How to transition to retirement

To prepare properly for retirement, you should start getting ready at least five years before the big date. It’s all about envisioning the lifestyle you want while making sure you have enough reliable income to fund it. And the transition doesn’t end when you do retire. You’ll need to keep adjusting your lifestyle and financial plan as you go, especially during the next five or so years. With the quality of your retirement on the line, it pays to plan carefully. Here’s our outline for managing the Big Transition.

In the last few years before you stop working, you need to gradually define your retirement goals, including when it will start and roughly how much it will cost. And you need to ensure you can afford it, perhaps the most daunting question of all. “The biggest issue for my clients is they’re worried they won’t have enough,” says Annie Kvick, a certified financial planner with Money Coaches Canada in North Vancouver.

If your finances are a bit short, the good news is you still have options—provided you deal with the shortfall while you’re still working. “If you’ve got an inkling that you cannot sustain this level of spending, you’ve got to deal with this now,” says Lee Anne Davies, a retirement educator with Agenomics.

You can make adjustments by pulling on three levers: save more, work longer or spend less in retirement. Working longer can improve your finances dramatically because it not only gives you more time to build savings, but also allows you to nudge up the payout rates on government benefits and your withdrawal rates on savings. “How much longer we work is a big determinant,” says Fred Vettese, chief actuary at Morneau Shepell and co-author of The Real Retirement. As an example, a single 65-year-old earning $65,000 a year with a nest egg of $300,000 should be able to increase his or her retirement income by roughly one-third by working just three extra years. (See “Getting Paid to Wait” in the September/October 2014 issue for more.)

If you don’t want to keep your nose to the grindstone full time, contract or part-time work might fill the gap. “Working part-time fits well with what people nearing retirement want to do, since almost nobody wants to keep working the big grind for long hours five days a week,” says Vettese, who is himself working a reduced workweek.

Your other two options—saving more while working or spending less in retirement—are closely related. At this point you only have a few years to save, but that can make a big difference. If you have an average-paying job or better, you’ve paid off your mortgage and other debts, and your kids are self-supporting, you should be able to save at least 20% to 35% of your income. That discipline will also help prepare you for reducing expenses in retirement.

Figuring out how much you’ll need in retirement is often the most difficult question. It’s easy to think we need $1 million in savings and loads of income, but don’t get misled. You can usually live comfortably on a lot less. (See “How much do you really need?) While rules of thumb can help, you should get a handle on how you spend your money now, considering major categories like utilities, clothing, groceries, eating out, entertainment, transportation and travel. Then look at what will change after you retire, dropping work-related costs but adding new expenses, such as travel and recreation. What activities are most important? Identify basic necessities versus the nice-to-haves. Then zero in on the priorities among the nice-to-haves. “It’s not about following a budget,” says Kvick. “It’s making sure we have our priorities straight so we know what we want to do in life, and then coming up with a plan. If you do that, you’ll probably find you don’t need $1 million. You may not even need $500,000.”

Conserve your assets

As you approach your retirement date, you should make sure you have a conservative mix of stocks and bonds or GIC rates. Once you’re retired, most experts say your fixed-income allocation should make up at least 40% of your total portfolio—possibly as much as 60% or 70%—with the rest in stocks. It also helps to pick investments within each category that are relatively resilient in downturns, such as blue-chip stocks and reliable dividend payers. You may want to avoid more volatile investments such as cyclical stocks, commodities and commodity stocks, growth stocks, and high-yield bonds.

You also need to be mindful of the potential risk of rising interest rates and inflation, so don’t go too heavy on vulnerable investments—particularly long-term bonds, real-estate investment trusts (REITs) and utility stocks, which tend to fall in value when interest rates rise.

Your portfolio should generate a reliable cash flow, so you don’t need to sell stocks during market downturns. You should be able to meet much of your income needs through interest and dividends, but that probably won’t be enough. One approach is to ensure your savings account has enough cash to cover one year’s worth of expenses. Then you create a bond or GIC ladder for two to four years (or longer), so you have bonds or GICs maturing in time to meet each year’s cash flow needs. “Ensuring a sustainable income in the first few years of retirement makes for a very comfortable starting point,” says Daryl Diamond, of Diamond Retirement Planning Ltd., author of Your Retirement Income Blueprint.

