Personal Finance

Follow these eight steps to keep yourself on track.
By Christine Benz | 30/05/16

An investment policy statement -- a blueprint that you can use to set up your portfolio and keep it on track on an ongoing basis--is a must for investors at all life stages. But in retirement, a separate set of variables come into play -- specifically, how you'll manage to extract the cash flow you need from that portfolio you worked so hard to accumulate.

About the Author
Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success.

Issues like your portfolio's asset allocation and the quality of the investments you choose are still important (which is why you still need an investment policy statement, even when you're retired) but so are factors such as how -- and how much -- you'll spend from your portfolio on an ongoing basis.

By creating a retirement policy statement, you're effectively committing yourself to abiding by a given system. That's not to say that your system won't evolve as the years go by, but having a plan in place makes it much less likely that you'll ratchet your planned 4% spending rate up to 10% in a given year.

Step 1: Specify retirement dates and duration.

Decide on the time lines of your retirement stage of life: your anticipated retirement date; for couples, the anticipated retirement date of your spouse, if different; your life expectancy and (if applicable) your spouse's life expectancy. According to the latest published data from Statistics Canada, life expectancy at 65 was 18.7 years among males and 21.7 years among females in 2010-2012. Individual expectations, of course, will vary.

Step 2: Outline your retirement portfolio strategy.

Simple and to the point is the name of the game here. For example, a retiree might write: "To maintain a portfolio that consists 60% of high-quality, dividend-paying stocks and 40% high-quality bonds, along with a cash component consisting of two years' worth of living expenses. Spend from the cash component and periodically refill using rebalancing proceeds. Use 4% guideline for spending."

Step 3: Document your retirement assets

Note your investment and savings accounts and other assets -- and their current market values. These include RRSPs, tax-free savings accounts, employer-sponsored vehicles such as stock-option plans and deferred profit-sharing plans, non-registered investment accounts, cash and cash equivalents such as deposit accounts and Canada Savings Bonds, and rental properties.

Step 4: Specify your spending plan.

Determine the extent to which your spending needs will be financed from your investment portfolio, and the extent to which they’ll be supplied by non-portfolio income sources such as Old Age Security, the Canada Pension Plan/Quebec Pension Plan and annuities.

By doing so, you can determine the rate at which you'll need to draw down from your investment assets. Your withdrawal rate equals the annual withdrawals divided by your total retirement assets.

Step 5: Detail how you'll address inflation.

Drawing a fixed dollar amount from your portfolio will help ensure that your standard of living declines as the years go by. That's not what most retirees want. Therefore, it's wise to factor your approach to inflation into your spending plan, to allow for higher withdrawals in years in which your cost of living is on the move. The "4% guideline," for example, assumes that a retiree withdraws 4% of his or her portfolio in year 1 of retirement, and then inflation-adjusts the dollar amount as the years go by. In making your inflation assumptions, consider that Canada's Consumer Price Index has increased at an average of 4.1% since its inception in 1968, but only 1.8% over the past 25 years. In years when inflation is low or non-existent, your spending needs are unchanged or your investment portfolio has declined, it makes sense to skip an inflation adjustment.

Step 6: Document your cash-flow generation.

This is the meat of the statement: Where will you go for cash from your portfolio on an ongoing basis? Option 1, living on income distributions alone, is the old-school way to do it, but it might not be practical given today's low yields. Nor will an income-centric portfolio necessarily be optimal from a risk-return standpoint. Option 2 is to use rebalancing, which entails selling highly appreciated portions of the portfolio, to fund living expenses. Option 3 blends the two strategies: The retiree uses income distributions to provide a baseline of living expenses but doesn't stretch for yield. He or she then periodically rebalances to shake out additional living expenses.

Step 7: Document your approach to withdrawals.

Like the previous step, this step requires careful consideration, because it can have a big impact on the viability of your plan as well as the variability of your cash flows during retirement. Here you're documenting not just your withdrawal rate--though that's in the mix, too -- but also your approach to withdrawals. Option 1 -- withdrawing, say, 4% of the portfolio and then inflation-adjusting the dollar amounts annually -- will deliver a fairly stable in-retirement cash flow. Option 2, spending a fixed percentage of the portfolio year in and year out, helps tether withdrawals to the portfolio’s performance, but will lead to significant variability in cash flows. Option 3 is a hybrid of the first two methods. It entails using a fixed percentage withdrawal as the baseline, but employs limits to ensure that spending never goes above or below certain levels. Under Option 4, a retiree is spending just a portfolio's income distributions, whatever they might be.

Step 8: Specify whether and when minimum withdrawals apply.

Document which of your accounts are or will be subject to required minimum withdrawals. These apply to accounts such as registered retirement income funds (RRIFs). Also note when RRSPs must be converted, for both you and your spouse, based on your birthdays. By the end of the year that you turn 71, RRSP assets must be transferred to a RRIF or to a registered annuity if you wish to continue to take advantage of the ability to defer taxes. The only other alternative, cashing out your RRSP, would result in the full amount being taxed at your highest marginal rate.

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