What are the major risks when planning your retirement?

To design an effective retirement planning strategy, you need to understand some of the variables involved: 1) life expectancy, 2) inflation, 3) how much income is needed 4) stock market risk and 5) health care costs.

Life expectancy is one of the most misunderstood aspects of retirement income planning yet it is one of the most important factors.  Most people assume that life expectancy is the same as lifespan. This is not correct. Instead, life expectancy is a median number of years - such that 50 percent of a particular age-group will die before this number of years, and the other 50 per cent will die after this period.

For example, a male who is 65 years of age today has a life expectancy of 21 years; this means that he is expected to live until age 86. There is, however, a 50 percent chance that he will live longer than 21 years.  A female who is 65 years of age today is expected to live for another 24 years (age 89). But she has a 50 percent chance of living longer than 24 years. Even more interesting is the result for a couple, both aged 65 – the life expectancy of one of couple being alive is 27 years.

Thus, when planning for retirement, it is important to look beyond your life expectancy - because there is a 50 percent chance you will exceed it.

The inflation rate is usually measured by the year-over-year change in the Consumer Price Index (CPI). It measures how much a "basket of commonly purchased goods and services" increases in price over time.  For example, if the inflation rate were four percent (the historical long-term average), you would need an income of $109,556 in 20 years’ time to buy the same basket of goods that you could buy today for $50,000.

There is a general principle that states you will need 60 to 70 percent of your income immediately preceding retirement in order to maintain your standard of living during retirement. The rationale behind this "rule of thumb" is that in retirement, you are no longer saving, nor do you have employment-related expenses.

It goes without saying that this number will be different for everyone. What you intend to do with your life in retirement will drive your personal income requirements.

In retirement, you should be prepared for a stock market correction every single day.  When you are working and accumulating retirement savings over a long period, stock market volatility is not a concern as long as your portfolio is properly diversified. One of the greatest risks in retirement planning, however, is having the stock market drop substantially just before or just after you retire. Proper diversification techniques alone will not offset this problem.

If you are unlucky enough to retire when the stock market is performing poorly (and you need to generate income from your portfolio), then you could deplete your capital at an alarming rate. Ultimately, this will reduce the chances of your portfolio being able to generate your required net spendable income throughout your remaining retirement years.

When you are working, you typically have only one source of income (your job). In retirement, you will have a mixture of different income sources that need to be integrated. You will probably be entitled to some type of government benefit (e.g. OAS and CPP), and you might have a company pension plan and you may have your own investment assets (e.g. RRSPs).  It is important to use these income sources in the most effective manner to generate the highest possible spendable (after-tax, after-inflation) income in your retirement years.

Finally, as the baby boomer generation retires, our health care system will continue to be under increasing strain. It is very possible that you may have to spend a substantial portion of your retirement income on health care costs.  It is very difficult to predict how much of your additional savings you should allocate to health care, but it would be imprudent to ignore this potential problem.

The earlier you start planning for retirement, the more time you will have to monitor and change the results should they prove to be unsatisfactory.

Clay Gillespie is a Financial Advisor with RGF Integrated Wealth Management. The views expressed are those of the author and not necessarily those of RGF Integrated Wealth Management, which makes no representations as to their completeness or accuracy.

©2019 RGF Integrated Wealth Management. Ltd., RGF Wealth Management. Ltd., Member - Canadian Investor Protection Fund 

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