We spend our working lives saving up for retirement; unfortunately, one expert says, we’re not very good at using those savings optimally
By Olev Edur
What with all the growth in financial and investment services over the past several decades and the ubiquity of the Internet, there’s no shortage of helpful information out there on how people can best invest their savings for a comfortable retirement. But in his book Retirement Income for Life: Getting More Without Saving More (Milner & Associates Inc., 2018), Frederick Vettese suggests that many if not most retirees are misguided when it comes to planning what to do with that nest egg.
“Drawing down one’s savings in retirement is something very few retirees do well, even with the help of professional advisors,” Vettese, who has been the chief actuary at Morneau Shepell for 26 years, writes in the book’s preface. “Some retirees outlive their money. An even greater number deliberately underspend for fear of outliving their money. And many retirees from both camps simply waste a substantial part of their wealth without knowing it.”
Vettese cites a number of reasons for “this sorry state of affairs.” In addition to the predictable industry focus on (commission-and fee-generating) asset accumulation, there may be family pressure related to concerns about a dependent parent or an inheritance being lost. Then there’s personal reluctance to part with one’s security blanket—a fear of the unknown. “A declining account balance makes one feel vulnerable and this becomes an ongoing source of existential angst,” he writes. “Drawing down personal assets in retirement is hard to do because it is a grim reminder of our own mortality.”
The author acknowledges upfront that his book is addressing readers other than those in the bottom 30 per cent of the income scale: “This is not because their needs are less important, but because they have much less need of a decumulation strategy than their higher-income counterparts,” he writes. “Most, if not all, of their income comes from defined-benefit sources like OAS, CPP, and other government programs.”
The first part of the book is devoted to setting the stage for what will be a detailed step-by-step guide to structuring your retirement income in a logical and efficient manner.
“Decumulation is not as straightforward as you might think,” Vettese cautions. He acknowledges that disaster can strike even if you do everything right but adds: “The good news is that a bad outcome can be averted with a better decumulation strategy.”
Your Retirement Type
The second chapter is about defining yourself in terms of your financial needs. Vettese first categorizes all spending as either regular, rainy day, or bequests, and then outlines four broad types of retiree based on their spending priorities for each income category:
Mainstream: Typical retirees.
Cleavers: Retirees coping with dependent adult children. “Anecdotal evidence suggests that the Cleavers are surprisingly common,” he notes.
Super-savers: “They are almost certain to end up with a significant amount of unspent capital when they die.”
YOLOs (as in “You only live once”): This group spends more in early retirement even at the risk of long-term prospects, and for them, ending up with unspent cash would be a sin. “YOLOs in Canada are rare,” Vettese notes, adding: “This is strange, as their philosophy seems perfectly rational, provided they exercise at least a modicum of spending restraint.”
Vettese then explains how each group approaches those three spending categories differently and how this can affect overall planning strategies, concluding: “It is wise to know your retirement type before you formulate a decumulation strategy.”
Retirement Income Targets
Having addressed the need for a personalized approach based on the type of retiree you are and where your spending priorities lie, the book moves on to the key question in the planning calculus: how much retirement income do you need?
In setting an initial income target, Vettese suggests for starters that the oft-cited 60 or 70 per cent of pre-retirement income may be much too high for those who simply want to maintain their preretirement standard of living. He refers to a Canadian study that found that “the vast majority of those from middle-income households who retired with enough income to replace 65 to 75 per cent of their final average earnings end up with a much higher standard of living in retirement. An astounding four households out of five in this category improved their living standard by 20 per cent or more. In some cases, the amount they had available to spend doubled!”
Such overestimation of needs stems not only from the factors cited above—an industry focus on profits and fear of the unknown—but also from the fact that people tend to underestimate the spending reductions that can occur in retirement: no more commuting, work clothes, payroll deductions, further savings requirements, and, for some, mortgage payments. Even income taxes go down.
“The real target for most people is lower than 70 per cent (in some cases, a lot lower),” Vettese concludes.
“The amount of retirement income you need tends to rise more slowly than inflation, especially between ages 70 and 90,” Vettese writes.
In support of this conclusion, Vettese cites several studies on retiree spending and quotes from a 1977 book on the state of retirement in Canada by Geoffrey Calvert, who observed that: “…as age advances, clothing and footwear expenditures fall steadily to less than one-half…furniture costs fall to one-third…automobile-related costs to one-sixth, while travel costs as a whole drop to one-quarter.”
