Reaping What You Sow - Decumulation
Decumulation — the newest buzzword for seniors and pension people!
A simple definition is “figuring out how to best use whatever assets we have set aside for retirement.” The tricky part? Figuring it out. Use this article as a starting point, then consult with a financial professional to develop a financial plan designed with your personal situation and goals in mind.
Gardeners plant seeds and flowers that spring up months later for our enjoyment. Many of us spend between twenty-five and thirty-five years saving up for retirement (planting the seeds) with pension plans and Registered Retirement Savings Plans (RRSPs). Teachers have a defined benefit pension plan where the pension provider (ATRF) calculates our pension. Others have a defined contribution (DC) pension where employers match employee contributions (to a predetermined amount) in a registered plan, often a group or individual RRSP.
The decumulation comes when you are ready to retire — it’s flower picking time! What dreams do you want to pursue, and how much will they cost? Teachers have their pension, Old Age Security (OAS), and Canadian Pension Plan (CPP), plus whatever we have managed to sock away in an RRSP. Those in a DC plan typically have a much larger RRSP, in addition to OAS and CPP.
Decumulation comes with many questions. Should you delay OAS and/or CPP until age 70? How much can you withdraw from the RRSP? Where should you invest your RRSP? When do you switch the RRSP into a Registered Retirement Income Fund (RRIF)? Remember, RRSPs must be converted into a RRIF by December 31 of the year you turn 71 at the latest. Should you purchase an annuity with RRSP funds? How can you make your money last as long as you do? What are the tax implications of these choices? This is where consulting a reputable financial advisor comes in handy.
Your conversation with an advisor should provide you with several solid options, but the final choices are yours. If you choose to invest your RRSPs and RRIFs in the stock market, professionals suggest using a combination of two or three Exchange Traded Funds (ETFs). This will provide a well-diversified portfolio of stocks that require little effort on your part, at a fraction of the cost of a typical mutual fund — also known as the couch-potato investment strategy. No need to worry about market ups and downs!
Annuities are offered by many banks and insurance companies and are gaining in popularity due to the recent rise in interest rates. The higher interest rates rise, the better the annuity payment. In annuity arrangements, you convert all, or a portion, of your RRSP to an annuity. A 70-year-old male making a lump sum payment of $50,000 at 4% for a fixed annuity would provide about $3,800 annually for the rest of his life (about $3,500 annually for a female). The payments are guaranteed for life, locked in once you buy the annuity, and require no extra work. One big potential drawback: the funds are no longer available should you need a large lump sum for emergency purposes like a major home repair or sudden medical need. There are several types of annuities, fixed (as described above) as well as indexed, variable, and deferred. Professional financial advisor, anyone?
Some “new kids on the block” include variable pool annuities. An insurance company will create age groupings, pooling all the funds of similar-aged members together. The funds are invested with a conservative, long-term focus. Actuaries can’t tell who will pass away early or when, but they can predict how many in each category. The pooling of funds spreads the risk over the entire group. If a member passes before they have received the value of their contribution, those funds are returned to the estate. However, any income generated from those funds stays in the pool. Those returns are used to provide income for those who live longer.
Keep in mind that there are income tax implications to every choice. Pension payments, CPP, and OAS are considered income and are therefore taxable. Any funds taken from your RRSP are taxable. Funds transferred from your RRSP into a RRIF or used to purchase an annuity are not taxed, but payments from the RRIF or annuity are taxable income.
How will you harvest your flower garden?
Ray Hoger
Chair, Pension & Financial Wellness Committee
Ray reminds readers: he’s just a simple, garden-variety retired teacher with an interest in financial matters. Always speak to an advisor before making significant financial decisions.