Rui Torrao’s 10% cap rate target is very difficult to find these days: a recent analysis by Boardwalk REIT found cap rates for high-quality large apartment buildings ranged from 3.75% to 4.75% in Vancouver and 5.75% to 6.75% in southwest Ontario. In this hypothetical example, we’ve assumed you put 50% down on a property valued at $300,000. We’ve also assumed the mortgage interest rate is 3.5%, amortized over 25 years.

Retired people are even more vulnerable to inflation than younger folks still in the workforce. If you’re earning a salary, chances are it will increase during inflationary times and help cushion the blow from the rising cost of living. But if you’re no longer earning income from employment, your portfolio has to do all the heavy lifting. Traditional building blocks such as GICs, bonds, and even stocks may not be up to the task. It may be time to think about protecting your retirement savings from the ravages of those inflationary dragons.

Inflation’s bite. When investors worry about inflation, one of their practical concerns is rising interest rates. As the world economy struggles, central banks have drastically cut short-term rates to encourage businesses and consumers to spend more. They’ve also helped drive down long-term interest rates by buying up government bonds and mortgages through a strategy known as “quantitative easing,” or QE. Like anything else you buy, bonds are subject to supply and demand: when central banks buy bonds in massive amounts, the prices of those bonds move higher. Since bond prices and yields are like opposite ends of a seesaw, bidding up the price drives interest rates down.

Problem is, central banks finance their bond-buying sprees by creating money essentially from thin air, and economists fear this will eventually cause a spike in inflation. The classic definition of inflation is price increases caused by too much money chasing not enough goods and services. That’s not an immediate worry, because the developed world still has loads of unused capacity and high unemployment. But eventually that slack will get used up and prices will have nowhere to go but up. “There will be a time when inflation rears its ugly head,” says David Rosenberg, chief economist and strategist at Gluskin Sheff and Associates.

At some point interest rates will rise too, and that might occur even before we see any general surge in prices. In fact, central banks like to bump up short-term rates to stall inflation before it gathers momentum. The Bank of Canada is expected to start modestly raising short-term rates in early 2014 to “mop up excesses in the system,” says Derek Burleton, deputy chief economist at TD Financial Group. (The U.S. Federal Reserve will probably hold off increases to its benchmark short-term rates for longer.) Meanwhile, longer-term rates will probably rise whenever major central banks ease off on QE purchases.

Will inflation stay contained? Will interest rates rise a little or a lot? When will it happen? Nobody knows, but worries abound. “When all the money printing by central banks ends, it won’t be pretty,” predicted Bill Gross recently in Barron’s. The question for retirees is whether to make portfolios more inflation-resistant now, or wait until inflation is a more imminent threat.

Gross, who manages the world’s largest bond fund, believes in acting now. Rosenberg says the bigger issue today is trying to find adequate investment income without undue risk. But he too believes it’s prudent to have at least some of your portfolio in inflation-resistant investments.

Unfortunately, the traditional balanced portfolio of stocks and bonds doesn’t do especially well when interest rates and inflation are on the rise. Fixed income suffers the worst: when interest rates soar, bond values plunge and inflation eats away at the purchasing power of the interest and principal. Stocks generally fare better, but seldom thrive in this situation. Companies can often increase prices to offset inflation if the economy is doing well, but their costs rise too, so profits don’t necessarily flourish. So, are there investments that can make your portfolio more inflation-resistant? Fortunately, there are.

Fixed-income ladders. With fixed income you can never totally protect yourself from rising interest rates and inflation, but you can reduce the impact. The most obvious way is to shorten the term of your interest-bearing investments. The sooner a bond or GIC matures, the sooner the money can be reinvested at current rates. And if short-, medium- and long-term interest rates all move higher, bonds with the shortest maturities will see the smallest price declines. But you give up something to get that protection: long-term bonds currently yield almost two percentage points more than short-term bonds.

You can strike a happy medium by constructing a bond or GIC “ladder,” says Hank Cunningham, fixed income strategist at Odlum Brown Ltd. and author of In Your Best Interest. To build a five-year ladder, purchase equal amounts of GICs or bonds that mature in one to five years. Every year, one-fifth of the ladder matures, and you can use that money to purchase a new five-year GIC or bond at current rates. To be sure, rising inflation would eat away at the purchasing power of your interest and principal, but the continual repricing of 20% of your portfolio every year allows you to gradually capture the benefit of higher rates. Cunningham says a 10-year ladder can provide some additional yield, but it would also be more susceptible to inflation: only 10% would be repriced each year at current rates.

To get higher yields—albeit with more risk—you can build your ladder with individual corporate bonds instead of government bonds or GICs. Or you can use ETFs for added diversification. Cunningham recommends using RBC’s family of target-maturity corporate bond ETFs (ticker symbols RQA to RQI): each one holds 25 or more bonds that mature in a given year.

Real-return bonds. Unlike conventional bonds, real-return bonds provide excellent inflation protection. RRBs are long-term bonds with a value that’s adjusted twice a year according to the current inflation rate. If inflation turns out to be what the market expects, RRBs will deliver the same returns as traditional bonds of the same maturity. If inflation is unexpectedly high, however, they will outperform. (For more see “Make your bonds inflation proof.”)

But there are drawbacks, Cunningham says. For one thing, current yields on RRBs are very low, so while you are assured of covering inflation you don’t get much more. For example, a Government of Canada RRB maturing in 2036 now has a “real yield” of only 0.51%. That means your interest will be adjusted to ensure you earn the current rate of inflation (as measured by the Consumer Price Index, or CPI) plus 0.51%. The principal you receive when the bond matures in 2036 would also be adjusted for inflation.

