Retirement may be the new 40, some advertisers suggest: Retirees are only as old as they feel, and the world is their oyster.
That may well be true, but their savings accounts don’t have the same elasticity as they did at 40. There are wrinkles — some deeply etched ones, in fact.
After all, at age 40, there’s still time to earn money enough to erase the physical evidence, though not the memory, of bad financial judgments. At age 65, the wrinkles have dug deep grooves, and the memories remain.
But they don’t have to.
Moshe Milevsky, a professor of finance at York University’s Schulich School of Business, and Alexandra Macqueen, a former advisor who now works on special projects for the Quantitative Wealth Management Analytics Group in Toronto, open their book, Pensionize Your Nest Egg, with a telling example.
Gertrude 1, an 85-year-old, lives comfortably on $50,000 a year from all guaranteed income sources combined. Meanwhile, Gertrude 2, also 85, has amassed some savings in mutual funds. The authors don’t specify the amount, but let’s assume that nominally, she could withdraw $50,000 a year. Yet she frets constantly about spending money.
The difference? One has a secure, if modest, guaranteed income for life, while the other is wrestling with whether she can afford to spend money without depleting her savings.
From the perspective of a 40-year-old, these may seem like slender differences. Both Gertrudes have plenty of money. And unlike the 40-year-old tied down with mortgages and school expenses, the Gertrudes are debt-free. They have money to spend. But one can spend without worry, the other can’t. Advisors need to make their clients aware of the differences.
Two decades ago, when I began a career in financial journalism reporting on the last great recession, I was struck by the spending habits of my peers — the original Generation X. They suffered, I thought, from the pension illusion. They spent freely in the here and now, assuming that, like their parents, pensions would pave their passage through old age.
Of course, they didn’t have pensions. As Milevsky and Macqueen note, few workers in the private sector do. Almost all civil servants do, and three-quarters are in defined benefit (DB) plans, often inflation-protected.
But in the larger private sector, only 17% of workers participate in DB plans, while 72% have no pension plan except for their RRSPs. And advisors know how few people max out their RRSPs: Only 30% contribute anything at all.
But even if everyone maxed out their RRSP, they wouldn’t have a real pension, as Milevsky and Macqueen define it: “A pledge that you — the retiree — will receive a real, predictable, and reliable stream of income for the rest of your natural life.”
That reliable income stream doesn’t come cheap. If you wait, say, until age 62, a guaranteed $60,000-a-year life annuity will cost $1 million. So how do advisors solve this $1 million question? First, we need to understand where the solution comes from.
In the first part of their book, Macqueen and Milevsky tackle retirement costs, the sequence of returns, and longevity risk. You can gauge retirement costs through a life annuity. That may not be a hopeful exercise for potential annuitants. But it’s the fail-safe option.