After retirement, there’s another major investment category to consider alongside stocks and fixed income: annuities. They provide reliable cash for life and are generally well suited to healthy middle-class retirees without employer pensions who are concerned about outliving their money. Annuities complement stocks and bonds and therefore help to diversify your portfolio. They generally provide a higher payout that is assured for life, but you lose access to the capital and nothing is left for your heirs after you die (although there is usually a period during which payouts are guaranteed). Withdrawals from a stock and bond portfolio aren’t 100% guaranteed to last (even when done conservatively), but you can still get at your capital, and if you plan properly and keep your withdrawals to less than 4% of your initial portfolio size each year, chances are there will be a pot of money left for your heirs.

One good strategy is to do both: you can fund your retirement from your own portfolio, but also purchase an annuity to provide cash flow for non-discretionary expenses that aren’t covered by government and employer pensions. That ensures you can at least meet basic needs, even if there is a nasty market crash. Many experts now recommend buying annuities gradually in your early 70s, but it can also make sense to start annuitizing in your mid to late 60s if you want to play it even safer.

Tap government benefits

You also need to figure out when to start your Canada Pension Plan and Old Age Security benefits. You can start CPP between age 60 and 70, and OAS between 65 and 70 (that’s transitioning to age 67 to 72). You get a smaller payout for longer if you start these benefits early, or a larger payout for a shorter period if you defer them. The adjustment factors are designed to provide no major financial advantage or disadvantage if you have average life expectancy. However, personal factors can impact the decision, such as if you have good reason to think you’ll either die young or live to an exceptionally ripe age.

Most Canadians start collecting these benefits immediately after they retire, as soon as they are eligible. In my view, that’s usually a good strategy for most middle-class Canadians without employer pensions. It’s a way to provide the first layer of reliable income in retirement.

It can also be a reasonable strategy if you are wealthy or have a generous employer pension, but in those cases the optimal approach can be complicated by the specific payout pattern of the pension or by complex tax and estate issues. Low-income Canadians, meanwhile, need to consider how their CPP income would affect other government benefits. For example, if you think you will be eligible for the Guaranteed Income Supplement at age 65, choosing an early CPP start date will mean your income will be lower and should increase your GIS benefit entitlement.

Many employer pensions have generous early retirement benefits with a “bridge benefit,” in which case your total monthly payout is actually higher before age 65 than after. The idea of the bridge benefit is to pay early retirees the equivalent of a typical CPP pension prior to age 65 so you’ll get a smooth amount of income before and after you start collecting the government benefit. In that case, if you retire early, you may be generally best off following the assumptions of the pension plan and wait until 65 to start CPP.

Draw down savings

If you have both large RRSPs and large non-registered accounts, you may be in a quandary of where to draw from first. The traditional view of many advisers is to unwind non-registered accounts first, but in my view you’re usually better off with a balanced approach to withdrawals. “The conventional belief does not generally work best in today’s environment,” says Diamond, who has looked at this question in depth.

There’s a trade-off to consider. It’s true that deferring RRSP withdrawals allows you to keep sheltering investment gains until later. However, if you keep doing this, you’re eventually forced to make mandated withdrawals from your untouched RRSPs at much higher levels after you turn 71. The progressive nature of the tax system means that those higher income levels result in much higher taxes and can result in clawbacks of OAS and other seniors’ benefits. In the case of couples, this will often get even worse after the death of one spouse, as the RRSPs are combined for the surviving spouse and the mandated withdrawals become much greater. “If we can smooth out the amount from registered and non-registered accounts, you can avoid income spikes later that cause you to pay taxes at much higher rates,” argues Diamond.

Pull it all together

In the last few years before retirement, you’ll need to figure out the right balance between the size of your savings, how long you work, and how much you can spend in retirement. When you actually do retire, you’ll need to combine cash flow from government pensions, employer pensions, and your own portfolio to provide reliable, steady, tax-efficient income that fully meets your needs. That will help you complete the Big Transition, and smoothly slide into a fulfilling and comfortable retirement.