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Build deeper member relationships: Focus your RRSP discussions on these retirement planning parameters

January 30, 2019

Each retirement plan is unique, based on a member’s specific personal and financial situation. The member’s specific retirement objective must be clearly defined prior to developing a retirement plan.

Retirement planning is complicated, and a substantial amount of time and thought must be given to the parameters that shape the retirement plan. A small change in any one variable can have a dramatic effect on the overall result of the retirement plan. This is particularly true of assumptions made about rates of return that compound over many years. The key retirement planning parameters are:

Lifestyle (both before and during retirement)
The specific lifestyle decisions members make in their 20s or 30s often affect the achievement of financial planning objectives throughout their working years. Members need to prioritize retirement savings and attempt to balance their existing lifestyle with their desired retirement lifestyle. Most members want to continue to live in a manner similar to their pre-retirement lifestyle. The level of retirement expenses determines how much money members must accumulate before they can retire with confidence.

Life expectancy (for both spouses)
The life expectancy of the average Canadian is increasing each year and each succeeding generation is living longer than the previous generation. In fact, members may spend a longer period in retirement than they spent working. Therefore, the biggest risk that members may face during their retirement years is the risk of outliving their money. Ideally, members should plan for a retirement period of at least 25 years, and perhaps as long as 40 years, in order to minimize the risk of outliving retirement assets.

Inflation rate (both before and during retirement)

Inflation is the general increase in the price of goods and services over time as measured by the consumer price index (CPI). As inflation increases over time, the purchasing power of money decreases. Inflation has a dramatic effect on a retirement plan because inflation occurs both when members are planning for retirement and continues during the entire retirement period. For the past 50 years, inflation in Canada has fluctuated between 2% p.a. and 14% p.a., with the average annual inflation rate being approximately 4.09% p.a. for the period. Because the retirement planning period is long, we recommend using an inflation rate of at least 3% p.a. to 4% p.a.

Rates of return on investments (both before and during retirement)
Determining the rates of return to use in a retirement plan both before and during retirement is critical. It is essential to be conservative and not to overestimate future investment returns, especially during retirement. Ideally, it is best to complete the retirement plan using very conservative rates of return, such as a real rate of return of 5% before retirement (8% nominal less 3% inflation) and 3% during retirement (6% nominal less 3% inflation). (We use lower rates during retirement because retirees generally have a conservative income-oriented investment portfolio.) Thereafter, a range of “what if” scenarios should be completed to illustrate how a member’s plan would change, based on different rates of return.

Income tax rates (both before and during retirement)

When planning for retirement we need to use different rates of return for registered investment assets and non-registered investment assets.

  • Before-tax Rates of Return for Registered Plans: Most members will save for their retirement by contributing funds to registered plans. The focus of the basic retirement plan is on accumulating funds in registered plans, and rates of return on these assets are on a before-tax basis (i.e., the income tax on the investment assets is deferred). Note that we also take inflation into account. Therefore, we use real, before-tax rates of return in the basic retirement plan.

  • After-tax Rates of Return for Non-registered Plans: If members accumulate non-registered investment assets, after-tax rates of return must be used to determine the future value of these retirement assets. Including non-registered assets in a retirement plan adds a further complication to the calculations in the plan. The difficulty with determining the future value of non-registered capital is that capital gains are not taxable until the gain is realized, while interest and dividend income is taxed annually.Therefore, when projecting the future value of non-registered investment assets to the date of retirement, we need to make certain assumptions regarding the marginal tax rate (MTR) in order to determine the after-tax rate of return for different investment income – whether it be interest income, dividend income and/or capital gains.

Retirement date (may differ for each spouse or partner)
While we consider age 65 to be the “normal retirement age” (NRA) for general retirement planning purposes, members may not necessarily retire at this age. Some members may leave the workforce as early as age 55, while others may face involuntary retirement when their jobs end earlier than anticipated. Still others will continue to work well past age 65, either for enjoyment or out of necessity. When dealing with couples, the spouses or partners may plan to retire at the same date, or one may continue to work after the other has retired. Recognize that different retirement dates complicate the basic retirement plan and it may be necessary to complete a plan for each spouse or partner.

This material is drawn in from CUIC 240 Fundamentals of Personal Financial Planning. Self-study options are available now and our next cohort begins on March 11, 2019. This course is designed for employees who want to increase their confidence when talking with members about any aspect of their financial life. Completing CUIC 240 Fundamentals of Personal Financial Planning qualifies for two course exemptions towards a CFP® certification with the Canadian Institute of Financial Planning.