Real-return bonds are highly sensitive to interest rate hikes. If long-term rates were to creep higher without any change in the CPI, the price of these bonds could plummet without any offsetting benefit from the inflation adjustment. Cunningham calculates that an uptick in long-term interest rates of half a percentage point (50 basis points) with no change to inflation—or inflation expectations—would cause the price of the 2036 Government of Canada RRB described above to drop in value by about 10%. So you’re only assured of getting the full inflation-fighting benefits if you hold the bond to maturity.

Gold. Just about every investor seems to have a strong opinion about gold. Some, like Bill Gross, are fervent believers. Others are impassioned skeptics. Gold advocates consider the metal a good hedge against inflation and against poor financial management by governments that control paper currencies like the U.S. dollar or the euro. Governments are always tempted to create more currency than can be justified by economic fundamentals. By contrast, the supply of gold is limited by the high cost of mining, so gold bugs consider it a more reliable store of value.

Others are wary because gold prices depend heavily on the whims of investors, since little is used in the production of goods integral to the economy. It isn’t subject to “real demand and real supply,” says gold skeptic John Stephenson, portfolio manager at First Asset Investment Management. Many arcane factors affect the price of gold, from jewellery demand in India to whether central banks are buying or selling it. As a result, gold has not always been highly correlated with inflation.

If you do want to add some gold to your retirement portfolio, an ETF is probably the best way to do so. The iShares Gold Trust, for example, trades on the Toronto Stock Exchange with the ticker symbol IGT. (You can also buy it in U.S. dollars on the New York Stock Exchange, where it trades under the ticker IAU.) Other investors prefer to invest in gold-mining companies, although share prices have generally done poorly in the last several years because mining costs have risen faster than gold prices.

Commodities. Historically, commodities such as metals and agricultural products have been a good hedge against inflation, though their prices can be volatile. Commodities also tend to perform poorly in slow economies, so sluggish growth in most developed countries suggests this is a poor time for these kind of investments. But growing demand from China and other emerging countries has filled the gap, allowing most commodities to thrive. People in those countries are using their rising incomes to purchase consumer goods like fridges, apartments and cars and that impact is huge, says Stephenson, author of The Little Book of Commodity Investing. “Seventy-five million people a year are coming into the global middle class.” He believes commodities are a hedge against potential inflation, but in general, “we’re in an environment I would characterize as good for commodities but not great.”

Investing directly in commodities is mostly done through trading futures contracts, but these markets are dominated by professionals and are too complicated for average investors to master, Stephenson says. One option is to use an ETF that holds a basket of commodities futures. For the most part, Stephenson recommends commodity-based stocks: currently, he sees attractive investments in some companies producing base metals and fertilizers. He also likes Canadian heavy oil producers, which he says should benefit when oil transportation bottlenecks start to get sorted out.

Of course, you may have all the commodity exposure you need already if you are invested in the broad Canadian stock market. That’s because so many Canadian stocks are commodity-related—almost half the S&P/TSX Composite Index is in the energy and materials sectors. But if you don’t have a large commodity exposure already, gradually adding modest amounts to your portfolio should provide useful diversification.

Real estate investment trusts (REITs). Property is also a traditional hedge against inflation, and real estate investment trusts are a good way to get exposure to this sector of the economy. REITs own commercial, industrial and residential properties and pass a portion of their rental income along to investors, so they’re attractive to retirees looking for cash flow.

But you need to consider other factors, says Leslie Lundquist, co-lead manager of the Bissett Canadian High Dividend Fund, which invests in REITs. For one thing, REITs have become so popular that yields have been bid down to a modest 3% to 6%, whereas not long ago they often yielded 8% or 9%. Most real estate values “are at the high end of average,” Lundquist says.

In this environment, REITs may not provide as much inflation protection as one might think, says Lundquist. With modest economic growth, they’re not expected to be able to raise lease rates aggressively in the next few years. And REITs typically have large mortgage borrowings, so if interest rates rise before landlords are able to jack up rents, REIT values may suffer for a while. “You can make the argument that REITs will provide a certain amount of inflation hedge, but that’s not perfect and immediate,” says Lundquist. “The immediate impact of rising interest rates is borrowing costs get higher.”

Remember, inflation is only one risk your portfolio will face during retirement. It’s prudent to make sure your investments have some protection from a possible inflationary scorching, but there are still other ways for your investments to get burned. Since no one knows what’s going to happen for sure, maintaining a diversified portfolio that performs reasonably well in different environments is still a good idea.

David Aston, CFA, CMA, MA, writes about personal finance. You can share your retirement spending experiences by emailing letters@moneysense.ca. He might include your experience in a future article.

These issues are daunting enough when you consider them individually. But then there’s the burning overall question: How do you put it all together?

One good approach is called income layering. While there are several versions, the general idea involves using different sources or “layers” of income to make cash flow smooth, reliable and tax-efficient. Think of it as a layer cake of cash. The base (what I’ve called Layer 1) is composed of income that is highly reliable, but usually not tax-efficient or flexible, such as government and employer pensions, annuities, and income from part-time work (if it is reliable and steady). Then you add a more tax-efficient Layer 2: this includes sources of income that are less reliable but more flexible, like your investment portfolio. Finally, you top it all off with Layer 3: the equity in your home or other property, which you can tap late in life if necessary.

Many financial planners use a variation of this approach, including Douglas Nelson, author of Master Your Retirement, and Daryl Diamond, author of Your Retirement Income Blueprint. In what follows, we’ll show you how you can adapt these ideas to your own situation.

