What is decumulation?
Practically speaking, decumulation is figuring out strategic ways to use the assets you’ve set aside for retirement, ensuring that everything you’ve accumulated lasts for as long as you need it to. As you near retirement, that means coming up with a solid plan of action, one which you may need to tweak as time goes on.
Decumulation is also a mental shift. All your life, you’ve been accumulating assets, building wealth and preparing for retirement. That day is now here, and it’s time to set up a plan to spend what you’ve worked so hard to acquire.
Decumulation readiness
How do you know when you’re ready to retire and start using those savings? This will depend on a few factors, including:
Your financial situation
How much do you have saved? Are you entitled to a workplace pension? Do you have debt or still have a mortgage? Are supporting children or parents? When you retire, will you be paying for your own health benefits – and how much will that cost?
How long you think you’ll need your money to last
No one has a crystal ball, but it can be helpful to look at your current health status and your family history to guesstimate how long you might need to keep supporting yourself.
Your plans for retirement
A retirement spent travelling, spoiling grandchildren and pursuing passion projects doesn’t come cheap. Costing out your plans for retirement (which equally might also include selling your home or downsizing in the future, moving to a less expensive postal code or no longer supporting dependents) will determine your plans. You should also be considering the affect of inflation over the long term in your spending plans.
Making your retirement savings last a lifetime
Many Canadians are concerned that their retirement savings will run out, or they’ll have a drastically reduced quality of life in retirement. Decumulation should be part of a wider retirement plan that takes into account your unique goals for this chapter of your life, and your specific circumstances. That’s why working with a financial professional is essential as you come up with a plan. Some things to take into account as you do:
Government benefits
Figure out what you’re entitled to from the Canada Pension Plan (CPP), Quebec Pension Plan (QPP), Old Age Security (OAS) or Guaranteed Income Supplement (GIS), and how far those go to cover your fixed expenses. (The age you decide to begin drawing these benefits will also affect how much you get each month.) Typically, this amount will not be enough to cover your preferred spending plan, which is where your own savings come in.
Pacing your savings
Having a realistic budget is essential when you’re figuring out how much you should be withdrawing from your savings each month. Remember to plan for life-stages: While you may spend more on discretionary purchases earlier in your retirement (like travel or hobbies), you may need to spend more on home care or moving into an assisted living or long term care facility later on. Think about it in 3 stages:
Go-go: You’re your most active, potentially traveling and spending on home improvements etc.
Slow-go: You’re slowing down, but still keeping busy with hobbies and local travel.
No go: Your mobility may be more limited, and you require more care.
Taxes
Minimizing the income tax you pay is a strategic way to help make sure your savings go further, as is balancing out annual taxes with what your estate may eventually pay. (Any money in your RRSP, for instance, will potentially come with a higher tax bill than if you’d used it in while living.)
There is also the potential for Old Age Security “clawback”, which is what happens when you exceed a certain income threshold. If this happens, you must pay a percentage (or all) of any OAS you received that year back in tax.
Money you might still earn in your retirement
There are several ways you can keep growing your nest-egg, even in retirement. You could continue working part-time for a period, for instance, or sell property or other assets that may have increased in value. You may earn dividends on your investments or see them appreciate in value if market conditions permit.
Withdrawing from your retirement savings
Most Canadians have their retirement savings stored across several different types of accounts, and you may choose to draw on them at different stages in your retirement. There are many strategies for this – especially when it comes to timing, risk and taxes – and all have their pros and cons. Some things to consider as you work with your advisor to formulate a plan:
Converting Registered retirement savings account (RRSP) into income
Option 1 – Withdraw before age 71
Pro: You can draw on it for income earlier in your retirement, when you’re not receiving government benefits, which may mean you pay a lower tax on your withdrawals because you may be in a lower tax bracket.
Con: The flipside of this is that you may sacrifice a few more years of tax-deferred growth for your investments. Whatever your choice, you cannot hold an RRSP past age 71, when you must either convert it to a RRIF or buy an annuity.
Option 2 – Convert to a RRIF
Pro: You can also convert your RRSP to a RRIF, which will allow your investments to continue their tax-deferred growth in a wide variety of investments, which you can choose. There is a minimum amount you must take from your RRIF each year based on federal government rules. Remember: Any money you withdraw is taxed like employment income, just like an RRSP.
Con: As with all investments that are not guaranteed, there is the potential for volatility, and your income could go up and down with the market. The other downside of keeping your money in a RRIF comes after your death: Assuming your partner is unable to inherit your RRIF tax-free (called spousal rollover), there is the potential for a sizable tax bill for your estate and less money to be left to your beneficiaries.
Option 3 – Purchase an annuity
Pro: You can use an RRSP or RRIF to purchase an annuity at any age prior to 95. A life annuity provides a guaranteed income for life for yourself and/or your spouse, which can be indexed to take inflation into consideration. You can’t outlive your life annuity, and it provides a predictable income that doesn’t fluctuate with the markets. You can also buy a guarantee period, meaning you’re guaranteed a certain number of payments over an agreed time period, like 5, 10 or 15 years. If you die before that time, your beneficiaries will receive a death benefit.
Con: You typically cannot cash out of a life annuity, and they have a limited estate value. If interest rates go up, your income will not.
Keep your Tax Free Savings Account (TFSA)
Pro: You can keep your TFSA for your lifetime, creating income simply through a plan of ongoing withdrawals, which aren’t taxable. You can continue to contribute to the government set maximums, and any growth remains tax-deferred.
Con: There currently is no income product available for the TFSA which could allow you to set up a systematic, regular income. Your investments are also subject to market volatility if not invested in a guaranteed investment.
Maintaining your stock portfolio
Pro: Outside of your RRSP, you can continue to hold these investments for as long as you wish, and they can become part of your estate too. There is potential for growth, and you can sell stocks whenever you choose to supplement your retirement spending plan. If you earn dividends, those are “tax-preferred,” meaning they’re taxed at a lower rate than your marginal tax rate.
Con: When you sell your stock, you may have to pay tax if your stock has had a capital gain. (Of course, you may also sell your stock at a loss, which means you can claim a capital loss on your taxes.) You should also consider market volatility, especially since you may end up needing to withdraw at a time when the market is on a downturn.
GICs
Pro: A guaranteed income certificate (GIC), which is an investment made to a bank, insurance company, credit union or trust company, provides a guaranteed rate of return based on an interest rate for specific time period, typically 1 to 5 years. At the end of time period, you get your initial investment back, plus compound growth unless you chose to have interest to be paid out over the term of the GIC.
Con: Your returns are subject to current interest rates, which are currently at a historic low. If it’s a cashable GIC, you typically pay a penalty to cash out early. There’s also the opportunity cost of investing your money somewhere else with better growth.
Decumulation and philanthropy
If you’re hoping to leave something behind for causes you care about, make sure that’s a part of your decumulation strategy. While you can do this via your will, it’s also possible to make the gift while you’re alive. You can transfer your segregated funds, mutual funds, stocks, precious art work and other assets to charities now using a product like the Canada Life Charitable Giving Program. By transferring the assets you can eliminate any capital gains you may have had to pay if you’d sold those investments instead and then gifted them.