Retirement income investing in a low-rate world

Make your money work smarter

The days of letting your money sit in a bank account and collect interest are largely a thing of the past. Today you and your money have to work harder to make it grow. But with the right mix of strategies and know-how, your work can pay off.

Having an investment income strategy is important at any age, but it should be a priority if you're retiring soon or are already there.

Assess your needs, resources

Being a successful income investor starts with taking time to assess how much income you really need and where that money will come from.

The general rule of thumb suggests that you’ll need to replace 60% to 70% of your pre-retirement income to maintain your current lifestyle after your working days. The reality is that no single rule is right for everyone; much depends on your own circumstances, goals, and objectives.

What do you spend on basic items such as food, transportation, shelter, health care, and taxes? Will you downsize to a smaller residence? And with retirement, it's a good bet you'll need less for commuting, wardrobe, and lunches. Plus, pension and EI contributions will be a thing of the past.

On the other hand, aging can also mean having to spend more on your health. Lifestyle choices will also have a major impact. Travelling the globe will require a lot more cash than puttering away in your garden. Frequent dining out, golf club memberships, or maintaining a recreational property all demand a larger budget.

When it comes to paying for it all, pension plans can do much of the heavy lifting. Based on current maximum Canada Pension Plan (CPP) and Old Age Security (OAS) payments, a couple can receive nearly $40,000 a year from the government alone. Add to this a workplace pension and the good news is you might have to generate less income than you think.

Retiring early demands a savings pool large enough to cover expenses until your pensions kick in. If you're counting on receiving CPP before 65, ask your advisor how early collection rules and calculation methods may affect your decision.

Building your income portfolio

Investing solely in government bondsᶲ or term deposits will all but eliminate risk to your capital. But the reality is you may not earn as much as you'd like in a low-rate environment, especially after adjusting for taxes and inflation.

On the other hand, choosing investments offering higher rates means taking on more risk.ᶲ The market value of those investments may decline, payments to you may be interrupted or reduced, or your full principal may not be returned. After you retire and your work pay cheques stop, replacing any losses will be even harder to do. Building an effective income portfolio takes the right balance of risk and reward.

Developing your core

A sensible income strategy for most people starts with a core position in federal and provincial bonds or bond mutual funds ᶲ(typically a diversified mix of government debt and high-quality corporate bondsᶲ) and term deposits. These traditional income choices deliver predictable cash flow and help anchor your investment portfolio.

Even with relatively low rates on safer investments, there are ways to stretch your core income. Spread your money equally among a mix of shorter and longer terms, say from one to five years. As your holdings mature, simply reinvest the funds in new five-year terms. This gives you access to a portion of your funds each year if you need them, and helps eliminate the rate shopping cycle, since you benefit from the higher rate of return typically linked to 5-year investments.

Adding yield sensibly

Once you have established your core position, look to enhance your income while staying within your risk tolerance.

More than growth vehicles, equities can also power your income strategy. Dividend-paying stocks,ᶲ income trusts, real estate investment trusts (REITs), and preferred shares can deliver higher regular payments than most fixed income choices. Even a small pickup in yield can make a big difference.

For instance, say you boost the overall yield of your portfolio from 3% to 4.50%, achievable with the right asset mix. While it's only a 1.5% change in rate, it translates to a 50% increase in income. Plus, equity income investing is tax smart. If the extra cash comes from dividends issued by eligible Canadian corporations it qualifies for the dividend tax credit when held outside a registered account. And unlike interest payments that are fixed until maturity, dividends can grow with a company's success.

The growth potential of equities can play a key role in maintaining your portfolio's income-producing ability. Because stocksᶲ are generally less sensitive to rising interest rates and inflation, they help shield the value of fixed-income holdings.

If you're attracted to the benefits of equities but don't like dealing with the market's ups and downs, you may want to consider segregated funds.

Like mutual funds,ᶲ segregated funds are professionally managed pools of savings. But as insurance products, they offer important advantages. Up to 100% of your capital can be protected. What's more, upon death, your investment can go directly to your named beneficiaries and bypass your estate, saving probate and related expenses. There can be important conditions or limitations around segregated funds, so ask your advisor if they're a good fit for you.

Converting your RRSP to income

You've worked hard to build up your retirement savings. But now that it's time to turn those savings into income, what are your options?

Current rules require you to convert your RRSP to a retirement income option by the end of the calendar year in which you turn 71. The most popular choice is a Registered Retirement Income Fund (RRIF). A RRIF allows you to keep your retirement funds taxed sheltered, an important advantage in preserving your capital. You can choose from the same range of eligible investments as your RRSP, so you can easily customize your income plan. Withdraw as much or as little as you need above the mandatory requirements. After death, the remainder of your RRIF can be left to your heirs.

While a RRIF offers a combination of tax sheltering and flexibility that's hard to beat, it's not a hands-off investment. Bad investment decisions can put your assets and income stream at risk. That's why for some, annuities are an attractive alternative.

With an annuity there's no guesswork. It's an insurance contract that offers steady, predictable payments either for life or to a specified age. These payments continue regardless of what the market or interest rates do.

If having peace of mind and simplicity are priorities for you, annuities may fit the bill. But know that once an annuity is purchased, you no longer have control over the investment money used and your funds cannot be returned.

Generally, the more you invest in an annuity, the higher your payments will be. How much you'll receive also depends on where interest rates are and how long you want your payments to last. For example, choose a longer contract and you'll receive less. Because traditional annuity payments are fixed, even low-level inflation can hurt. Inflation of just 2% annually will eat away a quarter of your income in 15 years.

When interest rates are low, it takes a larger lump sum to secure reasonable income with an annuity than when rates are higher. This makes annuities relatively expensive in the current market.

One approach to managing interest rate risk, inflation, and the cost of annuities is to avoid putting all of your savings in at once. Instead, consider purchasing a series of smaller annuity contracts to spread out your risk and let you take advantage of possibly higher rates in the future.

Choosing between annuities and RRIFs isn't an "either-or" proposition – you can combine these options in managing your retirement income. You'll benefit from guaranteed cash flow, while having the flexibility to add yield or alter your investment strategy as your needs change. Alternatively, you can start out with a RRIF in the early years of retirement and then switch to an annuity when you're older and no longer wish to actively manage your investments.

When rates are high, income investing becomes a simpler task. In a low-rate world, creating enough income takes a solid plan that looks at all of your options. Don't fall short. Your BlueShore Financial financial advisor has the knowledge, experience, and skills to thoroughly review your situation and help create a balanced approach to the income you need.