“It’s all about taking less risk, paying less tax, generating more income and connecting the dots in those pieces,” says Nelson, a portfolio manager with Nelson Financial Consultants of Winnipeg.

Income first

Nelson advocates an “income first” approach, placing the focus on generating a sustainable, tax-efficient cash flow that meets your spending needs. That in turn should drive your investment strategy, he says. Nelson suggests retirees aim to have at least their basic spending needs covered by secure sources of income in Layer 1, and says they shouldn’t rely on income from investments in Layer 2 to cover more than 30% of their total spending.

For retirees without good employer pensions, building a solid income base takes some effort. You should look at all sources, including the potential to work part-time, taking government benefits as soon as you retire, or purchasing an annuity. The income benefits of working part-time are obvious, but we’ll consider the other two opportunities in more detail.

Building a base

At one time you started Canada Pension Plan (CPP) and Old Age Security (OAS) at age 65 and that was it. Now you can start CPP anytime between 60 and 70, and OAS between 65 and 70. (Younger Canadians will eventually collect OAS between 67 and 72.) If you start early, you receive more payments, but each one is smaller. Start them later and you receive fewer payments for larger amounts.

There’s no huge advantage or disadvantage whatever your start date if you have average life expectancy. But if you have reason to expect an early demise, you should generally start your pensions as soon as possible. If you have reason to expect you’ll live to an exceptionally old age, then deferring might make sense. (For more details, see my article CPP: Less now or more later.)

Consider how this decision fits with your overall income needs. If you’ve recently retired and don’t have a lot of other secure income, you’ll probably appreciate a boost in guaranteed income. By shifting the timing of these government benefits you’ll provide a smoother flow of income as soon after retirement as possible…

For more on buying an annuity, portfolio options, making investment income more reliable and your home as a safety net, pick up a copy the February/March issue of MoneySense on newsstands now through March 31 or while quantities last. You can also buy it direct from your iPad.

David Aston, CFA, CMA, MA, writes about personal finance. You can share your retirement spending experiences by emailing letters@moneysense.ca. He might include your experience in a future article.

Middle-class seniors who need care outside hospitals typically draw on savings and equity in their paid-for homes. But Mayo wonders whether Canadians can still rely on those methods. His uncertainty is echoed by financial planners who promote long term care insurance. To help you make an informed decision, we’ll describe the health-care costs you could face later in life and compare financial strategies you can use to prepare for them.

Patchy government care

The focus of government support for seniors’ care is the nursing-home system (also called long term care, residential care, or complex care), although these facilities are often privately operated. Costs are shared by residents, but nursing homes turn no one away because of financial need. Many have long waiting lists, so you can’t necessarily count on getting into your first choice right away.

“The provinces have a really good basic system of nursing-home care, so you’ll always be able to get care somewhere, sometime,” says Peter Silin, author of Nursing Homes and Assisted Living and a care manager who operates Vancouver-based Diamond Geriatrics. But while government ensures the basics, don’t expect tightly staffed facilities to provide a lot of one-on-one attention. It may be worth supplementing care by, for example, paying a “companion” to come in several days a week to provide extra help or attention, advises Silin. Also, in some provinces you can pay a little more for a private room. The cost varies: in B.C. it’s 80% of income up to $3,022 per month, while in Ontario it’s $2,275 per month.

There is much less government support for relatively active seniors who want in-home care, or who live in a retirement residence (including independent living or assisted living). Here’s where it’s particularly helpful to have money of your own. “I think there’s a gap there,” Silin says.

Fortunately, middle-class seniors with moderate nest eggs and paid-for homes can usually afford decent levels of care in-home or in a retirement residence. There’s a good chance you can afford a care worker coming in for two hours a day (at around $25 an hour) if this is a priority. A 40-hour-a-week live-in caregiver costs about $18,000 through a federal government program, not including room, board and agency fees, Silin says. A typical cost for independent living or assisted living is $2,200 to $5,000 a month, depending in part on the level of help you need. That sounds like a lot, but in these residences you get your own small apartment with meals and most of your living costs included. (Costs are greater if you need a lot of care or choose a high-end facility.)

As you need more assistance, costs for in-home care or retirement residences can rise to the point where they outstrip the resources of all but the wealthiest. Yet this is precisely when nursing homes are most appropriate. If you’re wealthy and develop severe dementia, you could convert your home into a private hospital and hire three care workers to provide round-the-clock attention. But is that wise? Silin says some people hold on to the idea of staying in their homes beyond the point where it stops being the best place to meet their needs.

Insured for care

The chances that a 65-year-old will require long term care at some point are 49% for men and 65% women, says Paul Fryer, vice-president, individual business management, at Sun Life Financial, citing 2011 figures from reinsurers Munich Re. His industry developed long term care insurance (LTCI) as a way to help you pay for such costs. With LTCI, you start paying premiums when you’re still healthy—many buy it in their 40s or 50s—and expect to receive benefits later, when and if you require care. Payments are dramatically lower if you start early—although, of course, you’re paying for a much longer period. For example, an LTCI policy purchased at age 45 that provides $2,500 in monthly benefits plus some inflation protection costs $1,230 per year for men, and $1,912 for women, according to a recent quote. Purchase it at age 65 and it will set you back a whopping $3,017 per year for men and $4,838 for women. If you wait, you also run a greater risk of not being healthy enough to qualify.

