Challenges to Retirement Planning
30 YEARS OF RETIREMENT PLEASE!
A longer lifespan with the expectation of 30+ years in retirement has made obsolete the past approach to retirement planning. It was not that long ago that individuals retired at 65 and expected to live for fewer than seven more years. In addition, corporate defined benefits pensions plans were commonplace which combined with CPP and OAS offered retirees security while they lived out their final years. This is no longer our reality.
The typical sources of retirement income include the Canada Pension Plan (CPP), Old Age Security (OAS), rental income, and sometimes private pension plans. Many of these sources of retirement income are indexed to go up with inflation, as measured by the Consumer Price Index (CPI); however, many experts argue that the true "cost of living increases" are, in fact, in excess of reported CPI. In the short-term, this may not be a serious concern, however, the buying power of "inflation adjusted pension income" may significantly deteriorate over the long-term.
In the event, that a retirees expenses exceed their retirement income, the short-fall must come from the retirees private resources. This generally includes savings, RRSPs, home downsizing, and by repositioning other significant assets (such as a business sale or art collection).
The longer retirement time horizon has added complexity to the measurement of the expected retirement expenses. In the past, most retirees could maintain a single budget throughout their retirement years. However, this is no longer the case. Retirement expenditures tend have three distinct phases; the go-go years, slow-go years, and no-go years.
New retirees tend to spend their initial retirement years doing the things they always wanted to do during their working years. The go-go years tend to be like an extended holiday as the retirees fulfill many of their lifelong desires. However, at some point the retirees slow down; often this is triggered by a minor health issue that will keep the retirees closer to home and family. Interestingly, surveys have shown that the slow-go years are the most satisfying phase of retirement.
The third phase, the no-go years, occur when a retiree desires or requires assisted care services to live out their final years. While government facilities exist, many retirees pursue private facilities which can provide them a higher standard of care. These facilities tend to be relatively expensive, which means the retirees must have enough savings in reserve to properly fund this phase of their retirement.
In addition to the three distinct phases of retirement, a retiree must take into account irregular expenses. This may include single purchases, non-annual regular expenses, and preparation for unexpected events.
Interest from the Bank
In the past many retirees sought to support their retirement from income generated from interest bearing securities, such as GICs. However, with interest rates at an unprecedented low, it is unlikely that a retiree could maintain the buying power of their savings due to the erosion of inflation, let alone support their retirement income needs.
Many retirees believe that they can rely on the equity markets to provide them the returns necessary to support them throughout their retirement. While it is true that equities do contribute to the sustainability of distribution portfolios, there is a limit to the added value; more is not necessarily better. There is an optimum equity exposure for maximum benefit for each distribution portfolio. Too high an equity allocation increases volatility and when combined with the retirement withdrawals will cause a shorter portfolio life. This affect is called reverse dollar cost averaging (RDCA) and the greater the equity exposure (beyond optimum) the greater the damage that is done. In addition to the damage caused by RDCA the retiree is also exposed to higher stress and portfolio volatility while their retirement dreams fail their expectations.
One final point to make is that the purpose of the equity markets is not to provide for retirees. The equity markets fluctuate without consideration or purpose to serve any one individual. A retiree must appreciate that managing a distribution portfolio is different than managing an accumulation (savings) portfolio. There are unique risks for distribution portfolios and managing them for maximum retirement benefit requires a different skill set than for accumulation portfolios.