It’s probable that most readers of this magazine are still in wealth accumulation mode. That’s certainly the focus of the financial services industry and by extension the financial and mainstream media.
But with 10,000 North American baby boomers turning 65 every day for the next 20 years (according to Pew Research Center), it’s clear the next big trend is going to be wealth DE-cumulation. After 30 or 40 years of working, saving and investing (what author Timothy Ferriss dubs “slave, save, retire” in The 4-Hour Workweek), near-retirees will be forced to undergo a massive shift and think about how to start withdrawing all that money.
This is by no means a trivial exercise. In fact, as finance professor Moshe Milevsky of York University recently pointed out, no less an expert than Nobel-prize winning economist William Sharpe declared this to be the single most challenging nut to crack in all of personal finance and investing.gf
Milevsky, retired actuary Malcolm Hamilton, several other retirement experts (and I) recently took part in a brainstorming session sponsored by a new entity called The Decumulation Institute. It was launched on April 1 by Hungarian emigrant John Pur, formerly of pension consultants Cortex Applied Research Inc.
The institute’s focus is to help corporate sponsors of defined contribution pension plans better serve the needs of their plan members on this vexing issue of decumulation. By extension, the principles also apply to RRSPs and RRIFs.
Moving from accumulation to decumulation requires a radically different mindset but it’s arguable the vast majority of financial advisers are more focused on the former than the latter (perhaps because they themselves are still accumulating!). I’m aware of only a handful of advisers that specialize in decumulation: notably Daryl Diamond, who outlines the issues in his excellent book, The Retirement Income Blueprint.
Turning your savings into an income source is tough—do it wrong and you’ll run out of money
At the institute’s inaugural meeting this summer, the discussion started with the role of annuities. Pur noted it’s a puzzling fact that in practice annuities are much less popular with retirees than they should be, given their theoretical advantages. If retirees fret primarily about outliving their money, the “longevity insurance” aspects of life annuities would seem to be a no-brainer. Indeed, “economists seem to agree annuities are the best retirement vehicles for most people,” Pur says. But whenever they are offered, “Only a fraction of retirees opt to buy them.”
Decumulation is complicated by Canada’s byzantine tax and pension laws, and the same high investment costs that plague the accumulation side. As Hamilton noted, devising an efficient decumulation strategy must take into consideration not just investment costs, interest rates and fluctuations in the stock market, but also two factors that trump those purely financial considerations: tax and government benefits.
In accumulation mode, tax is scarcely considered as long as money is held in tax shelters like RRSPs and TFSAs. But in decumulation mode, those turning 65 must consider such things as clawbacks of government benefits like Old Age Security or the Guaranteed Income Supplement. As age 71 looms, would-be retirees must also factor in the forced withdrawal and taxation of Registered Retirement Income Funds (RRIFs), withdrawals that eventually force most retirees to break into capital.
Rational decumulation tactics include shifting investments to TFSAs, which upon withdrawal trigger neither tax nor benefit clawbacks. Another strategy is the so-called “RRSP meltdown.” This goes hand in hand with the idea of deferring Canada Pension Plan benefits to age 65 or 70, and doing the same with OAS benefits (which start at 65 for today’s retirees, but won’t begin until 67 for younger folk still in the workforce.)
Better to start drawing down on RRSP balances earlier in retirement, this reasoning goes, with the first annual $11,000 or so withdrawn almost tax-free, according to the federal portion of the Basic Personal Amount ($22,000 per couple). Still, by the end of the year you turn 71 those RRSPs must be annuitized or converted to RRIFs, at which point forced withdrawals come into play. You’ll pay tax on those withdrawals but the first $5,500 ($11,000 for couples) can be pumped back into TFSAs, generating more future tax-free investment income.
And what of annuitization? The question is not simple because health and longevity are interconnected. Assuming good health and normal prospects for a long life, Milevsky and others see annuitizing at least partially by age 85, keeping in mind some pensions and enhanced CPP and OAS benefits deferred under 70 also act like inflation-indexed annuities.
This topic won’t be going away any time soon. At MoneySense’s 15th anniversary event in May, David Chilton predicted this will be the dominant theme in the next decade, as more boomers grow older and enter semi- or full retirement.