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Longevity can take a toll on retirement funds

When retirement can last as long as a working life, it’s vital to build an effective portfolio to cover medical emergencies or unforeseen costs


Date: May 14,2014

With life expectancy estimates increasing, making it to 100 doesn’t seem far-fetched. The new reality is that Canadians may live longer than they think, so being financially prepared for retirement has never been more important.

“You could very easily wind up having a retirement that’s as long as your working life,” says Peter Drake, vice-president of retirement and economic research for Fidelity Investments Canada. “When people are in their 30s and 40s and working hard to save for retirement, it can still be hard for them to appreciate just how long their lives could be.”

Consider recent numbers from the Canadian Society of Actuaries: Men aged 65 have a 50-per-cent chance of living to age 83 and a 25-per-cent chance of living to 89. Women aged 65 have a 50-per-cent chance of living to 86 and a 25-per-cent chance of living to 92.

And it’s not just a preferred lifestyle that one needs to finance during those golden years. Declining health can potentially increase costs late in life. Whether it’s home care or assisted living, the associated expenses can be exorbitant.

“When you look at what is spent on health care in Canada, approximately 70 per cent is funded by various public plans and 30 per cent is out of pocket,” Mr. Drake explains. “Many people want to go out and spend a lot of money when they retire, reward themselves with a trip, boat, or cottage, and that’s fine, but we need to remember the effect of longevity.”

Canadians can enjoy financial security during their retirement, but it takes planning.

“People are more sanguine than they should be,” says Sherry Cooper, former chief economist at the Bank of Montreal and author of The New Retirement: How it will change our future. “I think people underestimate exactly what’s required and how difficult it is to accumulate it, especially if you haven’t started early enough in your life.

“You can never start too soon,” adds Ms. Cooper, who is now a professor at McMaster University’s DeGroote School of Business in Hamilton. “What’s essential is that you begin saving from the beginning of your career. Automatically pay yourself first, ideally 10 per cent of your gross income at the very least. That’s a good amount to put into an RRSP, and check if you’re lucky enough to have a corporate match, which is essentially free money.”

She suggests having at least four to five times one’s gross salary, in addition to the family home, as a nest egg.

“If you need $50,000 pre-tax to maintain your lifestyle after the receipt of pensions or the Canada Pension Plan, a nest egg that is four or times that amount is a significant amount of money,” Ms. Cooper says.

Using the age of 90 as a benchmark and a withdrawal rate of four per cent, Mr. Drake says there are many considerations when it comes to building an effective portfolio that weathers inflation and does not take undue risks in volatile markets.

“You do need to be careful about how conservative you are to generate returns you’re likely going to need,” he explains. “A proper financial plan will address diversifying sources of investments. You want to spread where you’ll be getting your income across different sources.”

That includes equities. “There was a time when it was felt that you could get rid of equities altogether, but that was when interest rates were much higher than they’ve been recently. Yes, interest rates will creep up and there’s more volatility, but equities have shown the potential for higher returns, and you really need to keep some in the portfolio.”

Bonds are also worth having, no matter what Warren Buffett says. “When you look to the future, bonds are not going to be a disaster and they’re still necessary for managing volatility and diverse asset allocation,” Mr. Drake says.

High-quality dividend-paying stocks are also worth considering, according to Ms. Cooper. “They have a very strong record of long-term growth and long-term dividend payment, which we saw so vividly during the financial crisis.”

Mutual funds have several characteristics that make them appropriate for those nearing retirement, Mr. Drake says.

They’re liquid and can easily be redeemed quickly in the case of a medical emergency or large medical expense; they can provide asset allocation that’s appropriate to the age and stage of an individual; they can provide tax-efficiency, thereby increasing the after-tax income of the investor at a time when that’s especially important, for example in a period of high medical costs.

Mutual fund managers also provide active investment management, relieving people of that responsibility at a time of life when they need or want to avoid making such decisions personally, Mr. Drake adds.

Insuring against health costs associated with longevity is another factor to consider in a proper financial plan. Long-term care insurance can help cover some of the expenses. It can be expensive, but it is cheaper if purchased early in life rather than waiting until one is at or near retirement.

Keep in mind, however, that other types of care or assistance may be required as a person ages, such as home maintenance, assisted transportation, or various mobility aids. Each of these can be costly in their own right.

“There is an alternative two-step approach to dealing with this problem,” Mr. Drake explains. “The first step is to save enough for retirement so that a discrete portion can be set aside for potential health-related expenses. It should be in a liquid form so that it is easy to get at if a medical emergency or significant cost arises.

“The second step is to go through a planning process around what the response would be if a major medical emergency or cost arose. What assets might be liquidated? If one spouse required care in a long-term care facility, would or could the family home be retained? While it’s almost impossible to avoid the emotional impact of such an event, the financial implications can be minimized by having a plan in place.”

Tax-efficiency is another aspect of a sound financial plan. Tax-free savings accounts are an option for those who fall into lower-income brackets as well as seniors who’ve reached age 71 and can no longer contribute to a registered retirement savings plan.

No matter what your age, an emergency fund is a must.

“Everybody needs cushions,” Ms. Cooper says. “The roof will leak, the car will break down; there will be unexpected expenses in retirement just as in pre-retirement.”

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