At some point, it will be time for your savings to start helping to fund your retirement—but what’s the best way to make that happen?
By Olev Edur
While much has been written about how to maximize the accumulation of retirement savings, advice on how best to withdraw those savings once you’re retired is harder to find.
How do you organize your savings to provide the steady income you need once you’re no longer getting those weekly or monthly paycheques from work? And what can you do to maximize that income without unnecessary risk?
To a certain extent, the lack of information on “decumulation” (to use the industry term) stems from the fact that people’s retirement plans and financial needs can differ dramatically so there is no one-size-fits-all solution. Nevertheless, there are certain strategies and guidelines that can apply to many situations.
“General rules about retirement income say that it should be 60 or 70 per cent of your expenses while working, but I don’t like applying rules because everyone’s retirement needs are different,” says Aurèle Courcelles, vice-president of tax and estate planning at IG Wealth Management in Winnipeg. “If you’re going to be more active in retirement and do more travelling, for example, then that figure may be closer to 80 or 90 per cent. It’s a very individual thing. You need to look at your retirement plan—what do you want to do?—and then consider what financial resources you have for meeting those goals. You can start by looking at your current expenditures and think about which expenses will continue in retirement and which will stop or be reduced when you’re no longer working.”
Terri Szego, senior investment adviser and portfolio manager at BMO Private Wealth in Toronto, agrees that rules of thumb aren’t very helpful. “We’ve found that the two most sensitive factors [in determining how much money you’ll need in retirement] are the age at which you want to retire and the amount you spend,” she says.
“You need to start by looking at the totals from your credit cards and bank accounts to determine how much you actually spend in a year.”
Courcelles cautions, however, that you can’t just extrapolate from your current expenses to arrive at a retirement budget, even if you account for such things as additional travel or entertainment. “As you look at your retirement goals, there are also some risks that you must take into account,” he says.
For example, Courcelles cites the damage that run- away inflation can do to even the best-laid retirement plans. There are also stock-market risks—equity investments, while they can generally provide a hedge against inflation and better returns over the long term than fixed-income investments such as GICs, can suffer sizable setbacks from time to time. “Then there are health-care risks,” Courcelles adds.
“Have you purchased health-care insurance to cover major illnesses or the possible need for home or institutional care? And there’s longevity risk—the possibility of outliving your expectations. Humans don’t have an expiry date, and statistics show that we’re living longer than ever. Given a couple aged 65 today, it’s very likely that one of them will live past age 90. So you have to take all these risks into account when you’re planning your retirement-income strategies.”
Szego concurs: “Things happen that can affect your retirement plans. They often tend to be health-related, so it’s really important to build some flexibility into your plan.”
The Retirement-Income Pyramid
Once you have a good idea of what your retirement will look like and what safeguards you want to put in place for managing the risks, you can turn to the matter of whether you’ll have enough funds to meet all your retirement needs and how to organize them most effectively. Unlike in the working world, retirement will involve income from numerous different sources, and that income will need to be rendered into a single dollar figure.
“Everyone is used to the idea of a steady paycheque to cover their weekly or monthly costs when they’re working,” Courcelles says. “Even business owners often pay themselves in cash or dividends on a regular basis. What you want to do is develop a single retirement paycheque with your income from all sources.”
In terms of basic organization, most advisers—including Courcelles and Szego—suggest that you picture your retirement income as a pyramid—“a pyramid consisting of three layers,” Courcelles says. “The big base layer would be guaranteed government programs. These programs constitute a basic income that you’re going to receive no matter what, so you never need to worry about doing without the essentials—food, lodgings, medications, and so on. What is the bare minimum that you need to survive? That’s the starting point.”
Guaranteed income sources include the Canada Pension Plan (CPP), Old Age Security (OAS), and, for those with low retirement incomes, the Guaranteed Income Supplement. (GIS is a geared-to-income adjunct of OAS.) “When it comes to these programs, you know how much you’ll get every month,” Courcelles says, but he cautions that OAS is subject to a 15 per cent clawback at income levels above $151,668, or $157,490 for those aged 75-plus (for 2025—these thresholds are adjusted annually). And non-OAS income can result in GIS benefits being reduced (more on that below). “It’s worth bearing in mind that these programs are all indexed to inflation,” Courcelles adds.
“That removes the risk of inflation eroding the value of this income and makes it ideal for covering essentials.”
The next layer of the pyramid may be an employer pension or a pooled RRSP or similar plan. “If you have a defined-benefit plan, the payments are guaranteed and can be considered part of the base layer,” Courcelles says, “while with defined-contribution plans and pooled arrangements, there’s an element of investment risk involved because payments are based on what your savings earn rather than being guaranteed regardless of invest- ment performance.”
The third layer of the pyramid comprises your personal savings: RRSPs and RRIFs, tax-free savings accounts (TFSAs), and non-registered investment accounts.
