However, in recent decades, retirement has become increasingly financially stressful, caused by a combination of factors that make it far more complex than before.
The decline of defined benefit company pensions
Having a defined benefit pension plan used to be the norm in Canada for many types of jobs. The employee and the employer would contribute to the pension and when you retired you would receive a guaranteed income for life. This certainly made retirement a much more manageable (and less stressful) proposition.
However, the number of Canadians paying into defined benefit pensions has been gradually declining since the 1990s. Without this guaranteed retirement income, Canadians have increasingly had to be responsible for their own retirement savings, with the prospect of retiring without a defined amount of income a far more complex situation.
Back in the olden days (the 1950s) Canadians could expect to live to around 68 (a little less for men, a little longer for women). Five years or so of retirement wouldn’t have been too difficult to finance, even without a company pension plan.
Today, the life expectancy for 65-year-old Canadian women is 87 and for men of the same age it’s 85. This means that, on average, Canadians need their retirement investments to last for 20 years or even more. They therefore need to accumulate substantial savings if they’re not going to outlive them.
One of retirees’ biggest threats is inflation. While government retirement benefits, such as the Canada Pension Plan and Old Age Security, are linked to inflation, retirement savings aren’t. This means that you ideally want your savings to at least keep up with inflation, so that your money doesn’t lose any of its buying power.
This can even be a problem when inflation is low and close to the government’s target of 2%. Safe investments (such as high interest savings accounts and GICs), typically offer very low rates of return when inflation is low. Therefore, to ensure their savings don’t get eaten away by inflation, many retirees need to invest in riskier assets. Which leads us to our next challenge…
The highest potential returns have historically come from investing in equities, as they provide returns in the form of dividend payments and capital gains (the increase in the price of your investment).
The tricky part of equity investing for retirees is that the stock markets can be, by their very nature, volatile. In the past, bear markets (when the stock market value drops by 20% or more) have occurred roughly every seven years.
Given that a bear market early in your retirement can have a serious impact on your retirement savings (read about how sequence of returns risk can impact your retirement savings), it’s not surprising that many retirees shy away from holding too many investments in equities.
Investments designed to combat modern retirement challenges
Given all of the challenges facing Canadian retirees, there are several key features that they typically need from their retirement savings:
Consistent income: When you make the switch from saving for retirement to using those savings to provide income, you need to be able to draw money from them as easily and tax efficiently as possible (when you’re withdrawing from non-registered accounts). Certain assets lack liquidity, meaning it’s difficult to quickly turn them into cash. For this reason, you need assets that either make consistent, reliable payments that will cover your retirement costs, or which are easy to turn into cash as and when you need it.
Stability: For many retirees, their retirement savings have to last for the rest of their lives with little or no employment income to supplement them, so they need to protect their savings against market downturns. Unfortunately, focusing on “guaranteed” investments, such as GICs, means that not only is your money locked in for a set period of time, but your returns often don’t even keep up with inflation. Instead, retirees need a mix of assets and strategies that are designed to provide stability by protecting your investment portfolio during times of volatility.
Growth: Given the danger to retirement savings from longevity and inflation, it’s not enough to just protect your assets from market crashes. You also need at least some of your portfolio to grow substantially. And to do that, you need to invest in assets with the potential to grow, such as equities, real estate, private credit and alternative investments.
Tax efficiency: The more tax efficient your retirement income is, the more dollars you keep, and the longer your savings last.
Retirement savings need to be able to deliver a seemingly contradictory number of goals: to provide stability while also growing and providing consistent income. It’s not surprising that many investors find this juggling act to be extremely challenging. Let’s look at some of the main options available to retirees to provide income from investments.
These are financial products designed to give you a set amount of money on a regular basis, either for a specific period of time or for the rest of your life. There are typically three types of annuities:
Term annuities: these pay out a fixed amount of money during a limited time frame. If you die before the term is up, your estate or beneficiary will typically receive the balance of the annuity’s value. If you outlive the term, you may then struggle financially.
Life annuities: these provide you with a set level of income until you die. Normally, payments cease on death, but some companies will let you add a beneficiary, for an extra cost.
Variable annuities: with these products, the financial company invests your money and provides you with a mix of fixed and variable income. The amount of the variable portion will depend on how these investments perform.
The payouts from an annuity can vary greatly, depending on a wide variety of factors, including:
- Your age.
- Your gender.
- Your health.
- The amount you’re investing.
- The type of annuity.
- The annuity provider.
For example, men would usually receive a higher payout than women because they have a lower life expectancy. The older you are, the higher the payout, and if you’re in very good health, your payout may be lower (as you’ll be expected to live longer).
The payout amount will also depend on how much you invest: for example, if you invest $100,000 in an annuity, you might receive as much as $8,000 per year if you’re a male aged 72, or $6,500 per year if you’re a male aged 65. You would then receive twice this amount if you invested $200,000, three times as much if you invested $300,000, and so on.
Different annuity companies offer different amounts, with the difference being as much as 10% between the highest and the lowest. The amount you receive will also vary depending on whether the investments used to buy the annuity are held in registered accounts (for example, an RRSP) or non-registered accounts. Annuities from registered accounts are usually taxed considerably more, but this will depend on your overall taxable income.
The main advantage of term and life annuities is that you’re guaranteed a specific amount of money every month, regardless of how the markets perform. However, there are several drawbacks that come with annuities, which you should be aware of:
- Your money is locked in — you can’t access any lump sums if you ever need them.
- You have no say in how your money is invested — the annuity company does this on your behalf.
- Your family may not get back what you invested if you die earlier than expected.
- If the company providing the annuity goes under, you may not get all of your money back.