As Jim Mayo learned when he started to research LTCI, policies vary widely. You typically qualify for benefits if you reach a defined level of mental incapacity, or need substantial help performing at least two of six activities of daily living (typically bathing, dressing, feeding, toileting, continence and transferring from bed). Most policies in Canada pay out an income you can use however you want to use it, but some reimburse specific care costs instead. Sometimes benefits are adjusted for inflation, sometimes not. Some policies require you to pay premiums for life (typically these are waived when you qualify for benefits), while in other cases you pay for only 20 years but premiums are higher. Benefits may be paid out for as long as you meet the medical criteria, or they may be capped after a specific time (like five years) or dollar amount. (See “What to look for in long term care insurance,” on p. 26)

LTCI premiums are intended to stay fixed after you buy a policy, although insurance companies reserve the right to raise them. Premiums on new policies have escalated in recent years, in large part due to low interest rates, says Brian Morin, a group LTCI agent and president of Canadian Long Term Care Insurance. (One insurance executive said his company had been forced to increase premiums on new policies by 20% this year.) Canadian insurers have so far managed to avoid increasing premiums on existing policies, but many in the industry fear they won’t be able to indefinitely.

Uncertainties abound

At one time, people tended to die quickly from heart attacks and strokes, says Paul Fryer of Sun Life. But it’s now more likely you’ll survive those events, just as it’s more common to live longer with diseases like dementia or severe arthritis. “You don’t know how much care you’ll need, how long you’ll need it, and when you’ll need it,” he says. “Then there’s uncertainty about how much the government will subsidize care or how much it will actually cost us personally in 30 or 40 years. When you add up all those uncertainties, funding for long term care becomes an insurable event.”

Many Canadians prefer to get care in their own home or in assisted-living residences, where government financial support is weakest, notes Reh Bhanji, regional director for individual insurance at Desjardins Financial Security. “People say, ‘I want that option to choose where I get care.’”

Save or insure? But is insurance the best way to cover long term care costs?…

To read the full article by David Aston, pick a copy of the Dec/Jan 2013 issue of MoneySense on newsstands through January.

So which is it? Is retirement overrated, or should we all be striving to get there sooner? The answer depends on your personal situation but also on how you define “retirement.”

Increasingly, the traditional pattern of retiring full-stop at age 65 to live a life of pure leisure has become outdated. Instead, people want more flexibility—the option to continue working part-time. It’s about staying engaged in a range of activities that enrich mind, body and soul—and maybe your wallet, too, if you need the money.

Advertisements showing smiling retired couples walking along beaches or playing golf may be too limiting. “People are pretty savvy,” says retirement expert Lee Anne Davies, who consults on financial issues of aging. “They know it’s not the ‘great vacation.’ The biggest thing they’re interested in is having control over their own time,” she says. “They often want some time away from work but still want a sense of fulfillment.”

Retirement by any other name

Call it the New Retirement—although many who talk of its evolution don’t much like the R-word at all. (It’s hard to find another term that everybody will recognize and like.) Whatever term you prefer, the role work plays in your life depends on many factors: how you feel about your career, whether you’re still healthy and productive, whether your skills are in demand, and how much you need the money.

Notes: 1. Estimate of typical annual pre-tax spending in today’s dollars, assuming a paid-for home. (According to Statistics Canada, the average senior couple spent about $53,000 a year in 2010. Single seniors spent an average of about $31,000.) 2. Maximum combined payments for Old Age Security (OAS) and Canada Pension Plan (CPP) were $18,380 per person if you retire at age 65, but most people don’t collect full CPP. About $15,000 per person is a rough estimate if you retire at 65 after a fairly long career at average wages or better. 3. Assumes no employer pension.

For more, read the full story Make your nest egg last.

This difficult investing environment is prompting retirement experts to ask the same question. Some doubt whether traditional guidelines about how much you’ll need to retire can still be relied on.

One popular rule-of-thumb says if you retire at 65 you can withdraw about 4% of your initial nest egg each year—adjusted annually for inflation—and expect your portfolio will last at least 30 years. That may not seem like much: after all, it’s just $2,000 a month (before taxes) on a portfolio of $600,000. Yet some retirement researchers suggest even 4% may be too high if you want to be certain your portfolio will live longer than you do. One influential paper even suggests 2% might be a more prudent maximum. With that small a withdrawal rate you’d need a massive nest egg to produce a trickle of cash flow, and most people will simply never save enough to make that feasible. So what’s a retiree to do?

The 4% solution.

The origins of the 4% withdrawal rate go back to William Bengen, who was working as a California financial planner in the early 1990s. When clients kept asking him how much they could safely withdraw from their portfolios, Bengen found he had no credible response. So he undertook a study using U.S. data on stock and bond returns since 1926 to find the maximum steady cash flow that could have been withdrawn each year from a balanced portfolio of half large-cap stocks and half government bonds. He assumed the money needed to last 30 years, so people retiring at 65 could be confident their nest eggs would make it to at least age 95.

His research in 1994 found the maximum safe withdrawal rate was about 4% of the initial portfolio, plus annual inflation adjustments. For example, say you have $500,000 in stocks and bonds when you retire. In the first year, you would withdraw 4% of that amount, or $20,000. In the second year, if inflation is 2%, you would raise that amount to $20,400 to maintain your spending power, and so on every year. (Note the withdrawal amount does not change as the portfolio rises or falls in value—all the calculations are based on the value of your nest egg in the first year.)

Bengen determined that if you followed this strategy during any 30-year period between 1926 and 1993, you would have never run out of money. That includes even the worst periods spanning the Great Depression and the double-digit inflation of the 1970s. In later research and a book he wrote for other financial planners, Bengen pushed the safe withdrawal rate to 4.5%. A host of other studies have used updated data, tinkered with the assumptions, or used other statistical techniques to come up with a number a little higher or lower than 4%. That’s the number many financial planners still use.

