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When retirement happens: how to withdraw funds wisely

Predicting the course of a retirement can be challenging, but advisors can help clients consider factors like inflation, lifestyle and health-care costs before the big day comes


Date: January 7, 2016

Most people look forward to the day when they can retire, but planning for that day is another matter.

When investors make that transition from working person to retiree, it’s more than simply withdrawing funds from a registered retirement savings plan (RRSP) or tax-free savings account (TFSA) and expecting everything to work out after that.

Investors will want to know how much they need to withdraw, when they should start and what tax rules they need to be aware of depending on what age they start to take out money for retirement.

“The conventional wisdom is that Canadians need to replace about 70 to 80 per cent of their pre-retirement income to enjoy a retirement lifestyle comparable to their working one,” says Paul Fryer, vice-president, individual business management, Sun Life Financial Canada.

“However, a careful analysis suggests that some Canadians can enjoy a successful retirement by replacing as little as 50 per cent of their pre-retirement income.”

People getting ready for retirement should understand that the way they use their money will likely be different than before their last day of work, adds Mr. Fryer.

“Some spending patterns in retirement are unexpected,” he says. “For example, real spending in retirement generally declines as Canadians progress through retirement. This is something that many don’t anticipate while they are still healthy and planning on living an active retirement.”

For many retirees, however, health care costs can increase later in retirement, especially if they require long-term care. “Canadians need to work with an advisor to complete a retirement budget to help develop a realistic spending plan that’s specific to them,” says Mr. Fryer.

Budgeting for retirement requires a lot of thought. In 2002, then-U.S. Federal Reserve Chair Alan Greenspan told a summit meeting on retirement, “One of the most complex economic calculations that most workers will ever undertake is, without doubt, deciding how much to save for retirement.”

His advice was to start planning long before retirement. “At every stage of life, individuals ought to make judgments about their likely earnings before retirement and their desired lifestyle in retirement.”

Mr. Greenspan counselled that people (and their advisors) should consider prospective rates of return, life expectancy, and the possible accumulation of a nest egg for children. “The difficulty that individuals face in making these projections and choices is compounded by the need to forecast personal and economic events many years into the future.”

Mr. Fryer agrees that predicting the course of someone’s retirement can be challenging. He notes that there are additional factors to consider, such as inflation, which can erode purchasing power over time.

“The latest data has inflation at 2.2 per cent (in the second quarter of 2015). But inflation has been much higher in living memory; the rate was 12.5 per cent in 1981.” Health care costs tend to rise more quickly than general inflation and retirees tend to be particularly vulnerable to this cost, he adds.

To determine how much to withdraw in retirement, clients may ask advisors about a retirement withdrawal plan known as the 4 per cent rule, says Mr. Fryer. The rule comes from an article published in 1994 by (now retired) U.S. investment manager William F. Bengen, who devised it as a method of prudently withdrawing funds based on historical data.

“The 4 per cent rule states that you begin to withdraw $40 for every $1,000 in your portfolio at the start of retirement and increase the withdrawal amount by the rate of inflation,” says Mr. Fryer.

“So if inflation is 2 per cent, you would withdraw $40.80 in the second year.”

People should keep in mind that this rule becomes more complicated when you add registered money, notes Mr. Fryer. Canadians must convert their RRSPs into registered retirement income funds (RRIFs) no later than the year they turn 71.

“Once your RRSP is converted to a RRIF, the RRIF minimum withdrawal schedule will apply and may require greater withdrawals than 4 per cent,” he says.

Not all experts agree that the 4 per cent rule is wise in an era of low inflation and low interest rates. A recent U.S. study by the consulting firm PricewaterhouseCoopers (PwC) noted how spending patterns change during retirement and questioned whether a constant, inflation-adjusted withdrawal rate made sense.

The basic premise is still valid though, says Mr. Fryer. “The sequencing of returns can materially affect a retirement portfolio’s performance. An advisor can help clients design a retirement income withdrawal strategy to meet their basic, health-care and lifestyle needs and protect against risks such as sequence of return and inflation.”

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