provided by Sun Life’s annuity payment calculator.
“A lot of people who are retiring at 60 or 65 will find the payouts from annuities not very attractive,” says Mr. Wood.
For many DIYers, creating their own reliable income stream might be more appealing. For example, $250,000 in a portfolio yielding 4 per cent would provide about $1,000 monthly. While not guaranteed, it could provide income similar to an annuity while offering the flexibility to draw on capital if needed, says Mr. Diamond.
There are many ways to build income. That includes income mutual funds providing a monthly distribution, and selecting a variety of securities (like covered call exchange-traded funds, dividend-paying stocks, bonds and GICs) to deliver a blended income.
This strategy can be tax-efficient when used in a non-registered account, as income can consist of dividends and capital gains taxed at lower rates than interest. As well, some income from funds and even annuities is non-taxable as a return of capital.
Many DIYers may only have two accounts: a Registered Retirement Savings Plan (RRSP) and a Tax-Free Savings Account (TFSA). One option may involve using the registered plan to provide pension-like income, converting it early to a Registered Retirement Income Fund (RFIF) before the mandatory conversion age of 71.
With this strategy, “You always want to do a projection where if you draw $2,000 a month, for example, you understand how long your money will last,” says MaryAnn Kokan-Nyhof, a certified financial planner at IG Wealth Management in Winnipeg.
This exercise is all for nothing without understanding your costs of living, she adds.
Another option is delaying CPP and OAS to age 70 for the maximum benefits, which are indexed to inflation for life. Then, the focus goes to drawing income from the portfolio in the years prior, while aiming to have enough capital remaining to assist with longer-term retirement costs.
It’s a difficult task to balance, and one reason why many DIYers seek advice and tailored strategies from financial planners. “A one-size-fits-all solution to this problem doesn’t exist,” says Mr. Diamond.