Financial planning is mostly an exercise in setting and achieving goals. For many working people, the main goal is to be able to retire. Financial planning consists of deciding how much to spend, how quickly to pay off debt, how much to save, how to invest the savings and monitoring progress toward the goal. But for retirees, that major goal has already been achieved.
A retiree’s situation is quite different. There are two main goals that now come to the forefront: producing enough income and making it last to the end of their life. Let’s look at a couple possible scenarios to see what type of planning is required. We’ll assume that debt is paid off before retirement, which is recommended.
Almost all retirees in Canada qualify for two government pensions: CPP and OAS. OAS is paid to anyone who has lived in Canada for 40 years or more (and may be pro-rated for those with fewer years of residency). This benefit pays up to $545 per month, although the amount is reduced for those earning over $70,000 from other sources. CPP benefits depend on the number of years worked and the proportion of the maximum pensionable income earned in each year. The maximum benefit is almost $990 per month, while the average is $530. A person who worked a decent job, earning $45,000 or more from age 20 to age 65 in Canada is likely to receive ($530 + $990) $1520 per month. Two spouses, only one of whom worked, could receive $2050 and two spouses who both worked could receive $3040 per month. For a working couple who doesn’t spend extravagantly and who both worked and who doesn’t want to retire before age 65, this might be adequate retirement income. It is guaranteed and indexed, so no retirement planning other than controlling spending would be required.
Those with a company pension would have another source of guaranteed income. It is important to understand whether or not the amount is indexed, meaning increasing each year with the cost of goods. Some generous pensions are indexed only to 60% of inflation, meaning that if the cost of goods rises by 3%, the pension will pay 1.8% more than the prior year. Whether this is adequate or problematic depends on a person’s lifestyle. Some pensions are not indexed at all. If inflation rises at 2.4% per year, prices will double roughly every 30 years. A 60 year old who retires with a guaranteed pension of $2000 per month in 1980 would find that in 2010 (at age 90) it only buys half as much as it used to. (The average inflation over that period was 3.4%.) Controlling spending might become even more important in this scenario.
Those with no company pension, especially those who don’t want to rely on the government pension, will be based on their own savings and investments. The first question is: what withdrawal rate is acceptable? For those invested in stocks, there is no rate that guarantees never running out of money. But for those invested in bonds, interest rates (currently less than 2%) may be too low to provide adequate income and keep up with inflation (currently around 2%). For people in this situation, a large part of financial planning is actually investment management, ensuring that the investments are producing adequate return and adjusting income accordingly. My preferred way to produce income in retirement is from dividends. A focus on dividend-paying stocks produces income that has been slightly higher than bonds (over the past few decades, but not before the 1950s), tends to increase with inflation (and corporate profitability) and has the potential for capital gains. This would imply a withdrawal rate of about 3.5% to 4.5%. As an example, a person with $1520 per month CPP + OAS who wants to spend $3000 per month will need another $1500 per month. Multiplied by 12, that’s $18,000 per year target income. Divided by 4% withdrawal rate, that requires $450,000 of invested capital.
The biggest challenge in financial planning for retirees is the unknown. How long will a person live? Will he have good health, or need medical care? Will she be able to care for herself, or will she need assistance? Care homes and nursing visits can be very expensive, and I am unfamiliar with the range of costs and social programs for those who need care but are unable to cover the costs. However, I have felt that owning a home that is debt-free should provide enough capital to cover the possibility of requiring extended care. Should there be additional cost, personal investments would need to be sold to cover that cost, until a financial need can be proven to qualify for assistance.
In my opinion, financial planning for retirees is a simplified case. Debt payment and saving should both be complete by this stage, so only the sources of income and the level of spending need to be managed. Life is full of surprises, but having capital in a home and in investment accounts, along with access to social programs, should allow most retirees access to the care they need.