But does it still work? Wade Pfau, an associate professor of economics at the National Graduate Institute for Policy Studies in Tokyo, came up with a much drearier number in a study last year. Pfau analyzed how interest rates, dividend yields and stock market valuations helped explain maximum withdrawal rates in the past. Then he combined those historical results with recent investment indicators to forecast a maximum withdrawal rate that might apply to people retiring now. His estimate was just under 2%.

That result is shocking and controversial, and even Pfau acknowledges it is far from conclusive. But as he wrote in a recent blog: “I think the real lesson from this exercise is that using a 4% withdrawal rate from a portfolio of risky assets is not as safe as the historical outcomes would lead us to believe.”

Bengen continues to say retirees can still rely on a 4% or 4.5% withdrawal rate, but acknowledges these are challenging times. “The future we’re facing has so many unusual circumstances. We may be heading towards something totally unprecedented. That’s why I raise these doubts and ask people to be cautious.”

The future may be different.

While the 4% drawdown is often called the “safe” withdrawal rate, you need to understand it isn’t bulletproof. No one has a crystal ball, so we can’t be certain future patterns of investment returns and inflation will be similar to those of the past. We can make assumptions based on history and current economic conditions but can’t precisely quantify the risks that lie ahead.

The financial risks you face when retired are different from those of other investors. First, there is longevity risk: the possibility of outliving your money. And you don’t know if your cash flow projections will be enough later in life if you run into expensive health issues.

But the most pernicious pitfall may be what the experts call “sequence of returns” risk. Many investors put faith in stock prices rising over the long run, but older investors are especially vulnerable to market meltdowns in the early years of retirement. If that happens, retirees may be forced to draw living expenses from beaten-down portfolios. Then, if markets stay low for a few years, portfolios may be too depleted to recover when things improve.

Most studies use data from major stock and bond indexes, but this assumes investors actually receive index-like returns—most do not, because of investment fees. Rather than subtracting costs from investment returns in his studies, Bengen lumps them in with other annual living expenses—so if you use a 4% rate to withdraw $30,000 and pay $5,000 to your adviser, you’d have just $25,000 left for everything else. If you deduct fees from your return assumptions, you’re probably still in the ballpark of a 4% withdrawal rate if you use low-cost index funds and follow a disciplined Couch Potato approach. But if you use other strategies with higher fees, you can’t ignore these in your calculations. “It has to be accounted for,” says Bengen. “It’s a big issue in a low-return environment.”

Finding your magic number.

So can you still rely on a maximum withdrawal rate around 4%, or should you go with something lower? It comes down to a judgment call: if you want more safety, you can always cut back to a withdrawal rate of, say, 3% or 3.5%, but we know many people will have a difficult time living on such reduced cash flow. Another approach is to stick with a 4% withdrawal rate and take steps to limit the risks. Here are four strategies to help you do that:

1. Cut withdrawals if you suffer losses. While the 4% safe withdrawal rate is intended to sustain you even in dismal investment periods, it’s still smart to reduce the amount you draw from your portfolio when it suffers setbacks. That way you reduce the risk of outliving your money. Bengen encourages retirees to keep an eye on their “current withdrawal rate,” which is the annual drawdown as a percentage of a portfolio’s value today (as opposed to its initial value at the time of retirement). As a guideline, he suggests cutting back if you exceed the following current withdrawal rates: 5.6% at age 65; 5.9% at age 70; 6.25% at age 75; and 7.5% at age 80. “The idea is to catch the problem before it becomes too big,” says Bengen. By the same logic you can afford to increase your withdrawals if your investments do exceptionally well in the early years, but you build in a bigger margin of safety if you avoid that temptation.

2. Use home equity for backup. You shouldn’t count equity in your home as part of your portfolio when calculating your initial withdrawal rate. However, that equity can provide backup support. Owning your home reduces your accommodation cost compared to renting an equivalent dwelling, so you don’t need to withdraw as much from your nest egg to enjoy the same lifestyle. Later on, it can help if your finances get tight for whatever reason. It may be that your investments underperform and it looks like your portfolio might run dry. Or you may have health problems and need to spend more than you bargained for.

If you stay in your home, you can tap into the equity using a reverse mortgage or secured line of credit. Or you can draw on the proceeds from selling your home to help cover costs of assisted living or a nursing home. Just don’t tap into the equity early in retirement for a frivolous purpose.

3. Add annuities to the mix. Traditionally, the key assets in a retirement portfolio have been stocks and fixed-income sources (bonds and GICs). However, there is growing recognition of the benefits of adding annuities as a third category. Most research into safe withdrawal rates has been based on traditional stock and bond portfolios, but Bengen is a staunch advocate of using annuities if finances start to get tight.

Annuities, which are purchased from insurance companies, provide cash flow for life in exchange for a lump sum. Not only do they ensure you won’t outlive your money but they usually have a higher payout rate than you can expect from a stock and bond portfolio, especially for older seniors. A recent quote for a joint annuity (which continues to pay while either spouse is alive) for an 80-year-old couple had an initial annual payout rate of 7.1%, with the amount growing by 2% a year, and a guaranteed payout period of seven years. Bengen says at age 80 retirees get attractive rates that are hard to beat with a balanced portfolio.

While annuities have advantages late in life, consider starting earlier. Many experts say the “sweet spot” when annuities make the most financial sense starts around 70 these days. But whatever age you start annuitizing, do it gradually so you’re not overly dependent on the payout rate at any particular point in time. The key downside of annuities is that while they last for life they won’t leave anything to your heirs (beyond any guarantee period).