Vettese also cites a 2001 study by noted actuary Malcolm Hamilton showing that retirees were saving or giving away enormous amounts of money: “Senior couples aged 75 and over either saved or gave away as gifts an average of 16.1 per cent of their income. Couples 85 and older saved or gave away even more. Hamilton’s finding is especially compelling given that the study encompassed seniors at all income levels, not just the wealthy.”
Finally, in developing realistic initial and ongoing income targets, Vettese advocates a range rather than a fixed number. The bottom of the range would be the absolute minimum on which you could get by, while the upper limit would allow for things you can forgo but would like to have.
“You want to determine your ideal retirement income target, as well as the lowest level of income that you would be prepared to accept,” he writes.
Vettese devotes a chapter to rainy-day spending: money for covering the unexpected and sometimes calamitous life events that can potentially throw all one’s financial plans into disarray. Given that they are unpredictable, he poses the question: “How do you prepare for that ‘rainy day’ in a way that makes sense?”
Vettese cites a 2015 study by the US-based Society of Actuaries (SOA), which investigated the rainy-day situations that retired Americans actually encountered—both “supply shocks,” when money vanished because of, say, investment losses or a drop in home value, and “demand shocks,” when home repairs or medical expenses required sudden outlays.
On the supply side, Vettese found that all the shocks were related in some way to investment risk, while on the demand side, by far the most prevalent shocks were major home repairs/upgrades (cited by 35 per cent of survey respondents) and major dental expenses (26 per cent); all other events were reported as single-digit percentages, including medical expenses (eight per cent), family emergencies (six per cent), and fraud (four per cent).
“As for medical situations, the chances that the cost will be catastrophic are exceedingly slim [in Canada] because our universal health care system covers most of the big-ticket items,” Vettese adds. “About the only really expensive health care expenditures that might not be covered are certain new drugs that can cost $1,000 a month or more. There is some real exposure here, though fortunately the need does not arise that often.”
Vettese also suggests that costly spending shocks are often family-related: divorce in retirement can halve your savings; unsuccessful children can become a financial drain; the costs of a serious illness may go well beyond those big-ticket medical items. But, it would seem, even such major demand shocks usually have limited impact on retirees’ long-term finances.
“You might be thinking that I am being a little casual in the way I’m brushing off the impact of the various demand shocks, so I will let the retirees speak for themselves,” he says, noting that 93 per cent of SOA survey respondents in the top third of the income scale, and 85 per cent in the middle third of income, said they managed “very” or “somewhat” well despite such shocks.
The author also acknowledges the spectre of needing long-term care. Describing it as “a complicated issue,” he writes, “Let me say, though, that it tends to be a real financial problem for only a small fraction of the population. The majority of people will never need long-term care, and many of those who do will need it for only a relatively short period of time, like one or two years.
“The financial shocks you are most likely to encounter in retirement tend to be small enough to be manageable,” Vettese concludes. As a reserve, he suggests that you could “hold back about three to five per cent of your retirement income each year and keep it in a separate account to be used exclusively for rainy day spending.”
A Step-by-Step Guide
After equally frank discussions of inheritances (how much, if anything, is enough, and what effect will that have on your retirement income?) and investment risks (how to assess and minimize them), and a chapter on “What not to do,” the second part of the book deals with the task at hand: a step-by-step strategy for optimally structuring your retirement finances based on investment type, resources, and priorities regarding regular, rainy day, and bequest spending.
The first chapter in this part of the book presents an overview of Vettese’s strategy, along with a checklist of steps that should be taken before all else, such as paying off the mortgage and all credit-card debt. The following chapters focus on a variety of “enhancements” you can use to maximize your income and adapt it to your needs throughout retirement, while minimizing fees, taxes, and other unnecessary costs.
The book’s third part, “Making it happen,” summarizes the foregoing information, focusing on certain key points, then looks at your options for putting the plan’s parts into motion in a final chapter entitled “Where do you go from here?” Both the second and third parts contain a wealth of potentially useful information on decumulation.
Retirement Income for Life is an original and thought-provoking guide to a financial process that often gets little scrutiny. Even if you quibble with some of the author’s conclusions, you’re forced to confront the issues that can arise in structuring your retirement finances. For that reason alone, this book is highly recommended.