There are lots of unknowns when it comes to retirement planning. Most of us focus on how much we need to save for retirement without giving much thought as to how much we’re going to spend in retirement. I’d say, in general, that most people want to maintain their existing lifestyle, if not enhance it with extra money for travel and hobbies.
A $1 million dollar nest egg can provide you with $30,000 to $40,000 to spend each year with reasonable assurance that you won’t run out of money. But if your ideal retirement lifestyle costs $60,000 per year, your million-dollar portfolio won’t be enough to last a lifetime.
Once you determine your magic spending number, the rest of the variables start falling into place. The earlier you can identify the amount of income you need to live the retirement you want, the easier it is to make your retirement plan and adjust course, if necessary.
Let’s say you’ve analyzed your retirement income needs and find, based on your current financial situation, that you won’t be able to fully fund your desired lifestyle. What to do?
Five Retirement Planning Options
Here are five retirement planning options to help you adjust course and reach your retirement goals.
1. Reduce your lifestyle
A $60,000/year retirement might be out of reach based on your current situation, but perhaps reducing your goal to $45,000/year can still provide a great lifestyle in retirement.
This lifestyle adjustment could mean travelling less often, making sure you retire debt free, downsizing your home, replacing your vehicle less often, reducing your hobbies, or a combination of all the above.
Don’t forget to include government benefits such as CPP, OAS, and/or GIS when projecting your retirement income. It’s worth sitting down with a retirement planner to figure out the best way to draw down your assets and when it makes sense to apply for CPP and OAS.
2. Work longer
It can be difficult to picture yourself working longer once you’ve got retirement on the brain, but a few extra years on the job can drastically alter your retirement projection.
The longer you work, the more you can save (or add to your pensionable service if you’re so lucky to have a workplace pension). But also the more years you’re working and earning a paycheque the fewer years you have to withdraw from your nest egg.
Are you healthy and willing to grind it out at work for a few more years? If so, you might be able to reach that $60,000/year retirement goal after all.
3. Earn more return from your investments
This is a tricky one because you might take it to mean investing in riskier assets (i.e. an all-equity portfolio), when in fact you can earn higher returns by reducing the overall cost of your portfolio. That’s the first place to start.
Imagine your $300,000 retirement portfolio is invested in a typical set of mutual funds that comes with a management expense ratio (MER) of 2%. The cost is $6,000/year but you don’t see the charge directly – instead it comes off your returns.
Switching to index funds and going the do-it-yourself route might reduce your costs to 0.5%, or $1,500 per year. That’s an extra $4,500/year staying in your retirement account instead of going into the hands of your advisor.
There might also be a case for increasing the risk in your portfolio. Say, for example, you tend to hold a lot of cash in your portfolio – you’re not fully invested. Or you hold a bunch of GIC’s and other fixed income products.
Dialling up your investment risk to include a portion of equities could help you achieve an extra 2-3% per year. The power of compounding can make a huge difference to your retirement portfolio and holding even a small portion of equities in retirement can help your nest egg last longer.
4. Save more
This one is so obvious it should be first on the list. If you’re not able to fully fund your desired retirement lifestyle based on your current projections then you need to save more.
Hopefully your final working years can give you the opportunity to boost your retirement savings. Big expenses, such as paying down the mortgage and feeding hungry teenagers, are behind you.
But an empty nest and paid-off home might tempt you to increase your lifestyle now rather than doubling-down on your retirement savings to boost your lifestyle later. That’s fine: See options 1-3.
That said, there’s no better time to enhance your nest egg by maxing out your RRSP contributions, including unused contribution room, and doing the same with your TFSA, in the years leading up to your retirement date.
Be mindful here, though, of strategies to reduce your taxes in retirement. It makes little sense to go make significant RRSP contributions in your final working years without considering how withdrawals will impact taxes or OAS clawbacks in retirement.
5. Supplement your retirement income
Much like working longer can increase your nest egg, supplementing your retirement income with a part-time job derived from a passion or hobby can prolong the life of your portfolio.
Imagine earning $10,000/year from driving a shuttle, working at a golf course or winery, writing personal finance articles, doing photography, or working a couple of days a week at Home Depot just to get out of the house.
All of a sudden you don’t need to withdraw $60,000/year from your retirement account. You only need to take out $50,000/year. That not only extends the life of your portfolio, but studies have shown that having meaningful work in retirement can extend your life, too.
Final thoughts
Retirement planning is critical and the earlier you start planning the easier it is to make these course adjustments and reach your desired outcome.
Related: The Retirement Risk Zone
Even late starters need not despair. The first two options – tempering lifestyle expectations and working longer – are on the table. Everyone can try to save more and earn more from their investments.
And, finally, a little retirement side hustle can give your lifestyle a boost and enhance your overall quality of life.
I mentioned we are building a new house, which we hope will be finished by spring 2023.
