By now, if you don’t have a pension, you’re probably wishing you did. Luckily, you can create your own pension-like retirement portfolio in your RRSP. We’ve enlisted the help of Malcolm Hamilton, a partner with Mercer Human Resource Consulting, and Colin Sinclare, senior vice-president of McLean Budden (the sixth-largest pension fund manager in Canada), to show you how. Hamilton says there’s no way you can replicate a government pension of the sort John and Susan enjoy—unless you can afford to sock away 30% of your salary every year. But you can replicate many of the benefits of a good corporate defined benefit pension if you follow these tips:
Use an RRSP
In corporate pension plans, the money compounds tax-free within the plan. You can get the same type of tax break by investing in your RRSP. Most people love the tax refunds that come with RRSP contributions, but it’s better if your retirement savings aren’t taxed in the first place—just like with a pension plan. File form T1213 with the Canada Revenue Agency, and you won’t have to wait for your tax refund to get your money working for you.
Make your savings automatic
A key benefit of most pensions is that the money goes in the plan before you see it, so no willpower is required. You can achieve almost the same benefit by setting up automatic transfers into your RRSP before you can touch your paycheque.
Know your risk tolerance
Defined benefit pension funds typically go through a formal process to assess their risk tolerance as part of establishing an overall financial plan, notes Colin Sinclare of McLean Budden. That helps them set an appropriate long-term balance between stocks and fixed income. Consider a similar process on your investments. Remember that different people have different risk tolerances. If the market crash of 2008 was too much for you, pick a mix of stocks and bonds that would produce a drop you could live with if the market crashed again.
Reduce exposure to stocks as you get older
Pension funds typically reduce exposure to stocks to make the fund less volatile as the average age of plan members increases, says Sinclare. Similarly, you may want to reduce your own exposure to stocks as you age, he says. One simple formula is to set the target proportion allocated to stocks at 100 minus your age. If you want your asset allocation adjusted automatically as you age, a good option is to invest in retirement target date funds.
Don’t forget to rebalance
Pension funds typically follow a disciplined process to rebalance their holdings as changes in value of different assets cause the mix to diverge from long-term targets. Individuals should do the same, advises Sinclare. That means, for example, if stocks have been hot and their value has surged, causing equities to exceed your allocation target, then it may be time to sell some and buy fixed income to get back on track.
Keep a “liquid” cushion
Pension funds try to ensure they can pay retiree pensions without having to sell long-term investments under duress. Individual investors should also keep an adequate cushion, say the experts. Sinclare advises that retirees consider having sufficient short-term investments and investment income to cover up to two years of living expenses to avoid having to sell stocks at inopportune times. “That will allow you to have the comfort to stick with the investment policy you might have in the long term and not be concerned about volatility.”
Keep an eye on your fees
Pension funds are known for their top money managers, but where appropriate, they also invest heavily in low-cost index or exchange-traded funds (ETFs) to keep their expenses down. You can do the same. See “The Couch Potato Makeover” on page 37 to see how.
Manage your “longevity risk”
Pension plans can use average life expectancies in their calculations because the higher payouts to exceptionally long-lived plan members are offset by the shorter payouts to those who die younger. But since you have a pension plan just for one (or two), you need to protect yourself from running out of cash in case one of you lives well into their 90s. You can do this by buying annuities that provide a steady guaranteed payment for life. Because interest rates are low right now—which means a low annual payout for every dollar you put in—you may want to use annuities sparingly for now and wait to see if rates rise.