Geoffrey Jones outlines how advisors can balance tax, debt, decumulation, and investment returns assist with the myriad issues Canadians face as they approach and enter retirement
The years leading up to and at the very start of retirement can be one of the most financially sensitive periods in any Canadian’s life. Investment time horizons start to narrow in the five to ten years approaching a set retirement date, making periods of market volatility harder to stomach. The need to pay off debts becomes more acute. Surviving parents may be aging into significant health issues, while children may require a financial leg up to get them started in life. All of these put pressure on Canadians who are working towards their retirements, or making sense of a new life after work. Now we can also add a cost of living crisis into that mix.
An annual BMO survey of Canadians shows just how much the cost of living is pressuring retirees. In 2019 Canadians estimated they needed $1,349,000 to retire comfortably. By 2022 they estimated they would need $1,743,000. In subsequent surveys that roughly $1.7 million figure has held, with estimates in provinces like Ontario and B.C. approaching or even exceeding $2 million. Geoffrey Jones, Director of Tax and Estate Planning at Foresters Financial, sees just how acute this cost of living issue has become for Canadians in and approaching retirement. He outlined how issues like tax, longevity, healthcare, and retirement income all need to be managed by advisors to get clients to a place of financial confidence.
“We might have to adjust our expectations in retirement. So talking about spending here, when I used to be an advisor, we often would tell clients that as you shift towards retirement, you can either choose to live off of 50 per cent of your peak income to get by in retirement, or perhaps 80 per cent of your income to live comfortably, or perhaps 100 per cent of your income if you want to involve travel and a little bit more luxury in your retirement,” Jones says. “And sometimes we do have to have that wake-up call that we can't all have what we want.”
Solutions for rising costs
Jones says he has seen many Canadians delaying retirement as a result of higher living costs. He notes, though, that working later in life or switching to part-time work can actually help with the transition to retirement. In addition to supplementing any retirement income, some kind of continued work can provide the small social connections and daily purpose that working adds to the lives of so many people. He notes that the loss of these aspects of work can be very challenging for some retirees.
In addition to extending their working years or revising lifestyle expectations, retirees are using other solutions to manage daily costs. That includes taking on debt. The Fidelity Retirement Report found that 22 per cent of Canadians are retiring with a mortgage. In addition, Jones sees some Canadians increasing credit card use, or leveraging their homes into additional cash flow. While he doesn’t write off the use of debt, he emphasizes the need to understand that many of these solutions create additional servicing costs down the road. Short-term debt needs to be taken on with a view towards consolidating down the road.
There is also the possibility of using strong market gains to support current cost of living issues. The challenges there are around psychology and tax. Pulling from strong investments early can be difficult for investors to stomach, as they know they’re giving up potential future returns. At the same time, selling those investments can generate high tax bills, which need to be considered.
Decumulating in a cost of living crisis
Those tax issues can be particularly acute, Jones says, for DIY investors who are now entering retirement. While the process of accumulation isn’t exactly easy, many investors have followed the core principles of diversification and risk management on their own to arrive at their stated retirement goal. Jones notes that these DIY investors now have to face the much more complex process of decumulation, working out where they will draw their retirement income from and when. Those investors, he says, are particularly vulnerable to tax leakage if they accidentally pull too much income in a given year or end up triggering OAS clawbacks. It’s in that decumulation stage, he says, where advisors can really make a difference.
Advisors looking at the rising cost of living for their clients have a host of financial planning tools they can use to make the rate of inflation manageable for their clients. They can also take advantage of strong markets right now, coaching clients around the psychological issues that come with selling securities and ensuring that those capital gains are balanced by the tactical sale of investments at a loss. All of those decisions need to be weighed against the client’s current tax bracket to ensure they don’t end up paying more tax than necessary.
There are other decumulation solutions that Jones believes can help, including T-class corporate class funds which can help defer tax bills through distributions formed out of return of capital. There is also the potential that comes with participating life insurance, which can grow in a tax-deferred manner and can be leveraged during the life of the policyholder to provide supplemental cash flow in retirement. Beyond advisors’ own understanding and use of these tools, Jones insists that their clear explanation to clients can help create a greater degree of financial confidence among Canadians as they enter these vulnerable years.
“We're always going to have volatility in the market, but the one thing that we really can control is our tax bill. Tax alpha, as I like to call it,” Jones says. “We don't know if we're going to earn 4 to 6 per cent rate of return, but with a good understanding of the client's situation, we can identify and come up with ways to reduce their tax bill and to figure out what tax planning might address their situation and help improve their overall picture.”
