Summary

Understanding Key Risks in Retirement Withdrawal Strategies

Longevity Risk

This risk arises from potentially outliving your savings. As life expectancies increase, the likelihood that individuals may deplete their retirement funds without proper planning for a prolonged retirement period becomes more significant.

Inflation Risk

Inflation risk occurs when the cost of living rises faster than anticipated, which can erode the purchasing power of retirement funds. If withdrawal strategies do not adjust for rising costs, retirees may experience a decline in their standard of living.

Market Risk

Market risk involves the possibility of market volatility adversely affecting the value of your investment portfolio. This is particularly damaging if funds are withdrawn during a market downturn, leading to substantial depletion of resources.

Sequence of Return Risk

This risk refers to the negative impact that the timing of returns from investments can have, especially when withdrawals are made during a market decline. Such timing can disproportionately affect the long-term performance of the portfolio.

Common Mistakes in Retirement Withdrawal Strategies

Given these risks, retirees often make several common mistakes in their withdrawal strategies:

Not Planning Early Enough

Many retirees start planning their withdrawals too close to retirement. It is recommended to begin planning at least five to ten years beforehand, allowing enough time for strategic adjustments and robust contingency plans.

Underestimating Financial Needs

A frequent oversight is the lack of a detailed projection of expenses, which includes regular lifestyle costs and potential emergencies. This can lead to a significant mismatch between expected needs and available funds.

Failing to Identify Short-term Income Needs

Securing immediate income needs is crucial. This often involves maintaining a “cash wedge” to cover at least one year’s expenses and holding two to three years’ worth of expenses in fixed-income securities. This strategy helps avoid the need to sell investments during market lows.

Not Separating Short-term from Long-term Needs

Proper asset allocation based on the timing of needs is essential. It protects short-term funds from market volatility and preserves long-term investments for future growth.

Ignoring Tax Implications

Overlooking the tax implications of withdrawals from various retirement accounts can lead to inefficient tax outcomes and reduced net income. Planning each withdrawal with its tax impact in mind is crucial to optimize retirement savings.

Full Transcript

Hi everyone, today we’re going to talk about the five retirement withdrawal mistakes to avoid. This is an important topic because it’s one of the biggest challenges in retirement planning. Typically, we go from having one to two sources of income to managing various accounts in retirement. You have RRSPs, TFSAs, pensions—both private and public.

Yes, non-registered too; just a lot of moving parts. The challenge is determining which account to withdraw from, when to do it, and how to make sense of it all. So today, we’ll discuss at a high level what a withdrawal strategy looks like. But first, I want to bring your attention to the risks involved with retirement and the withdrawal strategies. The first one is longevity risk—the longer you live, the greater the chance you’ll outlive your savings.

It’s a blessing, but it presents a longevity risk. We’re talking about retirement, about longevity risk, and for many, it’s a risk multiplier. If you have significant capital and you’re not touching your principal, that’s great. But that may not be the case for everyone. For those drawing down their capital, there’s a huge longevity risk. Then there’s inflation risk, which…

I think in today’s world, is a bigger concern than it has been in the last five to ten years. We all understand that the cost of living can rise faster than anticipated, eroding your purchasing power from your retirement fund. That’s another big issue. You have your investments, you have expenses, but those expenses are rising significantly. What we have here is a lack of planning for inflation.

Next, there’s market risk. Just being in the market, being invested—and I know I have an investment portfolio—means you might be invested in a particular business or real estate, whatever it may be, there is market risk, there is market volatility. The longer you are in the market, the more you might be negatively affected by it.

Right? And an extension of that is what’s called sequence of return risk. It’s really about the timing of the returns. If you have a long-term investment, you may experience fluctuations and negative periods. But what’s even worse is if you’re in those unfavorable times when you have a down market and you have to withdraw funds. This can disproportionately negatively affect the long-term performance of your portfolio because you haven’t allowed your portfolio to recover from that negative period. So, with that in mind, from the risk standpoint, I’m going to talk about some retirement withdrawal strategies. And these are some of the things you could do to avoid the mistakes I’ve seen. The first one is not planning early enough, right? If you’re not planning early enough, and you just jump into retirement, or maybe you’re already deep into retirement, and now you’re looking at withdrawal strategies,

Because your portfolio hasn’t been set up properly, it’s going to take some maneuvering. And so what happens is this causes potentially more challenges and maybe not even the most tax-efficient situation. And it’s great. You may have done a great job in terms of building up this portfolio, but now we’re at a place where we have to move things around for tax efficiency purposes. So not planning early enough is a big thing.

Now, depending on your circumstances, it could be five years, but I would say give yourself the opportunity to look at it at least ten years before and get some advice and put a framework in place and have that structured such that you can put your portfolio in a position where you can be in the best position for withdrawals and not, by the way, avail yourself of being in a position where you are dealing with all the risks that we mentioned before. And if we,

are able to sit down ten years before retirement, we could look at your entire situation and start to plan towards that and avoid a lot of those risks. The next one is underestimating your financial needs. You’ve got to get really grounded in your expenses. And a lot of times people kind of pull a number out of the air. I’ve seen it before. It’s like, you know, you say, “Okay, so how much do you need for retirement?” Sometimes it comes up early in a discovery session. People tell you a number.

