Transition

(Originally posted February 7, 2007)

Overview 

As we are approaching retirement there are many things to consider. The primary focus of this website is financial rather than lifestyle oriented. However, the choice of lifestyle will dramatically affect income requirements.

1. First the ‘what’:

-what do you plan do in retirement? Part-time work, volunteer, study, travel?

-where do you plan to retire? Stay put, move, become snowbird?

2. Then the ‘how much’ do I need?

-how much are you spending annually before retirement?

-what are your expected increases/decreases in spending after retirement?

-how much do you need to cover my annual expenses?

-what is your assumed life expectancy?

-are you planning to leave an estate and how much?

3. What are income sources and their timing?

-what pensions do you expect? CPP, OAS, company pension, SS? How much?

-how much assets do you have?

-do you plan to work part-time? Is it realistic?

-what’s your withdrawal rate from assets so as not to run out of assets?

-are there any major cash inflows/outflows associated with retirement?

-take a pension or the commuted value?  Immediate or deferred pension?

-at what age should you start your government pension (CPP, SS)?

-when can you afford to retire? Do you need to defer by a couple of years?

So clearly, you can start bottom up (what spend rate can you afford and then what can you afford to do) or top down (what is it that you want to do and how can you achieve it). Ideally, I suspect that a top down approach is preferable. Either way it will be an iterative process and adjustments will be required to establish a starting position. You may have to reduce the ‘what’ in scale or frequency, or scale up the ‘how’, the income, through part-time work or saving one year for a bigger trip next year. By the way, part-time work not only brings extra income but may reduce your expenses, since you are too busy to engage in activities requiring spending. Generally speaking, it is easier and less stressful to adjust the ‘what’ than the ‘how’, after all you are retired. However, at the risk of using cliches, this is not a rehearsal, this is your life and you want to live it to the fullest extent. Part time work may be an option for additional income, social interaction or just volunteering to help others and get the resulting psychic rewards. After pursuing the initial approach for a couple of years a review of assets, spend rate, return rate will no doubt result in some fine tuning of the plan.

What do I plan to do in retirement? 

The planned/desired lifestyle will affect the spend-rate in retirement.

Part-time work, volunteer, study, travel are increasingly more expensive activities during retirement. Not that I have heard of many retirees complain about boredom. If anything the message I am hearing is that there aren’t enough hours in the day to do everything planned. Still depending on the planned activities, allowances must be made for the corresponding expenses. 

Staying put, move to downsize/upsize, become snowbird renting/buying seasonal use property are generally increasing cost options to be accounted for in the transition planning to retirement. 

Staying put in your home is a reasonable baseline to start from. You are familiar with your surroundings, likely have a circle of friends and you have access to healthcare insurance in Canada.

Downsizing to a smaller house or apartment, is an opportunity to simultaneously free up capital to boost assets available for retirement and reduce ongoing expenses (property taxes, utilities, maintenance).

Snowbirding by renting or buying a property for seasonal use during the winter months can easily add $2000-4000/ month of use if renting and even more if buying property. In effect you must pay for (wastefully) occupying two footprints simultaneously, one being vacant at all times.

How much do I need: annual burn rate and longevity considerations?

One reads that required retirement income is 60-80% of pre-retirement income. However, given the increased time available for leisure and travel, it is not difficult to imagine income requirement equal to or greater than pre-retirement. Clearly there is a difference between essential and discretionary expenses.

Ideally, if pre-retirement you had a budget and kept detailed track of your expenses then that would be a good basis for adding removing cost when estimating retirement expenses. (It is a good idea to track expenses over at least a 3-4 month period; you’ll find it amazing where you spend your money and you’ll most likely find many opportunities for redirecting your spending.)

A less precise way of approaching this problem, would be to start with total spend rate pre-retirement and adding/removing major expense items. Often transition to retirement corresponds to mortgage being paid off, youngest child graduating from university, stop saving for retirement, reduced need for life insurance, not needing two cars if both spouses are retired and other major expense line item elimination or reduction. Major additions could include incremental travel, snowbird and second home expenses.