- It can be costly to add on certain extras, such as a named beneficiary.
- You may be charged commission and other fees.
- Income from annuities that come from registered accounts, such as RRSPs, may be taxed at the highest marginal tax rate.
Government and corporate bonds are basically loans made by you, the investor, to a government (local, provincial or federal) or company. You’re then paid regular interest until the bond term is up, at which point you get back the amount you originally invested.
By shifting your investments into a portfolio filled with a wide variety of bonds, you could ensure that you receive dependable interest payments that will provide you with retirement income.
This strategy somewhat fulfills two of the requirements of retirement income: consistent income and stability. However, you need to be aware that corporate bonds are riskier than government bonds, while typically providing higher returns. Also, if you need to sell your bonds before the term is up, you could lose some of the principal amount invested, if interest rates have moved higher in the meantime. And when it comes time to replace bonds that have matured, you may have to accept a lower interest rate.
One of the problems of keeping all your investments in bonds is that you won’t enjoy much in the way of growth. Bond interest (especially from safe government bonds) is typically much lower than the returns you can get from investing some of your portfolio in equities.
Another key issue is that interest from bonds is normally taxed at the full marginal income tax rate. This means that you could end up paying considerably more tax on income from bonds than you would from equities where you earn dividends and capital gains (both of which are taxed at significantly lower rates).
Having a portfolio of stocks of companies that regularly make substantial dividend payments can provide you with the consistent income and growth that your retirement investments need. The potential for growth in equities is considerable: the S&P 500 Index, for example (which is comprised of around 500 of the largest companies in the U.S.) has averaged annual returns of over 10% since it was introduced in 1957.
By investing in dividend-paying companies, you could receive dividends as high as 4-5% while also seeing your investments grow in value. Another benefit of this strategy is that dividends from Canadian companies benefit from the dividend tax credit, which means that this form of income is taxed at a considerably lower rate than bond interest. Also, gains made from the increase in value of your equities (capital gains) are typically taxed at half the rate you would pay on bond interest.
The main drawback of this strategy, however, is that your investments are all equities, and so they don’t provide the stability that retirement investments need.
And, while the stock market has always made back its losses eventually, retirees might have to cash in some of their equities to provide income, which would mean they would lock in those losses and their savings would lose a substantial amount of their value. This could mean that they’ll outlast their retirement savings.
Retirement income mutual funds
A retirement income strategy that can provide all three retirement income needs — income, growth and stability — is to invest in a retirement income mutual fund that uses a “total return” approach to how it provides income.
These funds contain a diversified mix of bonds and equities (often including dividend-paying stocks) and provide a consistent income through a combination of dividends, interest, capital gains and a return of your original investment, if necessary. Depending on the type of product you invest in, they can provide a payment of between 4-6% of the value of your investment annually, usually paid out on a quarterly or monthly basis.
This mixture of income sources can be very tax efficient, given that some of the income sources have preferable tax rates, and returns of principal are not taxed at all. By providing a consistent payment, regardless of how your investments perform, your savings should last you throughout your retirement.
How IG can help you turn your investments into retirement income
IG’s iProfile Enhanced Monthly Income Portfolios are specifically designed to provide retirees with a way of using their investments to provide retirement income that meets all of modern retirement’s challenges:
Provide consistent income: these portfolios offer options for either 5% or 6% annual income, based on your portfolio’s total value, and paid monthly.
Provide stability: they’re more conservative in nature and so are designed to provide consistent performance and protection during market downturns.
Provide growth: the portfolios employ proven global asset managers with a demonstrated track record of strong returns and income generation.
Tax efficiency: diversification in the type of income the portfolios pay makes for better tax efficiency compared to retirement income that just pays interest or dividends.
Talk to your IG Advisor about the two iProfile Enhanced Monthly Income Portfolios — Canadian Fixed Income Balanced and Canadian Neutral Balanced. They’ll be able to recommend the best one for your particular circumstances and also ensure that it fits in with your overall financial plan. If you don’t have an IG Advisor, you can find one here.
Written and published by IG Wealth Management as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an IG Wealth Management Consultant.
Commissions, fees and expenses may be associated with mutual fund investments and the use of iProfileTM Managed Asset Program. Read the prospectus and speak to an IG Consultant before investing. Mutual funds are not guaranteed, values change frequently and past performance may not be repeated. An asset allocation service, iProfile is a managed asset program for clients with a minimum of $250,000 invested in the iProfile program. Mutual funds and investment products and services are offered through Investors Group Financial Services Inc. (in Québec, a Financial Services firm). And Additional investment products and brokerage services are offered through Investors Group Securities Inc. (in Québec, a firm in Financial Planning). Investors Group Securities Inc. is a member of the Canadian Investor Protection Fund.
GICs issued by Investors Group Trust Co Ltd., and/or other non-affiliated GIC issuers. Minimum deposit, rates and conditions are subject to change without notice. Commissions, fees and expenses may be associated with mutual fund investments. Read the prospectus before investing. Mutual funds are not guaranteed, values change frequently and past performance may not be repeated. Mutual funds and investment products and services are offered through Investors Group Financial Services Inc. (in Québec, a Financial Services firm). And Additional investment products and brokerage services are offered through Investors Group Securities Inc. (in Québec, a firm in Financial Planning). Investors Group Securities Inc. is a member of the Canadian Investor Protection Fund. Written and published by IG Wealth Management as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an IG Wealth Management Consultant.
Insurance products and services distributed through I.G. Insurance Services Inc. (in Québec, a Financial Services Firm). Insurance license sponsored by The Canada Life Assurance Company (outside of Québec).