4. Invest conservatively. With stocks and bonds, you have to get the right balance of risk and expected reward. But if you agree investment risks are unusually high these days, it may pay to be more conservative.

Currently Bengen recommends an asset mix much more conservative than the portfolios on which his research is based. He suggests a typical 60-year-old investor consider putting as little as 20% or 25% of a portfolio in stocks, 8% in gold, and the rest (67% to 72%) in fixed income and cash. “I’d rather lose some returns than lose a lot of money for my clients,” he says.

Other experts aren’t as conservative as Bengen. One mainstream approach is to have 50% to 60% of your portfolio in stocks, but favouring relatively stable stocks that pay reliable and growing dividends. That won’t protect you completely from a market meltdown but it should soften the impact compared to stocks that don’t pay any dividends. In the event of a bear market, reliable dividends may continue to meet much of your income needs (though perhaps not all), thereby reducing the need to sell stocks at distressed prices.

In the case of Jim Phillips, the financial planner took the traditional route, advising him to withdraw 3.5% to 4% of his initial capital each year, with annual inflation adjustments. Luckily, this was in line with his middle-class spending needs. He has the extra advantages of a paid-for house and knew he could trim spending if conditions worsened. His wife, Linda, is still working and will get a good pension. All this “gave me the assurance we’re doing okay.” He retired last year and hasn’t looked back. “I feel I’ve made the right decision and I’m on track.”

In the end, like Phillips, you can still expect the 4% withdrawal rate will provide you with a secure retirement with little chance of outliving your money—but it’s always a good idea to hedge your bets.

How large will your nest egg need to be?

That traditional notion of retirement is pretty much dead. Today most Canadians are able to say goodbye to a full-time career sometime during their early 60s, but the new retirement comes in many forms. It might include golf, travel and volunteering, but it’s also likely to involve contract or part-time work, too. More and more, the goal of retirement is really about achieving financial independence—or to use the word coined by MoneySense editor Jonathan Chevreau, “findependence.” That’s the point in life where your career and lifestyle choices are no longer driven by financial necessity, and it may occur decades before traditional retirement.

The challenge, however, is that the responsibility is more on your shoulders than it was in the paternalistic past. Defined benefit pension plans are dying out, except in the public sector. And the government is starting to scale back seniors’ benefits such as Old Age Security, which will eventually start at age 67 instead of 65. Increasingly, your retirement income depends on how much you save and how you manage your own money. Unfortunately, just while this is happening, your nest egg has no doubt been afflicted by low interest rates and uncertain stock markets. All this makes the new retirement more precarious.

In what follows, we describe seven strategies that will speed you towards financial independence, preferably while you’re still young enough to enjoy it. You’ll also meet seven Canadians who are living out their lifelong dreams and reinventing the traditional notion of what it means to be retired.

Reinvent your job

Before you even think about giving up your full-time job, you need to figure out where your retirement income will come from. Your goals and circumstances are unique, but a couple enjoying a middle class retirement (or slightly better) should expect to spend $40,000 to $70,000 before taxes, in today’s dollars. Singles can expect to spend $28,000 to $49,000. If you retire at 65 with annual government benefits of $15,000 per person, you’ll need to make up the remainder with personal savings of $250,000 to $1 million for couples, or $325,000 to $850,000 for singles. If you retire earlier than 65, you’ll need a bit more.

If you don’t have enough money to retire, then you’ll need to make some tough choices. You can cut back your planned retirement spending, or find a way to save more. But these days, many Canadians are choosing to work longer. The average retirement age is 62, but that’s changing. “We see average retirement ages marching up, and we will get to 65,” says Malcolm Hamilton, partner at Mercer. “At some point we’ll likely go right through it.”

Working longer doesn’t have to mean holding your nose to the grindstone at something you despise. Older workers have an array of part-time, contract and temporary jobs available. How easy it is to find those jobs—and how much you’re paid—depends on your skills and the demand in your local market. You may have to accept less than what you earned at the peak of your career, but even a modest retirement wage can have a substantial financial impact.

If you don’t like the idea of working longer, you’ll need to ramp up your savings. That takes discipline, but even if you’ve saved little by your late 40s or early 50s, you have enormous potential to save if your mortgage is gone and your children are financially self-sufficient. The idea is to redirect into savings the money that used to go to your mortgage and kids. If you’re in that situation with an average paying job or better, you can probably save more than 30% of your income (counting RRSP refunds) if you set your mind to it. Do this steadily for a few years and it can add up to a tidy sum that may allow you to work only if you want to.

Protect your savings

Thirty years ago, retirees could put their savings in government bonds and earn 10% to 15% interest. Today 10-year Government of Canada bonds are yielding about 2%—you would be lucky to keep up with inflation, let alone earn a healthy income. Still, you need to keep a good portion of your portfolio in low-risk investments so you won’t be devastated if stocks get walloped. “You want to make sure you get your principal back on the fixed-income side,” says Hank Cunningham, fixed-income strategist at Odlum Brown Limited and author of In Your Best Interest, a guide to Canadian bonds. “Take risks with your capital on the equity side.”

Plain old GICs are among the best low-risk investments, but you have to shop around for the best rates. As we went to press, top yields for a handful of five-year GICs were around 3%, compared with less than 1.5% on federal bonds of the same maturity. GICs may even pay slightly more than investment-grade corporate bonds with terms of two to five years, Cunningham says, which is contrary to the usual pattern. The highest-yielding GICs are offered by small financial institutions you may never have heard of. You can also find higher-yielding GICs through an adviser or by going to the institution directly. Just make sure you stay within deposit insurance limits: usually $100,000 per institution.

