Running out of money is the most widespread fear about retirement. We are living longer and healthier lives and over the last few years, stock markets have driven our fears higher than ever, even sending some pensioners to head back to the unemployment line.
If moving in with your children only generates groans at family holiday meals, try one of these effective strategies as an alternative. Whether you’re retired now or if you’re planning for your retirement down the road, here are six crucial ingredients to ensuring that your financial future is secure.
1) Do what pension funds do.
Fewer and fewer people belong to pension funds today but that doesn’t mean that you can’t set up a mini-pension fund for yourself and use the clever strategies that they’ve used for years.
Most private investors put all of their money in the same kinds of approaches.
Instead, consider matching your short-term income needs with short-term investments, leaving the money that you won’t need for quite a while in a portfolio that typically takes longer to unfold and has a higher expected pay-off.
This is called liability matching and it is easy to apply to any investment strategy, yet very few private investors that I have met put this strategy to use. Simply hold a few bonds that mature on the dates when you need money. Having small amounts available over the next few years, you can invest the rest for longer periods to seek a higher return, such as a carefully selected equity portfolio that will grow as the economy grows.
You may also find that you feel less anxious about the ups and downs of the market in your long-term strategy, having your short-term needs securely met.
2) Guaranteed Income. Guaranteed Estate. Easy.
Consider establishing an insured annuity once you retire. There are a few steps involved but often the benefits of reducing the income taxes you pay, improving returns over current interest rates, and securing a guaranteed income for your retirement income outweighs the extra work.
Recently, a 60-year old retired teacher had inherited some money and with interest rates so low, wanted to make sure that she had enough income for the next 35 years while still pass wealth to her two children. We arranged a $500,000 prescribed annuity, which pays her $29,130 per year for her entire life, with only $1,530 in taxes at her 30% tax rate.
To ensure her children were taken care of, we established a $500,000 life insurance policy to benefit her two children. When she deceases, each child receives $250,000 tax-free and probate free at an annual cost to her of $11, 595 per year.
Today, the extra $1,333 after-tax each month compliments her pensions very nicely. She could have elected a smaller life insurance policy to increase her current income. Any combination is possible but always ensure that you keep some funds aside for unexpected events, since the funds in an annuity cannot be changed at a later date.
3) Plan for inflation.
The slow creep of increasing costs has surprisingly dramatic consequences over a 35-year retirement. Even at the low 2% objective established by the Bank of Canada, the cost of everything will double! If you’re retiring today, imagine that you’ll see a $10 loaf of bread during your lifetime. If you have years ahead of you, consider tripling the estimated costs of goods and services by the end of your time horizon.
Software programs for estimating future expenses and the amount that it will take to support your lifestyle are indispensable, especially over long periods of time. Our brains are not designed to adjust for inflation, which is why Aunt Mildred has given you the same $25 a year for your birthday for the last 20 years. Be sure to increase your income needs by at least 2% for every year you’ll need it in the future. Better still, project a higher rate of inflation to ensure that you don’t get caught dwindling your savings if prices suddenly spike.
4) Keep your eye on the horizon and don’t look down.
Fight or flight is a natural tendency to be alert during times of imminent danger. Evolution has provided these survival mechanisms, however, the same automatic reaction that raises the hairs on our neck and keeps us awake at night to ward off potential threats, also influences our decisions to abandon our well laid investment plans out of the market during times of high volatility. Suddenly, we become extremely risk averse and short sighted, if not overnight market timing experts, convincing ourselves that we can buy in again when the prices are even lower.
The truth is there are no skills known to investors today that accurately predict the bottom of the market. Often market swings are nothing more than investors who drive prices down in a panicked sale. Business earnings cannot account for such volatility, since income earned doesn’t change that quickly. In fact, there are known effects, such as the Gambler’s Fallacy and other natural tendencies, that fool us into thinking we have more control than we do.
You know that there will be ups and downs, even dramatic ones. Stay on the program and keep your long-term plans long-term. The time to change your investment approach is when markets are high and you are feeling euphoric.
5) Use tax shelters effectively.
No other bill is as onerous as the amount of income taxes you will pay during your lifetime. In Canada, using tax shelters wisely can keep thousands of extra dollars in your mason jar to fund your retirement.
You’ve probably heard people gripe about Registered Retirement Savings Plans (RRSPs), exasperated that taxes must be paid on the withdrawals anyway, so why bother? Well, the usual arguments that you’ll be in a lower tax-bracket after retirement than when you’re making the contribution, and that the value of a dollar saved today and paid tomorrow is lower due to inflation are both true. But that isn’t the whole story
When you invest in an RRSP, the government returns the taxes on that income. That money remains invested for years, if not decades, and by the time you send it back to Ottawa, it’s been invested for your benefit. Think of it as an interest-free loan from Canada Revenue Agency (CRA). Let someone else’s money work for you.
6) Plan for healthcare
Many of the families that I prepare financial plans for estimate that they will need less money after a certain age, speculating that they won’t be traveling or spending as much. Nothing could be further from the truth. Statistically, you will be in for much larger expenses for health and care than you may realize. (Stats Canada)
Instead of ratcheting your spending expectations down, put a few extra dollars in the coffer for a long and healthy life.