Preparing For Retirement: Managing Your Cash Flow
You’ll soon be heading into retirement. You’ve thought about what retired life will look like for you and your spouse (if you have one) and approximately how much this lifestyle is going to cost you. A good retirement budget will not only cover your day-to-day life but will also take into account such things as taxes, health care costs and any one-time expenses you may encounter in the future.
Now you need to determine where this money is going to come from.
Preparing For Retirement:
Guaranteed income
Guaranteed income includes payments from CPP/QPP and OAS as well as any work-place pension plans. The closer you are to retirement, the more accurate the estimates will be:
- Get a CPP estimate on your My Service Canada account.
- If you contributed to QPP contact them directly.
- If you have lived in Canada your entire life you will qualify for full OAS benefits. If not, check for your eligibility.
- If you are enrolled in a workplace pension plan, contact the pension provider for an estimate of the pension amount you should expect. If it’s a Defined Benefit Plan, ask for a copy of the rules used for the calculation. A Defined Contribution Plan however can only give you an estimate based on projected returns which may not be very accurate.
Subtract your guaranteed income from your proposed budget. You will need to draw on your savings to cover the shortfall.
Will my savings be enough?
Once you’ve decided on an annual withdrawal amount you will want to determine whether you have enough savings to last your lifetime.
There are lots of calculators online that can help you, such as the How Long Will My Money Last calculator, or this more detailed calculator which also generates a savings plan for you.
Be careful with the assumptions you use for returns and inflation. Different calculators yield different savings amounts. They also assume the same rate of return every year when, in reality, we know that investment returns fluctuate from year to year. It’s always best to select conservative assumptions when deciding how much to save.
Keep your withdrawal strategy simple
How will you turn your savings into retirement income? There are several retirement income models. Develop a withdrawal strategy from your investments that also keeps tax efficiency in mind.
1.) Withdraw a certain percentage from your portfolio each year. You may have heard of the 4% rule which suggests that if you withdraw that amount from your portfolio – with an adjustment for inflation each year – you will avoid running out of money prematurely. Your annual income will fluctuate with the return on your savings and could be inadequate in a poor market.
This approach is best when the retiree has a guaranteed income that will cover fixed expenses such as housing and food, and savings are used to supplement lifestyle enhancements. Otherwise, you need to be prepared to tighten your belt in the years the markets go against you.
2.) Total return approach. This approach is simplified if you use just a small number of broadly diversified ETFs. Each year you sell some bond or equity funds (or both) to replenish your yearly cash reserve, and rebalance your portfolio.
3.) The cash wedge or bucket. This system was developed by Daryl Diamond (Your Retirement Income Blueprint). You create a wedge, or bucket for your one-year cash spending. The next bucket covers your short-term (one to five years) cash needs in laddered GICs and the annual proceeds replenishes your cash account.
The long-term bucket holds a balanced portfolio of stocks and bonds. Profits are taken when appropriate and when the markets are down there’s still the cash cushion to provide cash flow until the markets recover.
4.) Annuities are often scoffed at, but it might make sense to “pensionize” some of your savings to create more guaranteed income.
Final thoughts
When you retire your cash flow will come from a combination of government pensions, employer pensions and your own portfolio. You want to provide a reliable, steady income that will meet your needs.
If your number crunching suggests you’re not saving enough to meet your retirement cash flow goal, you need to revise your retirement plan. You could choose to work longer so you can save more, work part-time in retirement, or lower your income expectations.
This article is of particular interest to me as I have decided to retire at 58. I sold off all my equity index funds but kept my fixed income ETF’s (VAB, ZPR, ZDB). I then purchased iShares XDIV and XDG high dividend equity ETF’s along with BMO CC Utilities ZWU ETF and the BMO ZDI ETF. I converted my LIRA and RRSP to RIF’s. My dividends from my ETF’s will bring in enough annually so I can likely forgeo taking CPP until 65 or even later. My wife is going to retire at 53 with the same income target from her pension and investments. This approach works well for us.
I think with the 4% rule, the annual draw increases each year by the inflation rate, so in fact doesn’t fluctuate with the markets. The studies that gave us the 4% rule were done with a total return approach, so may well not work with other strategies such as dividend growth investing, which is less diversified.
I’d like to suggest another point that could be added to the list under “Guaranteed income”. After the bullet point “If you have lived in Canada your entire life…” add:
“If you have not lived in Canada your entire life, check the government pension websites for each country in which you resided or worked, as you might be eligible for a pension from those countries too.” (or words to that effect)
In my case, I’m eligible for 17 years worth of UK state pension (approx. $7,600/y in today’s dollars), and I can buy additional contribution years to boost it further. My wife has bought 11 years of extra contributions so far. Unfortunately, these UK government pensions will not be indexed once we start drawing them when we are in Canada, but they will be increased when vacationing in the UK and many other countries! There is a lot more information on the UK pension for people who reside in Canada here: http://www.britishpensions.com/
@Bob Lin. That’s a good point. There are a lot of countries that have pension arrangements with Canada – especially UK and European countries – and it’s worthwhile checking this out. I would do this well ahead of retirement as, in my experience, they take their sweet time in processing these requests.