Retirees want to know how much they need to save in order to live a comfortable lifestyle. They also want to know whether their savings are enough to last a lifetime. These questions would be easier to answer if we knew how long we expected to live.
A good retirement plan aims to find a balance between maximizing life enjoyment and alleviating fears about running out of money in old age. And the fact that Canadians are living longer puts an even greater emphasis on a sound retirement plan.
But how do you estimate your lifespan if you don’t have a crystal ball to see into the future? Luckily, there are tools: FP Canada issues assumption guidelines for financial planners to use for long-term projections. They suggest using a “projection period for clients where the probability of outliving their capital is no more than 25%.”
For instance, a 55-year-old male today has a 25% chance of living to age 94, while a 55-year-old female has a 25% chance of living to age 96. That means planning for a 30- to 40-year retirement.
Indeed, retirement expert Fred Vettese recently shared a chart of 1,000 Canadian women aged 65 today, and more than half were expected to be still alive at age 90.
The bottom line: Canadians are living longer and need to plan to address the longevity risk in retirement. Here are six enhancements to your retirement plan that can help improve the odds you won’t outlive your savings:
Delay CPP and OAS
Canadians can take their Canada Pension Plan (CPP) benefits as early as age 60 or as late as age 70. Taking CPP at age 60 results in a permanent 36% reduction in your expected benefits versus waiting until age 65, while deferring your CPP to 70 results in a 42% increase in your benefits. CPP was designed to replace about 25% of your pre-retirement income, and a recent enhancement to the plan will bring that replacement rate up to 33% by 2065.
Old Age Security (OAS) can be taken as early as age 65 or as late as age 70. Deferring your OAS to 70 results in a 36% increase in your benefits. OAS is designed to replace about 15% of your pre-retirement income.
These valuable income streams are guaranteed, paid for life, and indexed to inflation. For context, CPP recipients in 2023 received a 6.5% increase in their benefits due to higher inflation in 2022. OAS payments are adjusted quarterly, with a total increase of 7.0% for the year.
Think of deferring CPP and OAS as longevity protection. You’re locking in an enhanced, inflation-protected benefit that will be paid for life, whether you live to 85 or 105.
Buy an annuity
An annuity is a contract with an insurance company that typically pays a guaranteed income stream for life. You can also purchase a “term-certain” annuity that guarantees an income for a set number of years.
You can purchase an annuity inside your RRSP or RRIF, or in a non-registered (taxable) account.
The income you receive from an annuity largely depends on your age (and life expectancy), and the current interest rate environment. Higher interest rates lead to higher annuity payouts, and vice-versa.
Keep in mind most annuities don’t offer inflation protection, so you’ll receive the same amount each year.
As for the right time to buy an annuity, consider the following comments from Mr. Vettese:
“The ideal time to buy an annuity is at the point that short-term inflation has peaked and starts dropping, but just before interest rates start falling to reflect it.”
Tap into home equity
The equity in your home may represent your largest asset in retirement. While most retirees want to remain in their homes as long as humanly possible, tapping into your home equity in retirement can allow retirees to spend more for longer.
The classic way to access your home equity is to downsize into a smaller home. This makes sense, intuitively, because empty nesters don’t necessarily need to live in the larger family home in which they raised children. Downsizing to a condo or smaller detached home can unlock home equity while maintaining quality of life.
Selling your home and renting is another option, especially in advanced years when seniors may consider moving to a retirement home.
Finally, retirees with a lot of home equity but little in the way of savings may consider a reverse mortgage as a way to increase income without having to sell their homes. A reverse mortgage allows a homeowner to borrow up to 55% of their home equity, either through a lump sum or smaller payments over time.
Consider variable spending
Retirees should be flexible with their annual spending needs to ensure their money lasts a long lifetime.
Consider setting a spending floor that allows you to live a comfortable retirement regardless of market conditions, and a spending ceiling that allows you to safely increase your expenses during years of strong investment returns.
Turn your spending up or down like a dial, based on your portfolio performance and how well the broader economy is holding up.
For example, a retiree who planned on building a garage might have put the project on hold when lumber prices doubled during the pandemic. A similar situation is occurring in the new and used vehicle market — with prices so high, some retirees are waiting to replace their vehicles. Flexible retirees plan for and then adjust the timing of large purchases as needed.
A detailed retirement plan can give you an approximate idea of how much you can safely spend without running out of money by age 95, using conservative investment return assumptions. Barring any market calamities, retirees can then feel confident in spending up to their ceiling during normal to strong market conditions.
Take a “Victory Lap Retirement”
Coined by authors Mike Drak and Jonathan Chevreau, a “Victory Lap Retirement” refers to a period when you transition from full-time work to part-time work (or semi-retirement).
Perhaps you’re not quite ready for a full-stop retirement. Your victory lap may be a transition to working two to three days at the same organization, consulting back to the same organization or industry, working in a completely new field, or starting a business.
The point is that transitioning to retirement can be a challenge for many who felt a strong sense of purpose from their work, or who enjoyed the fulfillment and socialization that comes from working in an organization.
A victory lap can help ease that transition, with the added benefit of boosting your retirement savings.
Give (carefully) with a warm hand
Retirees with more than enough resources to meet their spending needs and last a lifetime may not want to wait until they are 90 or 95 to leave behind a large estate to their children. That makes sense, given that your adult children may already be retired by that point and secure in their finances.
Indeed, it’s why many retirees now consider giving smaller, early inheritance gifts to their adult children at opportune times in their lives. It could be tied to hitting milestones, such as graduation, marriage, a first home purchase or starting a family. Financial aid could include helping children contribute to their tax-free savings account (TFSA) or to the new first home savings account (FHSA), providing a lump sum gift to help top-up a house down payment, or even funding registered education savings plans (RESPs) for the grandkids.
It’s important to give carefully, in the context of your retirement plan (see point #4 about variable spending) and understand where the funds are coming from. You want to ensure any gift you offer doesn’t impact your own retirement plan.
Final thoughts
Canadians are living longer and need to consider the impact of longevity on their finances and retirement plans.
Too many retirees still focus on average life expectancy without acknowledging that 50% of people will live longer than the average. Indeed, we should be planning as if we’ll live to at least 90 or 95 and make financial decisions accordingly.
Shore up your guaranteed income by deferring CPP and OAS to age 70 and buying a life annuity with excess funds in your RRSP, RRIF, or non-registered account.
Consider tapping into your home equity, if needed, to increase your savings and investments.
Find a range between a comfortable spending floor and a safe spending ceiling that allows you to live your best life in retirement without feeling anxious about running out of money.
Take a victory lap retirement as you transition from full-time work to full-time leisure.
Finally, give with a warm hand to your loved ones if you have more than enough resources to support you in retirement.
* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.
The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.
