I do a lot of flying across Canada. Because of that, I am conscious of the fact that most of the time, the plane almost lands itself (and, if you happen to be in the right plane at the right airport, it completely lands itself). But sometimes, the pilot is required to take over and make crucial decisions in response to changing weather, traffic or mechanical conditions — conditions that simply couldn’t have been planned for.
This is a good analogy for people approaching retirement. Even those who’ve done a good deal of pre-retirement preparation — who’ve got the plane close to the destination airport, if you will — may find that the glide path to landing on the retirement runway is different from what they’d expected. In this situation, clients must mimic the airline pilot and fly the plane themselves, with help from their financial advisor. The results are worth the effort.
In a column last year, I talked about four ways clients need to be proactive as retirement approaches. To recap, clients should project expenses in retirement; understand the sources of retirement income other than from the investment portfolio; discuss with their advisor the asset allocation of their retirement portfolio, its composite investment mix and the amount regularly contributed to the portfolio; and consider the impact of the planned date of retirement.
Come to think of it, carrying out these activities is a pretty good idea regardless of volatile financial markets, economic downturns and the reality that risk does, in fact exist. We appear to be heading toward a recovery, even though there are some risks to the outlook (as there always are). Even with much improved economic and financial market performance, we would do well to remember that the global economy and global capital markets (both of which we are part of, whether we like it or not) will continue to change.
So let’s revisit the four steps in light of recent events. Now is an opportune time to re-engage those clients nearing retirement to help them assess their respective “flight paths.”
1. Have clients projected their retirement expenses and divided them into essential and discretionary categories in the context of what has happened during the past two years? How would a drop in income from investments affect their view of both their overall expenses and the essential/discretionary divide? Has the market volatility led to a reprioritization of what are considered essential and/or discretionary expenses? Also, is there a sufficient margin of safety with respect to essential, must-have expense coverage?
2. Do clients have a thorough understanding of the other sources of retirement income they can expect in retirement, including government benefits (OAS, CPP/QPP), company pension plans and other sources unique to their situation such as rental or business income? Regarding company pension plans, do clients understand whether they are in a defined benefit or defined contribution plan; whether they are contributing an appropriate amount and taking advantage of employer-matching contributions, if available; and how their funds are invested if in a defined contribution plan?
Can clients meet the test of covering essential expenses with these stable, if not guaranteed or “sure” sources of income? Do clients understand the differences in monthly CPP/QPP payments depending on whether they are taken at the minimum age of 60, the maximum age of 70 or somewhere in between? Are they aware of the proposed changes to the CPP that would encourage taking payments later? Has any thought been given to whether OAS benefits will be affected by tax clawbacks? And have they examined their options for reducing taxable income in retirement by means such as pension income splitting and/or TFSAs?
3. How do clients feel about risk now versus before? How do they feel about the future? In the final analysis, clients must make decisions about their investment mix that allow them to sleep at night. But advisors can provide some much-needed education.
Let’s move beyond the basics — the clients’ time horizon and basic allocation — and think about two things: the costs and benefits of risk and clients’ retirement income withdrawal rate.
As a preface to the discussion about risk, don’t let clients turn it into a market forecast by the advisor. Risk always exists. What was different until a couple of years ago was that most people had forgotten about it. So, the discussion really needs to be about the relative risk between investable assets, and not short-term prognostications about whether stocks are going to outperform bonds, etc.
Most discussions centre on the potential investment gains or potential investment income foregone by having too conservative a portfolio. Here is another approach: to what extent are clients prepared to increase their monthly allocation to their investment portfolio to compensate for lower potential returns from that same conservative portfolio? This approach is not intended to scare clients into taking on more risk than they feel comfortable with, nor is it to take on extra risk to make up for recent losses. Rather, it is to better illustrate the cost of being risk-averse to help clients make decisions they really understand.
Many clients consider sustainable retirement income withdrawal rates as something to think about only at retirement. Nothing could be further from the truth. Applying sustainable withdrawal rates to projected retirement portfolios can be a useful tool to help clients understand the impact of their chosen investment mix and their savings rate on their expected level of retirement income. If clients follow step #1, they will know roughly what they need. Step #2 will tell them what their “sure” sources of income will cover. Now it is time to see what sort of cash flow the investment portfolio can sustainably generate in order to cover the balance. A conservative, age-appropriate withdrawal rate provides an important assessment of how likely it is that clients’ saving and investment activities today will meet their needs in retirement.
4. Finally, how do your clients feel about possibly working during retirement? Canada’s demographic realities — the aging of the population — convinced me a long time ago that more people would wind up working in retirement. A second part of the demographic evolution — that our life expectancies continue to increase — serves only to reinforce this argument. Longer life expectancies require more retirement assets and introduce more productive ways to spend time in retirement. Working in retirement can help with both.
Working in retirement, of course, isn’t for everybody. I know as many people who are happily working well into their retirement years as those who are happily staying as far away from gainful employment as possible. But, aside from the longer-term demographic issues, working in retirement can be a retirement income problem solver. In the first place, it can allow a longer period of retirement asset accumulation. In the second, it can simply help pay the bills. Working in retirement doesn’t necessarily mean delaying retirement from one’s main career position. It can mean working part-time in the same field, even for the same company (where the changes in defined-benefit pension rules that recently went into force may kick in). It can mean working in a completely new field, with all of the mental rejuvenation that entails. The point is, working in retirement is an option to ensure adequate retirement income, it is becoming increasingly popular, and it is worth discussing with clients.
Does all this mean that we completely dispense with automatic pilot and fly the retirement preparation aircraft manually? Not at all. The basics of long-term retirement/financial planning and regular contributions are as sound as they ever were. The difference — the new reality, if you will — is the recognition that there are usually storm clouds somewhere in the region. Being ready for them, and having some experience with taking control and making the appropriate decisions, are pretty handy tools to have ready when our clients fly into those clouds.