While the bottom layer, and perhaps part or all of the second layer, is dedicated to ensuring that your essential needs are met at all times, this third layer can be directed to funding discretionary items such as travel, entertainment, club memberships, and hobbies—in general, things that can be reduced or dropped without incurring severe hardship.
However, Courcelles notes, if the guaranteed income from government and private pensions isn’t enough to cover essential expenses, some people will purchase an annuity with some of their registered or non-registered funds to close that gap “if this helps them sleep better at night.”
Reviewing Your Investment Mix
When it comes to investments, you’ll need to determine how much income those various accounts can actually generate. This can be particularly tricky in the case of equities, which can go up and down in value. In the process, you’ll also need to give thought to the composition of your investment portfolio in terms of risk versus reward.
When you’re young, equities make sense because although asset values may bounce around, you have lots of time to allow for the markets to rebound. Once you’re retired, you may no longer have that luxury, and security of income becomes paramount.
“In general, you should get more conservative when you stop work,” Szego says, although she adds that how much of a portfolio consists of equities depends on the person. “It can also depend on the size of your savings.
Someone could have 60, 50, or even 40 per cent of their funds invested in equities in retirement. If, for example, you have a large amount of savings and you’re not a big spender, you can afford a high level of equities,” she says.
“Just make sure you have three to five years’ worth of spending invested in fixed-income assets—that’s the most aggressive position. In 2008, for example, the markets dropped dramatically and took five years to recover.”
“There are people at both ends of the spectrum,” Courcelles says. “Some avoid equities altogether, while others can afford to invest totally in equities. It depends on your tolerance for risk as well as the size of your nest egg. The more money you have, the more risk you can tolerate.”
Taxation and Other Considerations
In the process of reviewing your investment mix, as well as your pyramid structure, you also need to take taxation into account. While interest from fixed-income investments is fully taxed, earnings in the form of dividends and capital gains are taxed at lower rates. Similarly, pension income is fully taxed, as are withdrawals from RRSPs and RRIFs (even if the source of that income was otherwise favourably taxed dividends or capital gains), but TFSA withdrawals, on the other hand, aren’t taxed at all.
Given all these differing tax treatments for investments and for registered and non-registered plans and TFSAs, you need to calculate how to blend and prioritize these diverse sources of income in a tax-efficient way.
“Again, it depends on the individual and the situation,” Courcelles says. “But the key is to draw from your various sources of income in a way that minimizes taxes over the long term, from the start of retirement right until the end. If you pay less tax, you need to earn that much less. Ideally you want to stay in the same tax bracket throughout your retirement.”
Those with low retirement incomes may be eligible for GIS, which is a tax-free benefit. But because it’s geared to income, any earnings from sources other than OAS will reduce GIS at the rate of 50 cents per dollar earned (with a small exception for employment income). In this case, it pays to minimize that other income, perhaps even liquidating a small RRSP to maximize GIS in future years.
Another thing to consider when assembling your retirement paycheque is the ability to start drawing CPP at any time from age 60 to 70; the longer you wait, the higher your benefits will be. The same applies to OAS, although the window of deferral is only between age 65 and 70.
“One of the key variables [in developing a decumulation plan] is when you want to start collecting these benefits,” Courcelles says, noting that those with low incomes may want to retain their TFSAs as long as possible. “If you’re going to be eligible for GIS, then it can make sense to keep your TFSA until the last,” he says, as withdrawals from a TFSA don’t affect GIS benefits.
Szego adds some further considerations when it comes to prioritization: “If, for example, there are years in your retirement before age 72 when your income is low, then it can make sense to start withdrawing from your registered plans earlier in order to make use of that lower tax bracket. If you have a business, then you can use dividends from your corporation for the same purpose.”
Szego also suggests that whether to hold onto your TFSA depends on your situation. “If you need income and if withdrawals from a registered plan would bump you into a higher tax bracket, then you should consider using some of your TFSA funds instead.” But, she adds, “the TFSA makes a good rainy-day fund, and if you live longer than expected, it can make a good fallback resource.”
In addition, there’s the big question of estate planning. “If you want to leave an estate for your loved ones or for charity, that can change the whole picture,” Courcelles says. “What does your ideal estate look like? Some people design their estate first and then back into their retirement spending. Some people create an estate pool, while others buy a life-insurance policy and then spend the rest.”
A Balancing Act
As you can see from the foregoing, structuring your retirement income is akin to a multi-dimensional jigsaw puzzle in which numerous variables must be accommodated while fitting together all those resources in a way that’s efficient in terms of income and taxation and while meeting your particular retirement- and estate-planning needs. “It’s a complicated balancing act,” Courcelles says. “That’s why it’s best to work with an adviser who has the knowledge and tools to be able to look at all your options and choose which ones are best for you, given your needs as well as your risk tolerance and the extent of your wealth.
“Professional advice has always been invaluable,” he concludes. “Now planners have access to, and an understanding of, very powerful software programs that can do incredibly detailed projections and what- if scenarios to determine your best options, regardless of your circumstances.”
