As Canadians prepare for retirement, constructing a robust decumulation plan and an efficient retirement portfolio is key to financial well-being at retirement. While decumulation strategies may be challenging, retirement literacy can help Canadians overcome obstacles along the way. Retirement literacy can provide Canadians with a more in-depth knowledge of the issues at hand and how to best plan for the varying and diverse needs of retirees.  

Like many other things in life, we want to strike a balance with financial well-being in retirement. That is, achieving a balance between maintaining a desired standard of living, minimizing the risk of outliving retirement assets, avoiding overspend or underspend during the retirement years, and perhaps also leaving an estate. To best design resources that can guide Canadians through this confounding stage of life, let us examine the challenges Canadians are facing as they plan for retirement. 

Retirement Spending Patterns

In order to structure an efficient decumulation strategy to budget adequately for one’s years in retirement, it is important to understand the spending patterns one could expect at retirement. Conventional wisdom might have us assuming a flat annual amount (adjusted for inflation), however such an approach could result in unnecessarily overestimating retirement needs and underspending early in retirement.  

A more dynamic pattern often observed is the “Retirement Spending Smile”. Early years of retirement are defined by higher spending (e.g., on entertainment and traveling). Mid-retirement years are characterized by a decrease in mobility and therefore spending. The latter part of retirement typically experiences increased costs, such as health care and long-term assistance – although expenses do not always rise back up to the spending levels in the early years of retirement, especially when factoring inflation adjustments.

Retirement Spending Smile[i]

Literature surrounding potential retirement spending patterns can help individuals think about the lifestyle they would like to maintain and develop a better sense of where they may fall within this spectrum of expenditures. Understanding one’s retirement spending pattern is the first step to building a retirement decumulation strategy.

Longevity Literacy

Over the last century, we have seen continuous improvements in life expectancy. This is the result of numerous factors including medical and health care advancements as well as a focus on maintaining a healthy lifestyle including exercise and nutrition. Longevity, or how long one might live, is a crucial aspect in the retirement planning process. Understanding longevity provides a strong sense of the number of years one may spend in retirement and the funds necessary to minimize the risk of outliving their assets.  

Consider an employee who is planning their retirement. Having unbiased guides regarding life expectancy would immensely help them estimate a financially feasible retirement age, avoid overspending in the early years, and create a long-term retirement budget.  

Canadian mortality tables tell us that men and women who are 65 years old have a 50% likelihood of living to age 89 and age 91 respectively[ii]. Our perceptions of longevity, however, do not always align with these mortality tables. A recent study[iii] found that Canadians underestimate their life expectancy; women by approximately 5.4 years while men by 2.4 years. Lack of information on how long Canadians can expect to live can significantly impact one’s financial situation in the latter part of retirement.

A longevity modeler can help provide information on how long one might expect to live. The Actuaries Longevity Illustrator[iv] is an example of such a modeler designed to help users estimate longevity. Once basic individual information is entered, the modeler displays the likelihood of living to certain ages (for example, ages 85, 90, 95 and 100). 

Life expectancy in Canada has increased by approximately 13 years since the 1960s[v] and with it the probability of living well into one’s 90s. Understanding the likelihood of living to certain ages and how this translates into one’s financial well-being is vital in the retirement planning process.

Retirement asset expenses

During their working years, many Canadians receive regular income which is used for various living expenses such as mortgage payments or rent, groceries, entertainment, retirement savings, etc.  This income determines the living expenses and lifestyle that we can take on. Such monthly living expenses and their budgeting continue at retirement. However, there is another set of complex expenses that is key to successfully planning for retirement and the decumulation of assets; the expenses related to retirement assets. In order to understand the role retirement asset expenses have in Canadians’ financial well-being, it is crucial that ample, succinct literature is available that provides tangible examples and analyses of the impact of such expenses. 