If you use investment-grade corporate bonds, you might be able to boost yields a little by going longer term, since GICs don’t usually go out longer than five years. However, that makes your portfolio more vulnerable to rising interest rates (bond prices fall when rates rise, and the longer the maturity, the greater the decline). For a simple one-stop solution, consider the iShares DEX All Corporate Bond Index Fund (TSX: XCB), currently yielding just over 3%.

Another idea is to create a corporate bond ladder, which smooths out the effect of changing interest rates. While you can build a ladder of individual bonds, you can diversify further by using RBC’s family of target-maturity corporate bond ETFs. Each of the eight funds holds a portfolio of bonds that mature in a specific year, from 2013 to 2020 (the ticker symbols are RQA to RQH). By purchasing equal amounts of these ETFs, you’ll have one-eighth of your investment mature each year, and you can then reinvest that money at current rates.

Boost your income with dividends

While fixed-income investments can protect your savings, you’re not likely to grow your wealth with GICs and bonds. To stay ahead of inflation, you’ll need to keep a significant part of your portfolio in equities, and focusing on dividend-paying stocks may provide the right balance of risk and reward. “The best way for people to get a decent return these days is to have a good portion of that return come from reliable dividends versus less reliable capital gains,” says Bob Gorman, market strategist at TD Waterhouse. “This is going to be the era of the dividend growth stock.”

Picking the right dividend stocks is key. Avoid companies with the highest yields, because that may indicate the dividend is likely to be cut, and the stock price will suffer as a result. Instead, choose reliable dividend-payers that can maintain those dividends even in bad times, while also growing them consistently over time. Look for well-managed, profitable companies in stable industries with good balance sheets and modest growth. They should also pay out only a reasonable proportion of profits.

Income investors will appreciate that many such stocks generate higher yields than 10-year government bonds, the reverse of historical norms. These steady-eddy stocks may lag during booms, but often outperform in bad years. And dividends paid by Canadian companies are taxed at lower rates than interest when held in non-registered accounts. But because Canada’s market is so concentrated, it can be hard to diversify your holdings across a variety of industries, so you may want to consider foreign dividend-payers, too, especially in an RRSP or RRIF. Real estate investment trusts (REITs) can provide further diversification and steady income, although they don’t have the same tax advantages as dividend stocks.

The easiest way to build a portfolio of dividend stocks is with ETFs. For Canadian dividends, MoneySense columnist Dan Bortolotti recommends a combination of the iShares Dow Jones Canada Select Dividend Index Fund (XDV) and the iShares S&P/TSX Canadian Dividend Aristocrats Index Fund (CDZ). For U.S. dividend ETFs, consider the Vanguard Dividend Appreciation ETF (NYSE: VIG). If you prefer buying individual stocks, check out Stocks that pay you back from our April 2012 issue.

But for all the benefits of dividend stocks, you can get too much of a good thing. While the right mix of stocks and fixed income in your portfolio is highly personal, Gorman suggests retirees and near-retirees consider 55% to 60% in dividend-paying equities and the rest in fixed income.

Cash in on your home

Many people approaching retirement have good reason to complain about the investment climate they’ve endured over the last dozen years. But there is one area where they can’t bemoan their bad luck—at least not if they own a house. Real estate in Canada has enjoyed an enormous boom in recent years, and that’s allowed many long-time homeowners to build significant wealth without really trying. That can give you more options in retirement.

If you own an expensive home, you could add to your cash savings by downsizing or relocating. To give an exceptional example, Tony Ioannou, associate broker with Dexter Associates Realty, says some Vancouver homeowners are selling modest-sized homes in the west end, buying two-bedroom condos nearby, and winding up with $500,000 in their pocket. It’s more common for homeowners in other parts of Canada to net $100,000 or $200,000 after costs.

Consider the experience of Phil and Brenda Lewis. The retired couple in their 60s wanted to sell their semi-detached Toronto house and move to Halifax to be closer to their son and his family. The Lewises (whose names we changed) weren’t in dire need of extra cash, but they saw a chance to take advantage of Toronto’s hot housing market to top up their nest egg. So they sold their semi for $780,000 this spring and bought a renovated detached Halifax house in a desirable neighbourhood near the ocean for $620,000. They netted more than $100,000 after costs, while retaining home equity they hope will at least hold its value. “We could have bought a less expensive home in Halifax that gave us less equity and more money,” says Phil. “Instead we chose to buy the home we wanted, which gave us more equity and $100,000.”

The equity in your home can also provide a back-up plan if you run low on savings. If you stay put, you can cover essential expenses by borrowing against it with a reverse mortgage or home equity line of credit—albeit only as a last resort. Later in life, if you move into a retirement or nursing home, the proceeds from selling your house can defray those costs for years. Even if you never draw on your home equity, it can provide a great legacy for your kids.

Think differently about debt

When Catherine Christie split from her husband two years ago at age 61, she wanted to buy a house with her half of the proceeds from their marital home. Christie (whose name we’ve changed) fell in love with a nicely renovated three-bedroom house with a beautiful garden in Toronto’s east end that cost $460,000. However, she was $160,000 short and uncomfortable borrowing so much at that stage of life.

Carrying debt into retirement was once considered dangerous and irresponsible. But today’s low interest rates have changed the game—as long as you borrow smart. “If people want to give you money for free, take advantage of it,” says economist Jeff Rubin, author of The End of Growth. “Just make sure you’re able to finance at much higher rates than you’re financing now,” he advises. You can do that by making sure your debt payments are much lower than your capacity to cover them.

