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WINNIPEG (GlobeinvestorGOLD) — The fundamental dilemma in the sixth decade of your life is pacing income with expenses in the years that follow the end — or winding down — of a career. At this stage of life, either at the threshold of retirement or perhaps already into it, investors tend to change pace from asset accumulation to distribution of those assets to themselves or, through gifts and testamentary bequests, to their children or other heirs.
In retirement, investors have to balance income with expenses, even more than in earlier periods, said Warren Baldwin, vice president of financial planning consultants T.E. Financial Ltd. in Toronto. “What many people don’t realize is that the greatest flexibility may be in their lifestyles. A 60-year old should do a budget and be as painfully detailed as possible right down to the cost of magazine subscriptions and toothpaste. Project those expenses to the time that you are retired.”
The saying that time is money is vivid in retirement, Mr. Baldwin explained. “A person may travel more in retirement, but the cost of each trip may go down. After all, business travel tends to be at full fare while leisure travelers can take advantage of travel discounts. Retirement means that pressure not just to earn, but also to spend, relents.”
It is a truism that one must live within expenses, but a retiree can actually adjust income to expenses, Mr. Baldwin said. The baseline for income for most investors will be established pension plans built on RRSPs, company pension plans, the Canada Pension Plan or other government pensions, and Old Age Security.
Federal law sets out basic rules for management of RRSP distributions. By the end of the year in which an investor turns 69, he or she must distribute in one or more lump sums fully taxable as income, buy a life annuity or convert to a Registered Retirement Income Fund.
Is it better to cash in early or to postpone RRIFing an RRSP until as late as possible? Richard Nickerson, a financial planner with Assante Capital Management in Halifax, N.S., said, “I always look for opportunities to withdraw money from the RRSP at a lower bracket than a client may be at in future. For example, when Old Age Security kicks in at age 65, the client may wind up in a higher tax bracket. If there are other pensions, then the problem of minimizing total taxation over time becomes even more complex.”
Within any self-administered pension plan, the investor has a broad choice of assets. The investor may choose to shift assets from growth stocks to such things as income-generating real estate investment trusts or bonds. Growth tends to carry more risk but may provide higher long run returns for an investor in his or her early sixties and perhaps decades of life ahead. What to do?
First, one must avoid undue erosion of investments, said David Christianson, a fee-only financial planner with Wellington West Total Wealth Management Inc. in Winnipeg. “To avoid excess damage to your investments, divide your money into three pots. The first pot is cash and cash equivalents like treasury bills. It is for your estimated expenditures for the next two years. Pot two is income-producing assets used to replenish pot number one. And pot number three contains what is left of your longer-term equity investments. You use pot number three for growth and replacement of capital, including income-generating capital, over time.” This strategy gives the retiree time and flexibility to determine the best times to withdraw money from fluctuating investments.”
What is essential in any retirement cash management plan is risk reduction, Mr. Nickerson said. “An investor who has little money cannot afford to invest in speculative stocks or junk bonds because he cannot afford the loss. And an investor with a great deal of money — more than he will ever need for his customary way of life — simply need not take large risks to maintain his lifestyle.”
“As a person grows older, he or she may leave employment, cutting off one income stream,” Mr. Nickerson said. “That means that the ability to replace investment losses is decreased. You have less money and less time to make back your losses. In today’s low interest rate environment, one has to balance the cost of inflation not being compensated by low interest income investments like GICs and government bonds with the risk of capital losses from riskier investments,” he said.
Take no more risk than you need to get a required return, the planner emphasizes. “Put capital preservation ahead of capital gains,” he added. “Even at today’s low, single digit inflation rates of about 2 per cent per year, what costs $1.00 today will cost $1.50 in twenty years. Longer life expectancy has created the new challenge for those who have retired, for money accumulated in yesterday’s defined contribution pension plans has difficulty generating returns for as long as people now live. Those who have fully indexed pensions are less at risk; those who must generate returns to pace inflation must be financially diligent or assign that task to others who are, the planner said.
Andrew Allentuck writes about investments for The Globe and Mail, and reviews books on finance for globefund.com and globeinvestor.com. He is also the author of several books.