The article “Why Saving Too Much For Retirement Is Just As Risky As Saving Too Little” was originally published on Financial Post on May 22, 2019.
Only 20 per cent of 65-year old Canadians will live for 30 years — and that means their money will far outlive them
Professional financial planners spend most of their time helping people prepare so that they don’t run out of money in retirement. Longevity risk, inflation, poor sequences of returns and potential long-term care costs are among the risks we try to navigate and neutralize. But in the process of being overly risk averse, it is possible that retirees can encounter another risk: that of over-saving.
I may be jaded, having had a couple of clients and family members die much too young in recent years. But those experiences have led me to really question the costs of encouraging savers to be too prepared for a long retirement that may never come to fruition. The risk of saving too little is obvious and overdone. But what are the potential risks of saving too much, and how can they be avoided?
It is not uncommon for retirees to engage in relatively simple retirement calculations. Some aspire to live off investment income, so if a $500,000 investment portfolio is expected to generate 2.5 per cent in dividends and interest, they will plan to spend $12,500 of it each year. Or if they expect to need $25,000 in addition to their government or workplace pensions, they target savings of $1,000,000 at the same 2.5 per cent expected income.
Others use simple division to determine their withdrawals. If they have $300,000 and expect to live for 30 years, they will divide $300,000 by 30 to get a $10,000 annual withdrawal.
None of these approaches is perfect, but perfection in financial modelling and retirement funding is impossible.
An excellent 2017 Morningstar research paper by David Blanchett, Paul D. Kaplan and Toomas Teder titled Safe Withdrawal Rates for Retirees in Canada Today sought to Canadian-ize William Bengen’s sustainable withdrawal research that came up with the “four per cent rule” back in 1994. The four per cent rule used back-testing to determine that for a 30-year retirement in the U.S., an initial investment portfolio withdrawal of four per cent, indexed annually thereafter to inflation, had a low probability of fully exhausting the portfolio.
Blanchett, Kaplan, and Teder looked at historic returns for a Canadian investor, and even added in a reasonable one per cent assumption for investment fees (absent from Bengen’s initial research). They found that the safe initial withdrawal rate for Canadian investors with 50 per cent in Canadian stocks and 50 per cent in Canadian bonds was closer to 3.5 per cent. Even more interesting, the authors ran forecasts with a forward-looking perspective, and expect a sustainable withdrawal rate of only three per cent in the future for a 50-50 portfolio.
While I appreciate very much the importance of research that give retirees peace of mind that their investments will last for 30 years, 90 per cent of the time, I think it is also important to note that only 20 per cent of 65-year old Canadians will live for 30 years. That means that for the majority of Canadian retirees, planning to live off investment income or using a three to four per cent initial withdrawal rate means their money could far outlive them.
Money is very personal to people, and for many retirees, living off investment income without dipping into investment capital is as much psychological — a necessity to sleep soundly at night — as anything else. That is hard to argue with, as is the statistical research that gives us sustainable withdrawal rates and protects against the risk of living too long.
But for the many Canadians whose money may outlive them, I think it is also important to consider factors even closer to home. Homeowners, and particularly those in expensive cities like Vancouver and Toronto, may be sitting on savings that far outweigh the value of their investments or pensions. And while a brick cannot be used to buy bread and you will always need somewhere to live, a retiree in their 80s or 90s — if they make it that far — may not live in the family home forever.
Even if a 65-year old does end up in that unlucky 10 per cent whose three to four per cent initial withdrawal from their investments may not be sustainable, how much of an emergency fund might their home provide? And if an eventual downsize, or outright sale to move into a retirement home is not considered, how much too much did they save that they could have spent? How much too long did they work?
Another practical risk for Canadian retirees is that of having too much money in an RRSP or RRIF account. The tax sheltering of retirement savings plans is great, particularly for high-income earners who eventually have long retirements. But for those who die young, particularly if they do not have a spouse to whom they can leave their accounts on a tax-deferred basis, dying with too much registered savings can be awfully expensive.
In fact, a $500,000 RRSP or RRIF left to a non-spouse beneficiary, such as one’s children, could be subject to between 38 per cent and 54 per cent tax, depending on the province or territory of residence.
Potential long-term care costs are an unpleasant risk that retirees need to consider as well. The Canadian Institute for Health Information reports that the average long-term care facility stay is about 18 months, but no doubt there are many people who receive private or family care at home beforehand, or who spend many years living in such a facility.
My mother passed away in March, a few days after turning 66. She suffered from two terminal illnesses, had in-home care, and we were contemplating the best way to arrange and pay for her long-term care needs. Her care costs were minimal in the end, and her retirement savings, meant to fund her retirement for the next 30 years, turned out to be more than she ever needed.
I am acutely aware of the risk of running out of money, and by no means wish to suggest that savers and retirees live for today, at the expense of tomorrow. I spend most of my professional life helping ensure people still have money when they are 100 years old. But I can’t help but wonder if being overly conservative is doing them a disservice.
After celebrating Mother’s Day without my mom, I appreciate the risk of over-saving more than ever. I think it is important to maintain balance in life. If we only knew how long we would all live, it would make this retirement planning thing much easier.
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.