Many people spend their working years accumulating retirement savings and as they approach retirement start to wonder about the specifics of when and how to draw on their nest egg for retirement.
I often use a bucket analogy to illustrate the transition from retirement savings to retirement income. You spend your working years adding money to your Retirement Savings bucket and at some point you will convert this over to a Retirement Income bucket where you will draw income out to spend. The Retirement Savings bucket is where you put the savings each year in the top, and the Retirement Income bucket is where you cut a small hole in the bottom to start to withdraw savings out each year.
When we discuss the Retirement Income bucket, you have some options on how you can cut the hole to create income.
If you like flexibility you may choose to cut an adjustable hole in the bucket that can be made bigger or smaller at your discretion. This strategy provides great flexibility to draw income when and how you need it. However, you need to be careful not to take out too much. You don’t want to empty your bucket too soon. Outliving your retirement savings is a major concern.
For this type of flexibility you would convert your RRSP (Registered Retirement Savings Plan) to a RRIF (Registered Retirement Income Fund) using traditional investment tools (i.e investment funds, savings accounts, GIC’s etc). In this scenario you and your advisor continue to manage your portfolio in your RRIF the same way you did in your RRSP over the years using investments of your choice (adjusted for retirement time horizon, risk tolerance etc.) You make ongoing decisions on how and when to best draw out the income. Retirement: When you’re ready to start spending your RRSP savings.
While some people love this flexibility, it makes others nervous. What if I outlive my savings? Maybe you are the type of person who prefers guarantees. Perhaps you want to guarantee a flow of income for life.
Using the bucket analogy, you can choose to cut a permanent hole in the bottom of your bucket to offer a steady stream that will never run out. The continued flow of income is guaranteed, but you can’t adjust the size of the hole or change it.
For this type of income guarantee you would convert your RRSP (Registered Retirement Savings Plan) to a RRIF (Registered Retirement Income Fund) using an annuity. The amount of your savings combined with your age and life expectancy determine that how big the hole can be and how much it can provide for a lifetime. Much like a traditional pension plan (defined benefit), you receive regular income for the duration of your life.
One of the main reasons someone would choose an annuity is for security and peace of mind. It can be stressful to expose a lifetime of savings to the market, especially during volatile times. When you purchase an annuity, you essentially trade your lump sum of savings for a steady flow of income. The insurance company issuing the annuity then carries the investment risk and promises the annuitant (the person whose life the annuity is on) a certain amount of income for their life.
Annuities can be tailored with different features. You can purchase an annuity that covers the lifetime of two people which works well for senior couples to ensure income continues after the death of the first spouse. You can create an annuity for a certain length of time (term certain) rather than a lifetime.
There are guarantees that can be added as a safeguard to beneficiaries in the event of an early death which have minimum payouts attached for either a certain time frame (guaranteed period) or certain amount (return of premium)
How do you determine which strategy is best for you? There is certainly no one size fits all solution. You can draw your income from a variable investment portfolio, or from an annuity, or perhaps a blend of both. Blended solutions can offer a great mix of benefits.
You need to take into consideration pensions, cash flow needs, lifestyle, family history and life expectancy, the size of your retirement nest egg and estate planning wishes when you make your decision.
If you want to consider an annuity in your plan, you will need an advisor who is insurance licensed to provide you with advice and support in this area. Work with your insurance and investment advisor to determine the best fit for you.
Stephanie Farrow, B.A., CFP. Stephanie has over 25 years experience in the financial services industry, a diploma in Financial Planning from the Canadian Institute of Financial Planning and a Certified Financial Planner designation. Stephanie has been writing financial planning columns for local business magazine Elgin This Month since 2010. Stephanie and her husband Ken Farrow own Farrow Financial Services Inc. About our Farrow Financial Team.