Stretch your retirement funds

Boomers are leaving the workforce at a time when a staple of retirement cash-flow planning — fixed income — isn’t delivering the way it used to.

And, people are living longer. While that’s a welcome development, it does mean those planning to rely heavily on their Registered Retirement Income Funds (RRIFs) may need to take on more risk to generate the returns they need to cover future income needs.

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. Investors should also have no more than half their portfolios in equities, and the fixed-income portion should use mainly shorter-term bonds.

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 money you’ve saved dwindles as inflation rises
• Longevity – longer life spans raise the risk of running out of money

Otar advises planning 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 [investors] 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 you plan on drawing your RRIF payments. Wealthier investors who don’t rely on RRIFs typically take a few larger payments at year’s end. This allows them to grow their money tax-free as long as possible. “I try to have bonds that come due on December 1,” Moir explains.

If you prefer to treat a RRIF like a monthly pension payment, then “use equities that produce monthly cash flow, like balanced funds or publicly traded REITs,” Moir says.

And if you want the entire RRIF payment at the beginning of each RRIF year, then Moir suggests a five-year laddered-bond strategy. A bond will come due every year when you need to draw the funds.

And while risk tolerance decreases in the draw-down years, you can’t be too conservative in the current environment. Recent changes help a bit. Under the old rules, an investor turning 71 was required to withdraw a minimum of 7.38% from her RRIF. But the 2015 Federal Budget plans to lower that mandatory rate to 5.28%.

And, it’s moved the age at which retirees reach the top 20% withdrawal rate from 94 to age 95.

Still, if a large chunk of your investments are stuck in vehicles earning 2%, there is risk you’ll encroach on principal too quickly.

The annuity option

Longer life spans and less-than-stellar fixed income yields make annuities the best option for some investors, says Otar.

There’s a simple way to determine if it’s right for you. Say you have $425,000 of retirement savings, annual supplemental income needs of $15,000, and a 30-year time horizon. The yearly withdrawals will drain your savings around year 20 — a decade shy of the 30-year target. An annuity can be a good option here, since the issuer can pick up enough return, even at current meager interest rates, to meet your income needs.

Tax implications

RRIF withdrawals are taxed based on your bracket.

Investors 65 or older can claim federal and provincial pension income tax credits for RRIF income, explains Wilmot George, director of tax and estate planning at Mackenzie Investments. He notes pension income eats up these credits, so if a retiree has a pension and won’t rely heavily on RRIF income, it might be smarter to place the cash in a TFSA if there’s room.

While the RRIF payment is still subject to tax, future income generated by the remainder will be sheltered within the TFSA. You also have to consider taxation at the time of death.

RRIFs can be transferred at death into the RRSP or RRIF of a spouse or common-law partner without triggering tax. They also can be transferred to physically or mentally challenged dependent children in a tax-deferred manner.

RRIF nuts and bolts

• Canadians are legally required to convert their RRSPs into RRIFs by December 31 of the year they turn 71, though they’re free to do it earlier. The transfer is not a taxable event.
• RRIFs are subject to yearly withdrawal minimums. The younger the investor, the lower the minimum.
• An investor with a younger spouse or common-law partner can use her spouse’s age to calculate the minimum withdrawal. This would enable her to shelter more income in the RRIF.
• You must be committed to withdrawals after setting up the RRIF.

Dean Dispalatro is senior editor of Advisor Group.