It was a stressful time to sign a purchase agreement with a builder. We wanted to arrange our financing so that the new house purchase was not contingent on us selling our existing home (been there, done that, rented for 90 days in-between, and it sucked).
Meanwhile, with inflation soaring (including building materials and labour), there was risk for the builder if they priced their quote too low.
The builder wanted a quick decision to lock in the quoted price, but we had to refinance our existing home to expand our home equity line of credit and then apply for a new builder (draw) mortgage. Oh, by the way, we had a three-week trip to Italy booked during all of this.
I’ll spare you the details, but it involved a late night Zoom call with our lawyer from an Airbnb in Florence, followed by a frantic trek to find a pen(!), a printer, and a Mail Boxes Etc* to get the documents couriered back to Lethbridge in a hurry. Good times!
*“Etc” doesn’t include printing, apparently.
We got everything set up the way we wanted and the house build is moving along nicely. Now the stressful part is dealing with rising interest rates and the potential for our existing home to fall in value before we sell it.
With a draw mortgage, we put down an initial deposit and then have a progressive schedule of deposits as the house nears completion. We plan to use our own funds (TFSAs) for the first 1.5 deposits and then dip into our existing home equity line of credit for the next 1.5 deposits, before tapping into the new builder mortgage for the remaining draws.
Unfortunately, the interest rate on our line of credit is now at 4.70% and should at least rise another 0.50% before the end of the year. Our draw mortgage is also variable at 3.80%, so that will rise in lock-step with any rate hikes.
We’re only charged interest-only payments until the house is completed and the full amount drawn. Then we can renew into a new fixed or variable rate mortgage without penalty.
So, we find ourselves in mortgage rate limbo for the time being. The planner in me wants to know exactly what our costs are going to be so I can determine our spending plan for 2023 and beyond.
My hope is that inflation gets under control, the rate hiking cycle ends this fall, and that housing prices steady and potentially find new life in the spring when we’re ready to sell our existing home.
I’ll then continue my strategy of renewing our mortgage into the best of either a five-year variable with a deep discount off of prime, or a 1-2 year fixed rate if a big variable rate discount isn’t available.
By the way, my go-to mortgage resource (Rob McLister) at MortgageLogic.news says the value zone for mortgages right now is still the 1-year fixed rate while we wait for this rate hiking cycle to sort itself out. Makes perfect sense to me.
In the meantime, I’m planning with the assumption that we’ll sell our house for 10% less than appraisal. I’m assuming the interest rate on our new mortgage will be 4.94%. And, I’m assuming a ~50% downpayment on the new house after we sell our existing home.
That leaves us with some wiggle room for landscaping, realtor fees, moving costs, and any other extras we can think of. If all goes according to our conservative plan, we’ll still have some money left over to tuck back into our TFSAs to start filling up those accounts again.
This Week’s Recap:
Many thanks to The Globe & Mail’s Erica Alini for highlighting my post on how I invest my money in a recent Carrick on Money newsletter (Erica is filling in for Rob Carrick while he’s on holidays).
That article was also mentioned in this Financial Post piece on what advisors are doing with their own portfolios.
And, it was great to be back on the Build Wealth Canada podcast with Kornel Szrejber as we discussed workplace pensions. We talked about how to invest if you have a defined benefit pension, and how to take advantage of a defined contribution pension plan, among other things.
Here on the blog, I wrote about whether you should consider moving your portfolio when it’s down.
I also explored whether you should postpone retirement amid high inflation and depressed stock and bond prices.
Finally, I explained what the retirement risk zone is and how it might prevent retirees from wisely delaying their pension and government benefits.
Weekend Reading:
Speaking of government benefits, OAS payments have risen permanently for the first time since 1973. Here’s why retirees should defer them.
On the housing front, Rob McLister offers some clues as to when Canadian home prices may bottom (subs).
Here’s a trifecta from the excellent Morgan Housel:
- How gold fish and tech companies are related (little ways the world works).
- Three rare and powerful skills.
- Why an asset that you don’t deserve can quickly become a liability.
The latest episode of the Rational Reminder podcast explored the expected returns from using a factor-tilted portfolio. Factor-tilts would include small cap and value stocks:
Compelling stuff, but I maintain my argument that most investors should avoid complicated portfolios and stick with total market index funds.
A Wealth of Common Sense’s Ben Carlson tries to make sense of this year’s wild stock market ride.
Of Dollars and Data blogger Nick Maggiulli looks at the pros and cons of a Die With Zero approach to spending.
The Department of Finance has now released details on the new First Home Savings Account to launch “at some point” in 2023.
Finally, a great piece by Tim Kiladze on how Canopy Growth, the star of Canada’s cannabis dreams, fell from grace (subs).
Have a great weekend, everyone!