It’s not really grounded, meaning it’s not documented. There’s not a budget in place. You don’t know exactly what your costs are, your expenses are. If you understand what your expenses are, then that’s a great place to start. And then we look at how much more expenses will increase in the future, or maybe in certain circumstances, how much more will expenses actually decrease, right? And if you’re not grounded in that, this could lead to a mismatch between your expected needs and the actual available funds.

I would say available funds, it may be that you have the amount in your investment portfolio. It’s just that the amount in the most tax-efficient way to pull from the portfolio may not be the best way, as well as you just may not have enough funds too. But you’ve got to get really grounded on your expenses and how much you need annually, right? The next one is once you’ve identified how much you need annually, the good thing is you start to separate your short-term income needs and have that separate from your long-term investment portfolio. What do I mean by that?

So what you want to have is a certain way. A lot of people call it a cash wedge. We have a certain amount of funds that is accessible to you over at least a one-year period that is not participating in the market and not, you know, faced with market volatilities. Um, that often happens. And quite frankly, if you are going to retire, say at 55 or 65, depending on how long you live, you will

your portfolio will be exposed to market volatility and probably even a couple of crashes in the process, right? And you will obviously need income during that time. So what you want to do is structure it in such a way that you have at least a one-year cash wedge, a one-year amount that’s put aside that is not in the market and that will not be dealing with that market volatility. And then you want to have two to three years’ worth of expenses in some type of fixed return, some type of fixed income,

that is guaranteed, which means that, and sometimes it could be a GIC, but whatever it is, some type of fixed income, again, that is protected, earning a decent amount of interest rate, right? Some could be bonds depending on the circumstances, could be even a high-interest savings account, you know, a month ago or so, there were great opportunities, even a couple of weeks ago, with a decent return that you could have, right? You could lock some things in. So this is a great opportunity for you to separate your short-term income needs,

in terms of one year, two years, and three years, you probably want a one-year cash wedge and then for the next, the second year and the third year, you want to have that in some type of fixed income security, something that’s providing some decent interest rate, well, as good as you can and not have that money be a part of the market because if you have to sell that off and the market’s low, it’s essentially a double loss, right? Mark’s already low, you’re pulling from your funds.

It doesn’t give your funds the opportunity to bounce back, right? So again, this is not necessarily going to be, in many cases, a huge significant part of your portfolio, because you still want to have part of your portfolio participate in the market, having the opportunity to gain returns, but for the amount that you need for the next two to three years, you definitely want to put that aside. Now, once we establish it, we need to actually implement it, because a lot of times, it’s one thing if you have a plan.

It’s another thing if you’re executing on a plan. So I wanted to go this extra step to say, it’s one thing if we identified it, but then we need to have the proper asset allocations that reflect what we have identified, right? And again, this protects from market volatility. It protects your investments. We have, you know, a long amount, a decent amount over a longer period of time. Definitely protects against sequence of return risk, which is a big thing. What’s the last one?

Now, we have done well. We have the cash wedge. We have probably the GICs or some type of fixed income over the next two to three years. But then we got to pull that money out. We want to look at the tax implications of all those withdrawals. Right. So you’re pulling from different accounts. Again, I mentioned RRSPs, TFSAs, non-registered accounts, pension plans. You’re getting funds from all these different things. But realize that if it’s not structured properly, a lot of the…

benefits that you may have had, for example, if you contributed to RRSPs and you got some deductions, now you’re pulling from the RRSPs when you’re at a higher income, potentially you’re going to be paying higher taxes. Now you would have had the benefit of having tax deferral for that entire period, but now, you’re getting taxed at a higher rate than when you actually contributed. And for a lot of people, it’s not a fun thing. In fact, I could tell you this is one of the biggest things, biggest pain points for retirees.

So you may have all these things in place, but you have to also be strategic in how you withdraw from those funds. So you have done a good thing by having asset allocations in place. Everything’s great. But now when you go to pull from those funds, you have to look at the tax implications and plan that out on an annual basis and sometimes even revisit because I’ve seen in the past where, in the more recent past where because of inflation, you have a certain plan in terms of what your budget will be at mid-year, things go crazy.

because of inflation and things of that nature. In addition to that, things happen, right? You have unexpected expenses, you have family members you may want to support, things happen, you revisit it. Hopefully, this was helpful. And again, these are pretty broad strokes. Everybody’s situation is going to be a bit different, but this is a pretty good, I think, framework that you could use to see if you’re on track. No, what I would say is I strongly recommend that you work with a professional.

To get these details grounded and make sure that you’re using real numbers and that it makes sense and the tax implications don’t affect you and you’re not, you know, having your portfolio in the wrong things. So work with a financial planner, you can reach out to myself or if you already have one make sure that this process is taking place. This came about because I have conversations with a potential client and

and we’re having conversations about withdrawal strategies. So I figured I would just share this information. All the best. See you next week.