What’s involved with a Retirement Plan?

admin — Thu, 07 Apr 2011 15:42:46 +0000

Now that January has arrived, many Canadians are meeting with their advisors to make RRSP contributions. The problem is that many investors have not determined what their retirement income needs are, and therefore do not know what their saving requirements are. A rising trend is for Canadians to work well into retirement, either for personal fulfillment or for economic reasons. Regardless of what your goals are, a retirement plan will provide a framework to guide you.

To begin, one needs to determine the amount of income required during retirement. The accepted industry practice is to assume 60-80% of pre-retirement income. A simple way to estimate what your requirements will be, at a minimum is to track your current expenses. Look at what your essential expenses are. Remember, certain expenses will be eliminated: your mortgage will be paid off, one car is usually enough to get by on, you’re done saving for retirement and, hopefully the kids are out of the house. Once you have determined what your base living expenses are, now look at your variable expenses, the wants and dreams. Are you planning on travelling the world, working on your bucket list or spending winters in Arizona golfing? Initially your expenses will be higher during active retirement, but as time progresses these expenses will decrease. Consider that there will be some expenses that increase over time such as drug and medical expenses.

Now that you have determined your income requirements, factor in government pensions, work pension and RRSP savings. If you have a defined benefit plan at work, retirement planning will be less stressful as there is a guaranteed income for life once the employee retires. Prudent planning is required for all of us, specifically those of us without a Defined Benefit plan. Retirement income will come from a number of different sources like, Old Age Security (OAS), Canada Pension Plan (CPP), savings in RRSPs, Tax-Free Savings Accounts (TFSA) and non-registered accounts. Each source will likely not support retirement on its own, but aggregating the sources will.

Before calculating what your final nest egg should be upon retirement, we need to factor in taxation. Taxes make up the largest expense in life; so proper tax planning is essential. When calculating income we should look at after tax income. In this way we can determine what is left over, after taxes, to pay for all those wonderful things you want to do during retirement. One of the benefits of reaching your golden years is that at age 65 you are able to split your RRIF income with your spouse. A way of splitting RRIF income prior to 65 is by utilizing a Spousal RRSP, which in effect achieves the same result, but without the age 65 requirement. Up to 50% of your CPP can be split with your Spouse, assuming both have attained the age of 60. Defined Benefit Pension plan income can be split with your spouse as well. Don’t forget to look at utilizing income which is not taxed as regular income such as non-registered savings and TFSA money. The goal of all this is to reduce the income of the higher income earning spouse by transferring income to the lower income spouse. By doing so effectively, we can reduce the total taxation a couple pays to the tax man. Another benefit for high income retirees is that income splitting can reduce the OAS claw back. The claw back is a 15% tax on income in excess of $67,668 for 2011, to the maximum of OAS received. Effective tax planning can save thousands during retirement.

Inflation is another variable to consider in the plan. The definition of inflation is a general increase in prices of goods and services over a period of time. What you should be concerned with is maintaining your purchasing power. Each year your income should increase with inflation so you can continue to enjoy the same level of real income. Many Defined Benefit plans are inflation protected or indexed so you’re sheltered. OAS and CPP are both indexed as well. Non-registered accounts, and RRIFs are not specifically indexed, but can be protected by properly balancing equity and fixed income weightings in your investment portfolio to achieve this result.

The final consideration is the rate of return or growth of your investments to include in your calculations. During retirement, a higher return will allow for your money to last longer, but will come with higher volatility. Proper diversification and asset allocation between stocks and bonds is required. A safe number to use is a 5% rate of return. This is an easy to understand calculation, but a more in-depth assessment is needed to provide a statistical probability of your investments lasting based on withdrawal rates, inflation, age/longevity, rate of return and portfolio volatility. Professional assistance is always beneficial.

Having gone through the above process now we can calculate how much money is necessary at retirement to provide your desired income, net of taxes and adjusted for inflation for life. This final amount is what we have to work towards or specifically, save towards. A financial plan will set what your goals and dreams are while providing a process of how to achieve the desired results. With a plan in place, people feel more in control and hopefully, feel less trepidation about retirement. Consult a qualified professional financial planner for advice – that’s what we’re here for.

By Line:

Peter Marchl is a Certified Financial Planner and Partner with NorMaxx Financial Group

Normaxx Financial Group Ltd.

What’s involved with a Retirement Plan?