Improving our odds
Financial services companies and Government alike have made major efforts in recent years to educate the public about the need to prepare financially for retirement and motivate them to save.
Nevertheless, despite these major efforts, surveys routinely confirm that a large segment of the population lack retirement planning and investing knowledge.
The baby boomers are the largest generation in history of the western world, and they will be retiring over the next twenty years. They have high life expectancy and high lifestyle expectations, and will face increased health care costs in the midst of disappearing defined benefit pensions and uncertain public pension schemes.
How can we improve our odds of achieving financial security? By avoiding these five common retirement planning pitfalls. In our next post, we'll also explore another set of five pitfalls.
1. Insufficient savings
Most people have no idea how much they'll need for retirement in order to maintain their standard of living.
Here are a few ideas on how to ensure you'll have enough money:
- If you have a company pension or savings plan, contribute as much as possible to get matching employer contributions.
- If your employer does not have a retirement plans, maximize your contributions to a registered retirement savings plan and tax-free savings account.
- Calculate how much you will need using retirement planning software (including ours!)
- If you cannot achieve this target, look at alternatives, such as working longer or adjusting your retirement lifestyle.
- Within ten years of retirement, start thinking in precise terms how much you'll need each year by completing a post-retirement budget.
- Develop a plan to pay off all debt, including your mortgage before you reach your retirement date.
- Plan your sources of income, such as the Canada (or Québec) Pension Plan, Old Age Security and defined benefit pensions.
- Monitor your retirement savings to see if you are on track to meet your goal.
2. Unplanned retirement
More often than not, we don't choose our retirement date, it chooses us when we least expect it and are not ready.
This is retirement by default: loss of employment, health issues, disability. The older you work, the more common illness or disability will strike.
You can guard against an unplanned retirement by saving as much as possible from an early age.
To bridge the gap in these early years, get disability insurance with your employer. If not available, get personal disability insurance.
If you are forced to retire early due a job loss, consider part-time or seasonal work to supplement your retirement income until Government benefits become payable in full.
In a more general way, learn about the risks you will face at retirement and the various strategies you can use to protect yourself.
3. Unknown longevity
I hope you live a long life. And more than likely you will. In fact, if you have a spouse, odds are one of you will live 30 years or more after retirement.
This is a very long time to live off your savings, and there is a significant risk you or your spouse will outlive your savings.
You can use a life expectancy calculator to estimate your life expectancy. Some calculators take into account health characteristics to get a more precise number.
Look at the odds of living longer than average and ensure you have the financial resources to meet your expenses for this entire period.
If your resources are insufficient, scale back your retirement lifestyle in the early years.
4. Where is the money?
You must know what your sources of lifetime income are and where the money will come from to fill any gap relative to your budget. And you must be careful not to overestimate and be realistic -- especially when it comes to rates of returns you hope to earn in the future.
Make a list of retirement income sources. The most common retirement income sources include:
- Canada Pension Plan (CPP),
- Québec Pension Plan (QPP),
- Old Age Security (OAS),
- Supplements for low income seniors: Guaranteed Income Supplement (GIS) and provincial programs,
- Company pensions
- Savings plans,
- Annuities,
- RRSPs and Registered retirement income funds,
- Locked-in Retirement Accounts (LIRAs) and Life income funds,
- Tax-free savings account (TFSA),
- Taxable investment accounts, and
- Real estate (a home, cottage or investment property).
If you continue working on a part-time or contractual basis. include the income for the time you expect to continue work.
Keep your records handy and update them regularly. Track your account balances and estimate your investment return.
Estimate how much income each investment account you intend to withdraw from will provide.
Think about what you plan to do with your home equity and learn how home equity can be used as a source of retirement income: downsizing, selling, line of credit or reverse mortgage.
5. Erosion of income by inflation
Inflation has been modest in the last 20 years. But even at 2%, it chips away at your purchasing power over time.
You must plan not for a fixed lifetime income, but one that increases each year by the rate of inflation.
If you plan for an annual "pay" increase of , say, 2.5%, you likely won't suffer a reduction in your standard of living down the road.
Remember that your retirement budget will evolve over time: initially you will experience higher living expenses while most active, followed by a period of more sedentary lifestyle, then possibly increasing again late in life as long-term care becomes a necessity.
Determine whether income is inflation-indexed for each source of lifetime income. All Government sources are fully indexed to inflation: CPP, OAS, GIS and provincial supplements for low income seniors. Company defined benefit pensions are usually not indexed, unless you are in public service.
Since you must plan for an increasing stream of income over time, you should start with a lower initial amount that will increase each year.
Understand the impact of inflation over a long period: even at a modest 2.5% annual rate of inflation, your goods and services will be over 60% more expensive after 20 years. Retirees may experience higher inflation than the general population because health care costs have been increasing at a much faster pace than other goods, and this trend is expected to continue indefinitely.
Ensure your investments are ones that keep up with inflation, such as real return bond funds or real return exchange-traded funds, and keeping an exposure to equities, which in theory are a hedge against inflation.
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