Pitfalls of Retirement Planning

Retirement is something that many Canadians look forward to throughout their working lives. It can be amongst the most enjoyable periods of one's life. However, failing to plan properly can create a number of potential pitfalls. Take a look at the list below to see some of the common mistakes that people make in planning their retirement.

1. Failure to Plan: Picking an Age Is Not a Plan

In 2015, one in five Canadians aged 65 and older, or nearly 1.1 million seniors, reported working during the year. Seniors with a bachelor’s degree or higher and those without private retirement income were more likely to work than other seniors.

In 2014, 10% of seniors (ages 65 and older) declared bankruptcy.

Retirees go back to work for two main reasons. They either need additional cash flow or they enjoy working (that is, the structure, sense of community, and so on). To avoid the pit, you can do the following:

  • Be prepared for your retirement cash flow needs. Calculate your financial numbers or hire someone to do it for you.
  • Find something to do that replaces work.

2. Believing You Can or Will Cut Back on Expenses

Do you believe your expenses will drop once you stop paying off debt and children’s expenses? Try living off your projected retirement income for six months before retirement.

  • Debt and kids may be gone but other expenses replace them such as travel, home renovations or the lumpies (such as a car purchase).
  • Do the renovations and new car purchase before you retire (or have the money set aside for them).

3. Not Recognizing Investment Risks

We all need income to cover expenses. If every retiree had a fully indexed defined benefit pension that met his/her income needs, planning would be easy. Instead, the majority of us have Canada Pension Plan/Quebec Pension Plan (CPP/QPP) benefits coupled with investment-generated income. We may continue to work and receive salary and/or some of us will have defined benefit pension payments.

The more a retiree depends on assets for income generation, the more work is required to sustain and protect the portfolio for the long term. Plan ahead. You have multiple risks to manage. They are as follows:

  1. Inflation: a retiree’s worst enemy. What costs a dollar now could cost $1.20 in a few years. On a fixed income, you may still be getting a dollar worth of income, which is not enough to cover $1.20 worth of expenses.

Be aware and plan accordingly if your only income is from “non-indexed” pensions or annuity payments or the return on your investments is less than the rate of inflation. Identify whether you will have any built-in inflation protection beyond what CPP/QPP and OAS offer. To manage this risk, consider the following:

  • Do you own a defined benefit pension or an annuity with full or partial index or a cost-of-living adjustment?
  • Create your own inflation protection by ensuring your portfolio asset mix holds enough equities to generate investment returns that beat inflation over time. Adjust your equity holdings to reflect the level of inflation protection required.
  1. Sudden equity market downturn. A sudden equity market downturn can rapidly deplete the value of your portfolio if it holds too many equities. To manage this risk:
  • Hold some cash in cash-equivalent investments and short-term bonds or high dividend-paying equities for immediate and ongoing cash needs.
  • Periodically re-balance as funds are withdrawn, which diminishes the need for ill-timed cash-outs of investments that fluctuate in value.
  1. Outliving your money: experts are increasingly recommending a portfolio of 50% in equities is needed to balance income and growth.
  • Retirees who have less risk tolerance or higher income needs and healthy older retirees looking for income guarantees may want to consider selling some assets to buy an annuity payment for life.
  • Age, interest rates and cost of living protection affect annuity payments.

4. Expecting the Government to Support You

Benefits paid annually to eligible seniors are subject to an OAS benefit repayment of 15% on all retirement income exceeding the minimum threshold (approximately $75,000). This gradual repayment “claws back” OAS until it is entirely eliminated (once annual income exceeds approximately $125,000). Avoid this pitfall:

  • If you expect to have a retirement income of $75,000 or more in retirement, you may not want to factor in OAS when doing your planning. As increasing numbers of baby boomers turn age 65, there is a risk the clawback threshold may be lowered.
  • If you eventually receive OAS, consider it a bonus—you’ll likely find a way to spend the money!

Did You Know?

The OAS clawback is applied against each person’s income, not the family’s income. That means that each spouse/partner has a personal threshold. Pay attention to tax planning and focus on income splitting. A couple with their income evenly split 50/50, rather than all with one partner, will be in a better position to avoid having the clawback applied.

Conclusion

Beating the pitfalls in retirement may be outside our control but anticipating them and doing some planning is a sound first step.