After looking at the numbers, Christie decided that her home purchase made sense after all. Her mortgage payments would be only $600 a month, easily covered by the public service pension she gets when she retires. And the house had a renovated basement that could be rented out for more than that—with some of the mortgage interest tax-deductible.

You can take advantage of today’s low rates to position yourself for your later years. Many Canadians will soon renew mortgages with five-year terms from 2007 and 2008, when interest rates were one or two percentage points higher than today. On a $200,000 mortgage that’s about $2,000 to $4,000 in annual savings you can use to make extra mortgage payments or, if necessary, pay off other debts. If you have high-interest credit card debt that you can’t seem to pay off, you might consider tapping your home equity for a consolidation loan at much lower rates.

Just remember that your main goal is getting rid of that consumer debt, not just making it more manageable. Debt can be seductive, but as you approach retirement it’s critical to only borrow for productive purposes like buying a home or other appreciating asset. Low rates can make the difference for an otherwise unaffordable expenditure, but they won’t turn bad debt into good debt.

Wait before you buy an annuity

Many retirees like the idea of annuities, which provide guaranteed income for life in exchange for a lump-sum payment. In the past, people often purchased annuities as soon as they retired in order to replace their employment income, especially if they had no pension. That may not be such a good idea any longer.

Annuity payout rates are affected by interest rates, and current payouts are dismally low. That doesn’t mean you should shun these investments altogether—it just means it pays to wait. There’s always a trade-off when you delay buying an annuity. You’ll receive payments for a shorter period, and you’ll need another income source to bridge the gap. But those payments will be larger, so you’ll also have a higher stream of reliable cash flow to protect you if you live well into your 90s.

Many experts say the current sweet spot for annuities these days is about age 70. Moshe Milevsky, finance professor at York University’s Schulich School of Business, suggests easing in over five years starting at that age. For example, if you want to annuitize $500,000, you might purchase a $100,000 annuity each year. Financial planner Jim Otar (retirementoptimizer.com) suggests doing so over three years. This gradual approach makes you less dependent on payout rates at any particular moment. If your finances are tight and you feel the need for assured income, starting to convert at 65 might make sense, but you must be willing to put up with the low payouts.

Annuities suit many middle-class seniors but aren’t for everyone. They can be complex and come in multiple forms, so you will need to do your homework carefully before buying. How much savings you ultimately convert to annuities is up to you. Some retirees like to have a combination of annuities and government benefits cover basic spending. That way, if your investment portfolio suffers a big setback, your basic lifestyle is still assured.

Reduce your tax bill

Before 2009, RRSPs were really the only way for Canadians to shelter their retirement savings from taxes. But the introduction of the Tax-Free Savings Account (TFSA) has added another option. Unfortunately, the rules are complex and it’s not easy figuring out how to combine these two tax-sheltered investment accounts for maximum advantage.

If you’re saving for retirement with limited funds, whether you sock money away in your RRSP or TFSA depends on your tax bracket now compared with when you withdraw the funds. If you have a high income today, it makes most sense to use RRSPs first, since you get a juicy tax refund and you’ll eventually pay less when you withdraw money at a lower tax bracket. If your income is low today and you expect your tax bracket to be higher in retirement, then you’re better off with TFSAs, because your RRSP refund won’t be as large and you’ll avoid a larger tax hit down the road.

Problem is, it’s hard to know what tax bracket you’ll wind up in. But retirees typically live on 50% to 60% of the income they had in their peak working years, so RRSPs should be the first choice for those with average salaries or better. If your income in retirement will be about the same, a tie should go in favour of the TFSA because it’s more flexible. If you need the money for an emergency you can withdraw TFSA money without tax consequences, whereas RRSP withdrawals might cause you to pay hefty taxes if you’re still working. TFSAs are also better if you expect to end up with sufficiently low income in retirement to be eligible for the Guaranteed Income Supplement (GIS). Withdrawals from an RRSP reduce GIS payouts, whereas TFSA drawdowns do not.

Later on, you will need to figure out how to withdraw the money without paying too much tax. If you have substantial RRSPs and non-registered accounts, it’s even more complicated. The best strategy is to take a balanced approach to withdrawing money from both sources. (For more on finding the optimal solution, see How to tap your RRSP from our September/October 2011 issue.) That’s because of our progressive tax system, where higher incomes get taxed at much higher levels. Seniors who defer RRSP withdrawals in their 60s are often forced to make large withdrawals after age 71, when they’re required to convert RRSP money to a RRIF or an annuity. That can often push them into a higher tax bracket. “We try to smooth out the withdrawal pattern and make it work efficiently from a tax point of view,” says Daryl Diamond, financial planner with Diamond Retirement Planning in Winnipeg and author of Your Retirement Income Blueprint.

The path to financial independence isn’t always easy. You’re bound to suffer unlucky setbacks—although hopefully you’ll get some lucky breaks, too. “We try to give ourselves lots of options as we approach the age where we stop working, either by choice or because we’re required to,” says Malcolm Hamilton. “That’s about all we can ask for.” If you set reasonable goals now and make adjustments to stay on track, it will give you more freedom to choose later on. Then chances are you’ll achieve your own version of the new retirement that suits you best.

For more, pick up the brand new edition of The MoneySense Guide to Retiring Wealthy, available on newsstands, or at www.moneysense.ca/books.

Meet the retirees profiled in the MoneySense Summer issue, entitled Freedom Now!,  including The Entrepreneur and The Expats.