We spend so much time in the accumulation phase of our lives and careers that sometimes it can be hard to make the switch over to a new way of thinking that goes along with major life changes like the transition to retirement.
At this stage of life, though, it’s more important than ever to prepare a wealth plan to ensure certain decisions don’t sabotage a lifetime of savings.
Cash-flow planning is a particularly complex part of a retiree’s wealth plan. Not only are there multiple levers to work with — that is, various sources of money to draw from, such as registered plans, non-registered investments, corporate accounts, etc. — but there is often a shift in mentality about investment holdings, market volatility, inflation, and of course, taxes. Essentially, clients become emotional in retirement; they may want to move to fixed income for the no-fuss portfolio, or they may hold on to a concentrated stock position because of the emotional attachment.
Today, market volatility is probably the most obvious and worrisome factor impacting portfolios. When markets are volatile, individuals generally want to move into safer investments. They back away from equities and head towards fixed-income alternatives.
The risk here is that lower after-tax rates of return may not keep pace with inflation. For someone in the retirement phase of life, this may result in withdrawing more capital than might be prudent. Not only does this erode his or her net worth, but it also increases volatility risk even further, since the client may find himself or herself drawing capital at particularly inopportune times, when markets, and his or her investments, are at a low point.
It’s a relatively new phenomenon, but it’s important to be continually educated about the risk of retiring from investing. This is when clients want to take their investments and move entirely into fixed income in pursuit of a no-risk, no-mess, no-fuss portfolio. But in fact, this scenario opens clients up to a different set of risks — they’ll have to contend not only with the risk of earning lower rates of return, but also with an investment that produces interest income, which is subject to much higher tax rates compared to dividends and capital gains.After-tax rates of return are really a more important way of looking at cash flow in retirement.
Individuals entering retirement can also lose sight of their time horizons. Many think that with the move into their retirement years, it’s time to shift entire portfolios to fund short-term cash-flow needs. But this may not be appropriate, given a typical retiree’s investment horizon can be 30 years or more.
The third big risk is people can sometimes use their retirement funds before taking advice from their professional advisors. Helping children fund a business or purchase a home, or providing significant gifts during their lifetime are examples where specialized advice should be sought, as there might be more tax-efficient or secure ways of passing on the funds.
Fortunately, there are a number of products and strategies that help seniors liquidate their assets more tax-efficiently while providing a secure future.
Different income, different impact
Retirees also need to be aware of the impact drawing assets from different accounts has on their after-tax retirement income. For instance, clients should be aware of the impact dividend income has on the Old Age Security clawback, compared to capital gains or withdrawing pension income from their registered investments.
Discretionary income, such as income from private corporations or family trusts, should also be part of the equation.
The average pensioner may require help identifying all of the income-splitting opportunities available in order to save tax.
A high-net-worth executive, meanwhile, will likely be more concerned about diversifying out of concentrated company stock, conversion opportunities for executive health care benefits, and/or the loss of life insurance upon retirement.
Stock options or employee share purchase plans represent another area that needs to be managed appropriately for the high-net-worth executive. Having a significant amount of wealth tied up in one stock is risky, but on the flip side, diversifying can result in a significant tax bill.
At the same time, emotionally, it may be difficult to diversify, as this may have been a company that created significant wealth in the past and is most known to the former executive.
Where a client was formerly a business owner, it will also be necessary to understand shareholder’s agreements and succession plans (if appropriate) to ensure the family gets maximum value out of the corporation when the business is eventually sold. Even before this, though, business owners should be considering ways to efficiently draw their income without incurring large tax liabilities.
Importance of the plan
Often, individuals might have considered doing things differently during their lifetimes if they had had a better understanding of where they currently stand and what their future looks like. They might have looked more closely at implementing certain tax-efficient structures — amending spending habits, changing their will or pursuing more philanthropic interests.
So, overall, a properly balanced portfolio that generates different income streams and rates of return is important. Equally, if not more important, though, is having a proper wealth plan in place that takes into account the individual’s new, post-retirement reality. Having this in place can help determine how retirement is to be funded, and how much is available to pass on to children or charitable organizations.
Wealth planning throughout retirement is important most of all to ensure all retirees, no matter what their situation, are properly able to take tax efficiency, inflation, changing lifestyles and life stages into account, and to ensure they don’t outlive their money or leave too much of it in the wrong places.