Strategies for minimizing retirement risk

Sequence-risk solutions, RRIF withdrawal-rate changes

The onset of the COVID-19 pandemic has thrown many retirement plans into disarray. The collapse of the stock market in March, volatility in bond prices, the crash of energy markets, and the shutdown of virtually all economic activity naturally is causing a great deal of anxiety for those who were planning for retirement this year. But even now, there are financial strategies for pre-retirees and those in the early phases of retirement that can help protect your nest-egg and secure your income streams.

In its recently-released quarterly Monetary Policy Report, The Bank of Canada’s message was downbeat, to say the least. It estimated that real activity was down between 1% and 3% in the first quarter of the year, and will be 15% to 30% lower in the second quarter than in fourth-quarter 2019.

The BoC went on to say that it is unable to predict the trajectory of any recovery, saying, “the timing and strength of the recovery will depend heavily on how the pandemic unfolds and what measures are required to contain it. The recovery will also depend on how households and businesses behave in response. None of these can be forecast with any degree of confidence.”

All in all, we’re headed into a major recession that will have a bearing on how those who were planning for retirement in the next few months will proceed. Here are a couple of planning strategies for those now planning retirement to consider.

1. Postpone the plan – temporarily

With the March stock market crash, many equity-based portfolios have lost considerable value. For pre-retirees this is a classic example of “sequence-of-return risk” (or sequence risk) and one that in my view is absolutely critical for those on the verge of retirement to understand.

Sequence-of-return risk is basically the risk that starting to make withdrawals from retirement accounts (non-registered, RRSPs, TFSAs) at the wrong time in the market cycle will depress your investment portfolio’s overall rate of return. This can cut into your income stream if you depend on the income from that investment nest egg and are no longer contributing any new money to your retirement accounts.

Of course, sequence risk has less impact on cash or near-cash safety investments, or investments like government bonds and investment-grade corporate bonds. These generate a steady stream of income from interest payments, regardless of what happens in markets. But that interest rate will generally be lower than riskier investments like dividend stocks. So sequence risk is a bigger problem on volatile investments whose returns are unpredictable, including stocks, commodities like gold, and real estate.

When you do retire, you start to withdraw funds from your various retirement accounts. Chances are you are no longer contributing any money to them. During a bull market, withdrawals aren’t a real problem. Some of the drawdown will simply fill up again through portfolio growth. But in a bear market, as now during the COVID-19 pandemic, it’s a different story. Your withdrawals deplete your investment accounts, and you’re not making any new contributions. There is no regeneration of your accounts.

Sequence-of-return risk is not totally under your control. After all, who could have predicted the pandemic last August? But even so, you can limit your downside with a few simple strategies.

Hedging sequence risk

* Delay retirement if you can. If you’re on the verge of retiring, but haven’t yet pulled the trigger, consider working as long as you can so you can continue contributing to your retirement savings plans. The coming recession, which could be one of the severest since the Great Depression, can hit retirement accounts hard if you decide, for example, to convert equity holdings to fixed income or an annuity now. Equity values are near rock bottom. So are annuity rates. Put off the day you have to convert as long as you can.

* Keep working if your employer lets you. If you’re self-employed, work for as long as you have clients, and can keep them. If you’ve been laid off or lost your job because of COVID-19, apply for the Canada Emergency Response Benefit. It makes no difference whether you’re ready to retire in a few months or not – you’re entitled to it for as long as it lasts if you’ve lost your job because your employer has closed their doors or you have otherwise lost your job.

* Gear down. Many retirees keep working for former employers on a part-time contract basis. High net worth senior executives often offer their services on boards of directors. Other create start-up businesses, perhaps turning a hobby into a lucrative sideline business.

* Keep saving and investing even after you retire. If you’re past age 71, you have to convert your RRSPs to a RRIF or annuity. But you can still contribute to a TFSA or open (or keep) a non-registered investment account. If Canada Pension Plan and employer pension income is enough to cover living expenses, move the minimum amount that’s required by the RRIF rules into a TFSA.

If you need money sooner, diversified fixed-income ETFs and mutual funds could provide an alternative income stream.

2. RRIF reductions – a gift from the feds

As part of its COVID-19 emergency response plan, the government decreased the required minimum withdrawals from RRIFs by 25% for 2020. All seniors should take advantage of this, if you don’t strictly need all the RRIF funds to live on, because it keeps more money working on a tax-sheltered basis in your RRIF, at least for 2020.

Normally, required RRIF withdrawals are based on an age-based percentage “RRIF factor” that’s multiplied by the fair market value of your RRIF assets as of Jan. 1 each year.

For example, normally, if you were age 71 at the beginning of this year, and you had $500,000 in your RRIF, you would have to withdraw 5.28% (the factor for your age) x $500,000 = $26,400. The factor rises annually until age 95, when it is capped at 20%.

Under the federal government’s COVID-19 Emergency Response Plan, for the year 2020, that factor is reduced by 25%, to 3.96% at age 71, rising to 15% at age 94. So for 2020, the 71-year-old retiree would have to withdraw 3.96% x $500,000 = $19,800 from their RRIF, a difference of $6,600, which can be left in the RRIF to grow on a tax-deferred basis.

For RRIF withdrawals of those younger than age 71, the factor is calculated as 1 divided by (90 minus your age on Jan. 1, 2020), and reduced by 25%. So for example, a 67-year-old would have a reduced RRIF factor of 3.26% for 2020. And with a RRIF valued at $500,000 on Jan. 1, their minimum withdrawal would be $16,300.

And here’s a handy tip to reduce those minimum withdrawal amounts even more: Use your spouse’s age to calculate RRIF withdrawals. Yes, the rules let you base your minimum RRIF withdrawal calculation on your spouse’s age. If your spouse is younger than you, that could be a benefit because your spouse’s minimum withdrawal amount would less than yours, which not only keeps more in the tax-sheltered account but brings less into your taxable income for the year.

Robyn Thompson, CFP, CIM, FCSI, is the founder of Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management for high net worth individuals and families. Contact her directly by phone at 416-828-7159, or by email at rthompson@castlemarkwealth.com for a confidential planning consultation.

Notes and Disclaimer

The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned are illustrative only and carry risk of loss. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please contact the author to discuss your particular circumstances.