Boomers are heading into retirement at a bad time. The staple of retirement investing — fixed income — isn’t delivering the way it used to.
Magnifying the problem is the otherwise welcome fact that people are living longer. Clients who’ll rely heavily on their RRIFs may have to take on more risk than retirees are accustomed to.
Investing RRIF assets
Jim Otar of Otar & Associates suggests moving equity holdings into dividend-paying funds five-to-six years before converting RRSPs to RRIFs. Clients should also have no more than half their portfolios in equities, and the fixed-income portion should use mainly shorter-term bonds.
Advisors need to consider three main risks:
- Market – fluctuations can lead to a sequence of negative returns, and there’s not enough time in the retirement phase to recoup them
- Inflation – the purchasing power of savings dwindles as inflation rises
- Longevity – longer life spans raise the risk of running out of money
Otar says longevity risk is particularly important given longer life expectancies and that advisors should plan to age 95 for men, and 97 for women.
“If you use the average life expectancy — 79 for men, 83 for women — there’s about a 50% chance clients will be alive when their money runs out. That is far too much risk.”
Bev Moir, senior wealth advisor and financial planner at ScotiaMcLeod, varies her approach depending on when and how clients plan on drawing their RRIF payments. Wealthier clients who don’t rely on RRIFs typically take payments all at once at year’s end. This allows them to grow their money tax-free as long as possible. “For this type of client I try to have bonds that come due on December 1,” Moir explains.
Some clients are not very disciplined with their cash flow and want to treat their RRIF like a monthly pension payment. “In that case, I may use equities that produce monthly cash flow, like balanced funds or publicly traded REITs,” Moir says.
Some clients want the entire RRIF payment at the beginning of each RRIF year. In this case, Moir uses a five-year laddered-bond strategy. A bond will come due every year at the point the client wants to draw the funds.
For these clients, Moir says she takes a conservative approach to RRSP contributions made five to seven years before converting to the RRIF. She keeps them in cash or shorter-term bonds to plan for a $50,000 payment, for instance, on day one of the RRIF period.
It’s important to maintain enough flexibility to take advantage of good buys. How much cash and equities a client has depends on age, asset levels and expenses, but the portfolio should have enough liquidity to seize immediate opportunities, says Moir.
“In the midst of the 2008 crisis Canadian financial institutions were issuing a lot of Tier 1 capital bonds. A 10-year bond that I put in clients’ accounts pays 7.24% interest per annum — equity-like returns out of a bond from a high-quality issuer. It was nice to have the cash available to seize this opportunity,” she explains.
While risk tolerance decreases in the draw-down years, clients can’t be too conservative in the current environment. RRIF rules say a 72-year-old client must draw 7.4%, but if a large chunk of her investments are stuck in vehicles earning 2%, she’ll encroach on principal too quickly.
When fixed-income returns were in the 7% to 9% range, advisors could ladder them over a 10-year period. Every year the client had a bond coming due with a great return, and that would be the RRIF payment.
“But in the current environment, with yields so low — a 10-year Government of Canada is 2% — I’m looking more at balanced mutual funds and dividend-paying equities” to extend the RRIF’s best-before date, Moir explains.
“It’s more risk than clients normally take on at this point in their lives. But it’s important to discuss this option with them,” she adds.