When it comes to retirement, one of the most difficult things to plan for is the number of years that will need to be funded. Nowadays Canadians are living longer, and our longevity continues to increase. Will you need to fund 25 years, 30 years or more?
It’s troublesome because it can affect your sense of security during retirement. Some people feel anxious, never knowing how much they can safely spend each year. Others worry they’ll outlive their savings.
Fortunately, there’s a way to alleviate these worries — by creating a retirement income floor. The “income floor” is the amount of annual income required to meet only the basic living expenses. The strategy is to cover this floor with guaranteed and ultra-conservative investments.
The retirement income floor does more than provide peace of mind — it also helps with other aspects of financial planning during retirement. Knowing that your basic expenses are covered can give you more freedom to pursue higher-yielding fixed-income and growth-oriented investments. For estate planning, it can be easier to determine what you can leave to the next generation when you’re not worried about outliving your nest egg.
Breaking down the retirement income floor strategy
Step 1: Estimate expenses
It all starts by estimating the amount of your basic living expenses for a typical year (see the details at the bottom of the page).
Remember to include any specific items that are unique to you or your family, but stick to the essentials only. Lifestyle expenses, such as vacations, discretionary travel, or the cost of a new car, are separate from your income floor.
Step 2: Add up guaranteed sources of income
The next step is to determine the annual amount of your Old Age Security (OAS) and Canada/Quebec Pension Plan (CPP/QPP) benefits. Add any other pensions you receive, plus any regular income sources, like rental income. If you have a spouse, combine the amounts for the two of you.
Is your guaranteed-income total enough to cover your essential expenses from step 1? For many people, the answer will be no. The gap between the two is the shortfall in your retirement income floor.
Step 3: Decide how to fund the floor
You have a wide number of options when it comes to funding your retirement income floor, and your advisor can help you determine which would best suit your risk tolerance and personal preferences. The choices may include:
- Guaranteed or highly secure income-generating vehicles – examples include Guaranteed Investment Certificates (GICs), treasury bills, money market instruments, government bonds and mutual funds that invest in these.
- Annuities – typically, a life annuity which provides a guaranteed annual income stream for as long as you live.
- Your own investments – part of the mix may be income from your Registered Retirement Income Fund (RRIF), Tax-Free Savings Account (TFSA) and/or non-registered investments.
Consult your advisor
The income floor strategy can be implemented at different stages — before you retire, upon retirement or any time during retirement. No matter which stage you’re in, consult your advisor if you’re looking for peace of mind that your basic needs will be covered for as long as you live.
Your advisor can also help you with other important decisions, such as when to begin taking CPP/QPP benefits. With the income floor approach, government benefits typically start upon retirement, but depending on your situation, you may benefit from either delaying the start, even to age 70, or starting early.
What’s your floor?
The retirement income floor approach starts by estimating your basic living expenses for a typical year. What should you include? The checklist below will give you an idea of the key items to tally up.
1. Household expenses:
- Utilities (heat, hydro, water)
- Home insurance
2. Meals — include some dining out as well as groceries
3. Clothing and personal care
4. Health care
5. Automobile costs and essential transportation:
- Lease/loan payment
- Car insurance
- Car maintenance/repairs
- Public transportation
6. Emergencies – add a reasonable amount for unexpected costs
7. Gifts and holiday costs
- Life, disability, critical illness, long-term care
9. Income tax