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RRIF rules causing withdrawal pains?

Drawdown minimums should be reduced and start later than age 71, experts propose, so that retirees minimize the risk of outliving their savings


Date: August 20,2014

Free at last of the daily grind, some newly retired “feel like going out and blowing a bundle.” That’s understandable; retirees deserve their fun, says Peter Drake, vice-president, retirement and economic research, for Fidelity Investments Canada.

But there is a growing danger that more of us will outlive our retirement savings, economists warn, “and that creates a bit of a conundrum,” Mr. Drake said in a recent interview.

This is already on the radar of Canadians who are retired or soon to be, Fidelity found in a 2013 survey. In the report, Retirement 20/20: Achieving Retirement Fulfillment, researchers found that 46 per cent of pre-retirees and 29 per cent of retirees are moderately or seriously concerned about the risk of taking too much out of savings and running out of money.

While “obviously, not everybody is going to make it, you want to think about living to age 90,” Mr. Drake said.

Retirement planners recommend, as a rule of thumb, that annual withdrawal rates from retirement nest eggs should not exceed 4 per cent.

By the time RRIF holders reach 71, however, the federal government’s age-related formula dictates they must withdraw a minimum of 7.38 per cent of their RRIF, with the mandatory minimum withdrawal rate increasing each year.

This poses serious problems for Canadians trying to balance their need for current income against the risk of outliving their savings, warn William Robson and Alexandre Laurin of the C.D. Howe Institute.

“To the RRIF holder, the minimums pose a threat. They oblige the holder to run tax-deferred assets down rapidly,” Mr. Robson, president and chief executive officer of the institute, and Mr. Laurin, associate director of research, said in a research bulletin.

“Today, people can expect to live much longer after retirement, and real returns on investments that provide secure incomes are much lower. RRIF holders now face serious erosion in the purchasing power of tax-deferred savings in their later years. The minimum drawdowns from RRIFs and similar vehicles should start later and be smaller or even disappear entirely,” they propose.

Mr. Drake shares the C.D. Howe Institute’s concern and expects there will be growing pressure on the federal government to change the retirement fund income withdrawal rules.

“For the federal government to give up some tax revenue in order to lower the mandatory withdrawal rates might just be the best investment it ever made because, in the final analysis, somebody is going to be on the hook to look after the older generation. If people can’t do it themselves, the government is ultimately going to be on the hook,” Mr. Drake said.

In the meantime, retirees who are required by law to withdraw more income from their RRIFs than they need to meet current expenses don’t have to spend it. They can reinvest, Mr. Drake suggests.

“The smart thing to do is to take the surplus that you don’t need and promptly put it into a tax-free savings account (TFSA). You can have almost any investment vehicle in those accounts, and the great thing about that is that you will never pay tax on any investment income that you make inside the tax-free savings account. That’s the most tax effective way of dealing with it that I know.”

The withdrawal rate is just one factor that must be accounted for in any retirement plan. Fidelity found in its survey that Canadians are also worried about inflation and the potential for rising prices to erode purchasing power, the chance that out-of-pocket health-care costs might drain savings, and getting asset allocation right.

And then there is the good news-bad news scenario posed by longevity, with 47 per cent of pre-retirees surveyed by Fidelity and 34 per cent of retirees worried that they will outlive their savings.

Financing retirement is far more complicated than it used to be, Mr. Drake said, and it is prudent to find expert advice.

For those who have the basics covered off by a defined benefit pension plan, supplemented by CPP, OAS and an investment portfolio, withdrawal rates are important. For those funding their retirements primarily though savings and investment plans, “the withdrawal rate is really critical,” he said.

“One of the things you can do to reduce withdrawal risk, obviously, is to take some of your portfolio and get an annuity” which, in exchange for a single lump sum investment, guarantees regular payments to an investor for life, or for a set period of time.

“There are some pluses and some minuses, as there are with all of these decisions. It can provide a sure stream of income, you can index it to inflation at a cost, you have options about the length of time it goes on and survivor benefits,” Mr. Drake said.

“The downside is that you have no more liquidity left for that particular amount of money you put into the annuity … so a recommendation a lot of people make is that you don’t want to put all of your portfolio into an annuity, you want to leave some in case you need some liquidity [to deal with the unexpected],” he said.

“People tend to think of the unexpected in a negative sense – the furnace quits, so I have to spend several thousand dollars, I have a health issue that costs me money, someone in my family has a problem and I have to help. But there can be an upside, too – the opportunity to take a lifetime trip that you never thought you would take and things like that, so it’s always going to be a balance.”

Drake added, “The key to a successful retirement is creating choices and incorporating those choices into a plan. Having a plan doesn’t mean locking yourself into a specific retirement route. It allows you to make the choices you want and it helps you to make adjustments to changes in your life and in financial markets.”

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