The traditional approach to retirement planning is to arrive at some percentage of the available assets for the first year of retirement and then adjust the dollar amount for inflation annually. However, Ty Bernicke published a paper entitled Reality Retirement Planning: A New Paradigm for an Old Science” which brings new data to the table and makes persuasive arguments that the traditional constant spending model needs a fresh look. The data he starts with is the U.S Bureau of Labor’s 2002 Consumer Expenditure Survey, which shows that spending decreases during retirement (although the data needs to be adjusted for long-term care needs) and that the traditional approach is too conservative, and may overstate the assets required and the probability of running out of funds in retirement. Factoring in these considerations, which he calls “reality retirement planning”, can lead to not just to possible earlier retirement, but may also impact estate planning, tax planning and investment management. This feels intuitively right, not just because there is significant support data, but also because it is reasonable to understand that the activity/spending level of 55-65 year olds will be higher than 75-85 year olds.

We also need to answer the question of longevity. Life expectancy has been lengthening over the last 100 years quite significantly. New drugs, improved nutrition, more exercise have all contributed to expected longevity of the overall population. Of course it is impossible to predict individual lifespan, but it is quite realistic to predict expected values and longevity distributions for the overall population. Very interesting research was done by TIAA-CREF’s Heller and Schmierer. They report that during the 20th century life expectancy has been increasing 1% and 1.5-2% every five years at birth and at age 65, respectively.

Heller and Schmierer also show the two tables, in the above referenced document for 2003 gender independent annuitant survival probabilities of one individual (page 19) and one of a couple (page 23). Note that their numbers are for annuitants, rather than the general population, i.e. people choosing to buy annuities, who generally tend to be those who are healthier and expect longer lives than average.

Note that the probability of a 65 year old surviving to age 95 is 26%, but probability of one of a 65 year old couple surviving to age 96 is 46%! Of course for planning purposes, the fact that a 65 year old couple has close to 50% probability of having one of them alive at age 95 is critical, and using old rules of thumb that life expectancy of 65 year olds is about age 82 is the wrong way of looking at the problem.

The other question is whether you are planning to leave an estate and how much. This is clearly a personal matter for each individual, but except for the completely selfless individual (or a person whose children are particularly needy, e.g. handicapped) the answer would have to be that this is a desired outcome but not at the expense of serious or even minor depravation during retirement. (You recall the old joke, if you don’t travel first class, your children will.) The retired individual’s needs would generally come first, before those of the descendants. Furthermore, it would seem desirable that if say children were to be helped by the retiree, that should happen earlier rather than later, i.e. during retiree’s lifetime.

Perhaps a way to deal with both the questions of the estate and it’s desired size, and the unknown age of death is to combine them. That is plan to leave an estate if possible even at age 85 or 90, but if necessary that estate is the buffer should one of you live to 95 or 100.

What are income sources and their timing?

Here we must start with an inventory of known and potential income sources and their respective amounts, star/end dates and whether these are partially or completely inflation indexed:

        -Canada Pension Plan(s), Old Age Security, Social Security, company pensions

        -Planned/expected part-time work and is it realistic (health, opportunity) 

        -Available assets for retirement and potential withdrawal rates 

        -Mortgage or reverse mortgage on a fully paid-off home

Of course you must adjust available assets for any major cash inflows/outflows at time of retirement (special retirement transition payments, cash from downsizing home or cash outflow from buying second home)

You must consider at what age to start CPP/SS/other pension. A factor that must be considered is the individual, rather than average, life expectancy. There are websites that allow you to answer some personal health and lifestyle questions and it gives you an expected age of death. A terminal illness or family history of early death coupled with an immediate need for the additional income would suggest that taking pensions as early as possible may be preferable. However, apparent good health, a family history of relative longevity and no immediate need for the additional income would suggest that deferring the start of a pension, to a later date, usually resulting in a substantially larger pension, may be preferable. This is especially true for indexed pensions like CPP/OAS/SS.

Trade-offs between commuted value and a pension would again be driven by considerations such as stability of plan sponsor, the funded status of the pension plan, the ability to roll the entire pension without tax consequences into a tax sheltered plan (like RRSP), the expected returns realistically attainable, whether the pension is fully indexed, etc.

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