Consider a retiree (age 65) with an account balance of $300,000 is looking to invest the funds and make an annual withdrawal of $20,000. How the funds grow, and how much would be left for beneficiaries should they so wish, depends on the fees charged to manage the retirement assets. Lower investment management fees can result in an additional 5 years of payments; that is another $100,000 of income to the retiree[vi]. Retirement literature and modeling tools that highlight the explicit financial impacts of investment fees will go a long way in helping to shape decumulation strategies and retirement outcomes.  

Now imagine that same retiree is considering using the $300,000 to buy a guaranteed annuity which pays out $20,000 annually for as long as the retiree is alive. Once again, literature that can provide tangible ways to assess the cost of purchasing an annuity compared to investing on their own, would help them assess an optimal decumulation strategy.  At a minimum, it’s important to understand the likelihood of recouping the original premium of $300,000 when purchasing an annuity. At annual payments of $20,000, it would take 15 years to recapture the original premium. A longevity modeler such as the Actuaries Longevity Illustrator can be used to determine that a 65-year-old in moderate health has a 70% to 80% likelihood of living another 15 years, depending on their gender. 

New and unbiased literature or modelers could help individuals compare these options pragmatically and decide on the best decumulation strategy, taking into account unique preferences and priorities at retirement, such as bequeathing.

Sources of income at retirement

In order to effectively plan for retirement, resources that provides a deep understanding of the various sources of income at one’s disposal are key. Equally important is providing Canadians with the information to help understand how these streams of income can interact with one another so that a retirement portfolio can be constructed as efficiently as possible.  Having a holistic view of one’s retirement assets and income streams can put in perspective which amounts are predictable and payable for life, and which amounts can fluctuate.  Such fluctuations are often a result of varying investment income and with it, varying risk-reward strategies. Understanding the proportion of predictable income will help set parameters around the income that may fluctuate.  

Government benefits such as Canada Pension Plan (CPP), Old Age Security (OAS) and Guaranteed Income Supplement (GIS) provide predictable, monthly payments that increase with inflation periodically and are paid as long as the retiree is living. Similarly, an employer-sponsored defined benefit (DB) pension provides monthly payments for life.  RRSPs and defined contribution (DC) plans yield a lump sum at retirement that can fluctuate with investment return, is subject to investment management fees and may deplete at some point. Gauging how to draw down such lump sums requires insight into expected spending patterns, longevity, and what portion of one’s retirement income is predictable.   

Risk-pooling vehicles enhance the effectiveness of savings that may fluctuate. Economies of scale can be leveraged to enable lower investment management fees which, as noted above, can increase the amount of income paid to retirees.  Pooling of funds can facilitate access to asset classes that individual investors may not be able to otherwise access; asset classes which may reduce volatility without sacrificing investment returns.   

Products such as Variable Payment Life Annuities (VPLAs) provide numerous advantages in creating a comprehensive retirement portfolio. VPLAs are an innovative and cost-efficient solution to converting lump sums into lifetime income.    To reference our previous example, this means that a $300,000 retirement fund used to purchase a VPLA may provide higher annual payments than a guaranteed annuity would while also mitigating the risk of outliving one’s assets.  

While a VPLA is subject to fluctuations in payments, its risk-pooling characteristics can provide access to strategies that minimize volatility. Moreover, it is only when viewing one’s entire retirement portfolio, combining both guaranteed monthly payments and amounts that can fluctuate, that the overall potential volatility can be assessed. 

Literature that describes innovative retirement vehicles and their considerations as well as modelling tools that combine all potential sources of payments will provide Canadians with a holistic overview of their retirement income as well as the options available to them. 

A call to action

Hundreds of thousands of Canadians are retiring each year. As professionals within the pension industry, we are well positioned to equip Canadians with unbiased and concrete literature and modelling tools to assist in retirement planning. Let us create awareness of the decumulation challenges Canadians face. Continued dialogue and industry collaboration will help forge a path forward for innovations and solutions within the retirement and decumulation space.