Many years ago, my boss (Jerry) was all set to retire at age 58 when the federal government decided to impose a tax on the distributions of income trusts and royalty trusts. He was heavily invested in the energy sector – in oil royalty trusts with a history of generous payouts thanks to years of special tax treatment. Share prices of the trusts dropped immediately following the announcement and distributions were slashed as income trusts converted to conventional corporations.
Jerry decided to postpone retirement – to keep working and give his investments time to recover (though many never did). He worked two more years before leaving the hotel. I ran into him several months later at Home Depot, where he had picked up a couple of shifts a week to keep himself busy. Part of me wondered if he still needed the income to help fund his retirement.
Many soon-to-be retirees may be wondering if they should postpone retirement after markets crashed earlier this year and we’re (still) faced with high inflation and the possibility of a recession.
Related: Your Retirement Readiness Checklist
Stocks and bonds just endured one of the worst six month periods in history from January 1 to June 30, 2022. The S&P 500 was down 20.47%, while Canadian stocks were down 9.86% and Canadian aggregate bonds were down 12.33%. Stocks and bonds have shown a modest recovery since then (as of this writing) but a balanced portfolio is still down about 10% year-to-date (Aug 11th, 2022).
If you had planned to retire this year, or even in the next three years, your portfolio has been dealt a significant body blow. Is it enough to alter your retirement plans?
When to Postpone Retirement
My former boss Jerry had his entire retirement portfolio invested in income trusts and dividend stocks. His retirement income plan was to live off of those distributions. That changed in a hurry during the “Halloween Massacre” when then Finance Minister Jim Flaherty announced changes to the taxation on income and royalty trusts. Share prices fell, and distributions got cut in half or were eliminated entirely.
Are you nearing retirement, with the majority of your portfolio invested in dividend paying stocks and REITs? Are you expecting to rely on income from these investments to fund your retirement?
Let’s assume your portfolio is down 10-20%. That’s okay, right? As long as those dividends keep rolling in. Just remember that while dividend cuts are rare, they do happen from time-to-time.
There’s no doubt investors nearing retirement have been impacted by stocks and bonds falling in 2022. This is precisely why I advocate for a safety cushion of cash that includes one or two years worth of spending money in your bank account, and the remainder of your retirement funds in a risk appropriate investment portfolio (preferably low cost ETFs). Conservative investors with sufficient resources may also opt to hold another 3-5 years worth of spending in GICs.
But that’s not helpful to you today if your portfolio is down and you don’t have a cash cushion to fall back on. That’s like telling someone who just got laid off that he or she should have had an emergency fund. Thanks, Captain Obvious.
While not a desirable solution, postponing retirement does offer a trifecta of benefits for soon-to-be retirees whose portfolios have been decimated by the recent market crash:
- You’ll have more time to earn income and save for retirement
- You’ll have fewer years of retirement withdrawals, thus extending the life of your portfolio
- Your investments have more time to recover, which also gives you time to build your safety cushion of cash and GICs
Perhaps a more desirable solution is to work part-time like Jerry did at Home Depot. Many retirees have found joy working at a golf course, garden centre, driving shuttle, or pursuing an entrepreneurial activity. Others ease into semi-retirement with their current employer, opting for 2-4 days a week or taking on a consulting role.
The point is, earnings from part-time employment can supplement your income in retirement so you rely less on investment withdrawals – especially during a market decline – or can be used for your “fun money” like spending on extra travel and hobbies.
Just Retire Already
Other soon-to-be retirees might be fretting over nothing. These are the investors who already have a safety cushion of cash, perhaps accompanied by a nice workplace pension. They’re invested in a risk appropriate portfolio that is still built with an eye to the long-term. Besides, as a balanced portfolio, it’s only down 9 percent for the year. Annoying, yes. Devastating, no.
Related: The Retirement Risk Zone
Long-term investors know that a portfolio falling 10-20% is entirely within the range of expected outcomes in a given year. That’s why they’ve built a margin of safety with enough cash and pension income to rely on for 1-5 years and give their portfolio time to recover.
Their retirement plan is conservative enough to provide income to age 95, with assets left over (including their home) in their estate.
Their cost of living is low enough to afford them flexibility in their retirement spending – with the ability to increase spending in good times and reduce spending in bad times.
These near-retirees would likely be able to retire and meet their spending needs, even amid a global pandemic, high inflation, or an economic recession. Their plan is relatively bullet-proof.
Final Thoughts
A market crash can be a scary time to retire. Real dollars are at stake, and it can be emotionally painful to see your portfolio fall 20% or more in such a short time. Seemingly sound plans can get thrown out the window in the blink of an eye.
If you’re feeling nervous about retiring soon then perhaps you need to re-examine your retirement plan. Perhaps a decade of stock market gains had clouded your judgement and made you overconfident.
Postponing retirement, even by six months to a year, can be a great way to shore up your finances and put safety measures in place so that the next time the market crashes it doesn’t take your retirement plans down with it.
Looking for a retirement reality check? Talk to me about my fee-only financial planning service.