Friday, June 22, 2012

Five More Retirement Planning Pitfalls!

5:07 PM

Looking to improve our odds

Last time, we looked at five major retirement planning pitfalls and pointed out ways to improve odds of achieving financial security.

We complete our list with five more in this post.

6. Early death of a spouse

There are two cases to plan for: you die first and your spouse dies before you. Thinking that that the typically older male will pass away before a younger female spouse is only one possible scenario.

You have to look at the consequences of the early death for each spouse. How will be each do, considering the many years the survivor may live?

If the surviving spouse's budget reduces substantially,  with the combined assets remaining untouched, then it will have little effect on financial security.

A decrease in income from reduced survivor pensions or lifetime pensions ceasing at death may require a reduction in expenses.

Here are a few ways to protect each other:

  • Estimate what expenses will decrease after death, such as food costs. As a rue of thumb, the surviving spouse may be able to maintain her standard of living on about 80% of what was required when both were alive.
  • Ensure each spouse has the appropriate type and amount of life insurance. You can set up a policy to pay the face amount on either, the first, or the last death.
  • Select a "joint and last survivor" pension option if you have a defined benefit pension plan with your employer.
  • Consider purchasing a joint annuity with a portion of your retirement savings.
  • Determine which income sources will be lost or reduced (such as CPP) when a spouse dies, and how any shortfall can be met going forward if required.

7. Long-term care

This is a topic we don't like to think about.

We tend to think we'll never need long-term care (LTC). Few can afford to self-insure and fewer buy long-term care insurance coverage.

A few things to consider when planning for this possibility:

  • LTC insurance is quickly evolving, so keep abreast of what is available, review coverage and premiums of each carrier.
  • Premiums increase rapidly with age, so consider it as soon as possible while premiums are still affordable.
  • Think of the financial impact for your spouse and for your estate goals if you do require long-term care.
  • Review what your provincial health care covers in these situations, and whether the level and quality of care is sufficient for your needs.

8. Saying no to annuities

We just love receiving a cheque each month for life.

However in practice, few set up their retirement to eliminate the possibility of running out of money.

In essence, we are trying to self-insure against long life and this is very difficult to do.

Having lifetime income that doesn’t depend on the vagaries of the capital markets greatly reduces the chance of having to reduce your standard of living in retirement.

Consider investing part or all of your savings in an annuity. If your sources of lifetime income (Government plus annuity) cover your essential expenses, you've eliminated the financial consequences of living longer than you ever thought.

Remember that as interest rates go up, annuity premiums go down. This is because premiums are determined based on funds earning fixed income rates of return.

Here are a few ideas to deal with the (desirable) prospect of living a long life:

  • Work as long as you can, even on a part-time or contractual basis to reduce the period of time you'll need to rely solely on retirement savings.
  • If you have a defined benefit pension plan, do not take a lump sum option when retiring or leaving your employment; only consider it if you are a long way from retirement.
  • If you have a defined contribution pension plan or group RRSP, consider using these funds to purchase an annuity when you reach your retirement age.
  • Ensure you have enough guaranteed income to meet your budget for essential expenses.
  • Get professional advice to decide how to allocate your assets between portfolio investments and an annuity.
  • If you have a spouse, consider a joint and last survivor annuity, so both of you can benefit from the lifetime income it provides.
  • Consider staggering your annuity purchases over time to take advantage of lower premiums as you become older, and reduced premiums if interest rates rise.
  • Determine the amount and payment terms for you and your spouse for each source of retirement savings. This includes CPP, OAS, a defined benefit pension and annuities.

9. Lack of Investing Knowledge

In the last 20 years, there has been a shift in responsibility from Government and corporations to the individual for covering financial needs for retirement. We need to save over our working career and manage our invested funds.

And this requires that we increase our knowledge in this area in order to earn decent returns and avoid common pitfalls.

Here are ways to address our shortcomings in this area:

  • Get a solid understanding of financial products (stocks, bonds, mutual and segregated funds, etc.)
  • Review your asset allocation and rebalance regularly in order to be in line with your target asset mix.
  • Do not listen to forecasters, prophets of doom or irrational optimists. The future is unknown and will unfold differently than their predictions. If they get it right time, it’s more than likely because of luck.
  • Do not attempt to time the market and don't sell when times get tough. You will be missing out when markets rebound.
  • Consider investing in target date funds, which automatically shift the asset allocation to a more conservative portfolio as you get closer to retirement.
  • Invest tax-effectively: it's the after-tax return that counts. Put fixed income investments in your RRSP and equities in a taxable account.
  • Your target asset allocation should be measured against all your assets: registered and non-registered.
  • Seek professional advice if you can't handle your investments.
  • Invest in accordance to your risk tolerance. Do not take more risk than needed.
  • If you'll have more than enough money, you don't have to take undue risk.

10. Getting Poor Advice

It's okay to discuss with friends, family and co-workers who are not financial professionals, but do take any advice from them with caution.

Consider the following when it comes to receiving advice:

  • Get your information from reliable sources: online and offline.
  • A financial professional can assist you to sort out your retirement planning issues and help you formulate your goals and plan to meet them.
  • Ask financial professionals for their credentials, in particular their retirement planning expertise.
  • Ask how your financial professional is compensated, in particular whether compensation varies based on the product you are investing.

We touched briefly on approaches to deal with some of the most important post-retirement risks: longevity, inflation, untimely death of a spouse and long-term care. We will expand on each of these in future posts.


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