Closing the retirement income gap
More and more baby boomers are entering the "de-accumulation" phase of their lives, in which they'll soon start dipping into the money they've set aside over the course of their working years.
For many, that means confronting a future that's both difficult to visualize and to understand — particularly as it’s so different from that of prior generations.
For instance, fewer than half of current retirees actually use personal assets for retirement income, according to a recent study from Hearts & Wallets, a financial research company.
But, with defined pensions becoming a thing of the past, the chances are good that you’re going to spend a lot more of your time juggling assets to create that income.
Hearts & Wallets recently developed a new measure, the Retirement Reachability Ratio (RRR), which tracks the progress of mature households toward the saving goals needed to fund a self-defined desired lifestyle after retirement.
This metric includes various sources of retirement income — including both pensions and part-time work — as well as the impact of higher or lower levels of spending, and different real estate or family situations.
How are most of us doing so far? Not too well, it seems. The median household approaching retirement is only at an RRR of 55 per cent, representing the percentage of assets required for the long road ahead.
Only one in five (21 per cent) is at 80 per cent or more of their self-stated asset goal.
The truth is, most of those retiring in the coming years are going to see the size of their assets shrink gradually as they nibble at them. This means they’re going to need lots of help if they’re going to avoid running out of money entirely.
Advisors use a wide range of methods to ensure that retirees are able to generate sufficient income from investment portfolios without exhausting their resources.
Some favour a bucket approach which groups stocks and bonds by the time horizon in which they will be used — i.e. early, later and more distant phases of retirement.
Others use systematic withdrawals where you regularly redeem a set portion of the portfolio in the hopes of replacing the income payments with additional investment gains.
Another school of thought relies on annuities to create a guaranteed floor for a large part of their retirement needs, piling higher-risk stock portfolios on top of them.
And, with interest rates likely heading up next year and thus improving annuity yields, expect to hear more on this option.
Since the target equity allocations remain constant — say 15 or 20 per cent of the overall mix — retirees can use all the available floor dollars to purchase income. Throughout retirement, money is withdrawn only from the floor portfolio for spending.
For instance, if the equity portion of the surplus account exceeds a certain percentage of the overall portfolio, then you sell enough equities to return to the base allocation and use the proceeds to ratchet up your spending while supported by the secure floor portfolio.
This way, while spending can increase, it doesn’t decrease. While the equity allocation could potentially be eradicated during a bear market, the secure spending floor remains in place and the retiree is exposed to, at worst, a set drop in their overall assets, the thinking goes.
In each instance, the goal is to produce the cash flow you need, while maintaining the nest egg through the expected length of your lifetime. But you have to do your part as well.
Every good retirement plan starts with the question, “How much do I need now?” Followed by: How long? How often? How safe? How consistent? How flexible?
Only you can provide those answers. And only then can you work with an advisor to plan your investments to keep up with inflation, as well as unexpected or discretionary expenses later in retirement.
To give yourself time to settle in, consider setting aside enough cash to cover your spending needs, after non-portfolio income sources like CPP ands OAS or a pension, for at least the next 12 months.
Longer term, don't be afraid to tap into your principal. Sure, some lucky retirees with very large portfolios may be able to live comfortably on the money spun off from predictable income sources alone.
But that’s tough for many people to achieve — especially in a low-interest-rate environment.
The truth is, it's okay to spend principal in retirement. In fact, for most people, it's both sensible and necessary. It’s the pace you have to watch out for.
Got a question about investing, saving or retirement? Send Gordon an email and we might answer your question in a future column.
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