Q: I have a defined benefit pension, real estate (but not income-generating) and cash in GICs, but no equities.
At 63, I would like some assurances of my future income stream. I am obviously risk averse, but I am willing to look at other options.
Can you help me?
A: As people enter their 60s, whether they like it or not, they need to consider how they’re going to fund their retirement. One of the universal phenomena I observe is that people are uncomfortable converting from accumulation to decumulation. Even those who have more than enough can feel very anxious.
Having a defined benefit (DB) pension makes it a little easier for you, Penny, because at least you have a guaranteed source of retirement income. Fewer retirees have DB pensions these days than previous generations, so you have at least a moderate degree of certainty coming from your pension. Even the way in which a monthly pension is paid out – on a regular basis, like your pre-retirement salary – is appealing.
In addition to your DB pension, Penny, you will have two more DB pensions in retirement from the federal government.
The average Canada Pension Plan (CPP) retirement pension at age 65 is currently $8,221 but could range from nothing to $13,370 annually depending on your past contribution history. You can confirm your CPP entitlement with Service Canada.
Old Age Security (OAS) is based on your years of residency in Canada. If you’ve been resident for at least 40 years since the age of 18, OAS pension for those who are 65 in 2017 is $6,942. If you have less than 40 years of residency, your pension will be pro-rated accordingly. If your net income is over $74,789 on line 236 of your tax return, your OAS pension gets reduced by 15 cents on the dollar. And your OAS would be fully clawed back at $119,615 of income.
You mentioned you are 63, Penny. If you are going to work past age 65, you should consider deferring your CPP and/or OAS.
You have the option with CPP to start your pension as early as age 60 or as late as age 70. There’s an 8.4% increase in your pension for each year you defer after 65. There’s even a post-retirement benefit (PRB) with the CPP where you can contribute after age 65 and boost your pension by up to 2.5% per year.
You can start your OAS as early as 65 or as late as 70. Delaying after 65 results in a 7.2% annual increase.
I don’t want to get into too much detail, but I think it can be hugely beneficial to consider deferring your CPP and OAS pensions past age 65. The statistics show only about 1% of people do it, but I’m sure way more than 1% of people would be better off doing it.
As a conservative investor who likes a sure thing, you would likely benefit from deferring your CPP and OAS pensions, Penny. It may not feel comfortable drawing down on your GICs earlier as opposed to later, but government-guaranteed, inflation-adjusted income that lasts as long as you do is a pretty good reason to cash in those low-yielding GICs early in retirement to defer your pensions.
If you have a decent DB pension, Penny, I could make an argument that you could take on more risk with your investments because your pension means you need less fixed income in your portfolio. I could also make an argument that GICs are poor investments these days, given the yields are barely keeping up with inflation. I could also make an argument that a diversified portfolio of stocks always goes up over the long run, even if stocks can be down for a few years at a time and can be volatile along the way.
But investing is like clothing or food. Your tastes may be different from someone else and it’s ultimately up to you what you put on your body, in your body or in your investment portfolio.
I think the best thing you can do given your concern about retirement income, Penny, is to do some retirement planning. At the very least, try to get a sense of your CPP, OAS and DB pension income. Use an online tax calculator to try to get a rough sense of your tax payable on that income. Take your GICs and divide the balance by 20. This is at least a rudimentary sense of your retirement income. How does this line up with your current spending? Have you factored in home repairs, new cars and other extraordinary expenses?
I find that most retirees spend a similar amount in retirement to what they are spending in their final working years, but everyone is different.
Want some further validation? Many DB pension plans have retirement income calculators that will help you model future retirement income, including from government pensions and private savings. If your employer offers this, take advantage and do some modelling of your own.
There are fee-for-service retirement planners who specialize in modelling retirement income and assessing your retirement funding. Because they charge a fee for their service, they aren’t interested in selling you investments or talking you out of your GICs, Penny. The MoneySense Approved list is a good starting point to find one.
If your retirement income goals are going to be comfortably met with only a modest return on your retirement savings in GICs, great. But if you’re not on track and could come up short, maybe it’s worth considering more risk with your investments. Once you have a sense of the rate of return you need to earn to achieve your retirement goals, you can decide whether staying with course with GICs will suffice.
If not, you may need to decide between spending less in retirement or taking on more uncomfortable investment risk. With knowledge you can decide accordingly.
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.
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