The article “Life Expectancy Is One Of The Great Unknowns In Retirement Planning, But These Strategies Cover You No Matter What” was originally published on Financial Post on January 27, 2021.
Here are some strategies for both a long and short retirement
Life expectancy is an important, albeit challenging factor in financial planning. Certified Financial Planners are supposed to help people structure a retirement that could last well into their 90s, but there is a big difference between 90 and 100 when it comes to determining how far a client’s savings will go. Unfortunately, we have to live with that uncertainty.
Some people expect a long life expectancy based on their health or their family history. In most cases, people should try to minimize the risk of living too long when they are making their spending and saving decisions so they can avoid running out of money. However, health issues may shorten someone’s life expectancy — or a terminal illness may significantly reduce it.
Someone with a short life expectancy has certain pension considerations that may benefit their spouse or their estate. They should consider starting their Canada Pension Plan (CPP) retirement pension as early as age 60 and their Old Age Security (OAS) pension as early as age 65. These pension payments will be reduced compared to delaying them, but someone with a short life expectancy may not benefit from deferring their pensions. At the same time, the spouse of a pensioner with a short life expectancy may want to defer their CPP retirement pension as late as age 70, to ensure they have larger payments later, when they might be on their own.
A defined benefit (DB) pension plan member with a spouse should consider their life expectancy before beginning their pension. Different survivor options may be available when selecting a pension option, so someone with a short life expectancy may want to select a 100 per cent survivor option if available. It will lower their monthly pension payment during their life but may avoid a reduction in their pension after they die, benefitting their surviving spouse.
There are also tax strategies that may benefit someone with a short life expectancy. These can include strategically triggering certain types of income such as registered account withdrawals or capital gains over a period of years or implementing an estate freeze.
A common example is with a Registered Retirement Savings Plan (RRSP) or Registered Retirement Income Fund (RRIF). If someone with a short life expectancy defers their RRSP withdrawals to age 72 or takes only the minimum withdrawals from their RRIF, they may squander the years they are in a low tax bracket. If an RRSP or RRIF is not transferred to a spouse on death and is payable to children, for example, the tax payable could be more than 50 per cent in most provinces. Even if it is payable to a spouse, that spouse will have all future income taxed on their tax return, so splitting income between two tax returns while the opportunity exists could maximize the surviving spouse’s future income and ultimately the estate.
Some provinces have high probate fees payable on death to validate the will of the deceased before distribution. These fees can be avoided by naming beneficiaries, holding assets jointly with right of survivorship, using insurance products, or by establishing joint partner or alter ego trusts. Some provinces charge flat fees for probate, while others charge a percentage. A small percentage of a large estate can still be significant. Despite the cost of probate, the time and effort required may be reasons to try to avoid probate as well.
The risk of living too long is an important possibility to plan for and a risk to mitigate when planning retirement. Family history may contribute to life expectancy, but someone can live to a ripe old age even if their parents did not. There is a 50 per cent probability of a 65-year-old man living to age 89, and for a woman, two years longer, to age 91.
Deferring the start of a CPP or OAS pension to as late as age 70 is a good way to plan for a long life expectancy. A pensioner who lives well into their 80s may be better off in the long run, despite a delay to their pension in the short run. It may mean they need to draw down on their investments earlier in retirement while they hold off on government pensions, but this can be a beneficial strategy for someone who does not have a DB pension plan from their working years. CPP and OAS are increased for every year they are deferred, up until age 70, and are also indexed annually to inflation.
CPP, OAS, and DB pensions are forms of annuity income. An annuity is a series of payments paid regularly, typically monthly. You can buy an annuity using your RRSP, RRIF, or non-registered investments from an insurance company. The calculation of an annuity payment is based on a health assessment. If you have good health, your payments will be lower. If your health is poor, your payments will be more. Interest rates are also a factor. Low rates mean lower payments, and higher rates at the time an annuity is purchased will increase annuity payments. Annuities can be a way to insure against living too long.
Retirees or those approaching retirement should count on a conservative rate of return from their investments when projecting their retirement cash flow, but obviously strive for as high a return as their risk tolerance may be able to achieve.
A low rate of return assumption can help mitigate investment risks like a stock market downturn early in retirement. Another consideration is that an investor’s risk tolerance could change as they age. A confident investor in their 60s may lose confidence in their 70s or 80s. Cognitive impairment may even mean a more conservative spouse or child may take over as power of attorney and their risk tolerance may be lower. An aggressive, self-directed investor who pays no fees may someday turn over their portfolio to an investment advisor whose fees may reduce returns, or who may recommend a more conservative asset allocation that could reduce returns.
One risk of living too long is that of depleting assets in advance of or because of incurring late-life long-term care costs. People can buy long-term care insurance to potentially cover these expenses, but paying the premiums also reduces the assets that could otherwise be used to pay for the care. As a result, planning for an estate that can outlast you may be prudent based on several risk factors.
There are different strategies to plan for a short or long retirement. The best approach with financial planning is to regularly revisit circumstances and reconsider your plans. I helped my mother plan to live at least as long as her father, who died at 86. She was still working part-time when she was diagnosed with a terminal illness at 64, retired before being diagnosed with a second terminal illness at 65, and died the same week we celebrated her 66th birthday. Some of the same strategies for both a long and a short retirement mentioned above are those I implemented for my own mother and those strategies obviously changed relatively quickly.
Someday, hopefully many years from now, I will die too. I plan my own finances based on the possibility it could be tomorrow, or I could be 100 years old. Frankly, I prefer not knowing.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.