Most discussions around retirement focus on how much money you need to save to live comfortably in your post-work years, and how much you can withdraw annually from your investments without too much risk. These are questions that both aspiring retirees and their financial advisers strive to simplify. The problem is there is no universal method to determine the answers, and the guidelines may overlook other important considerations.

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Sequence of returns

The well-known four per cent rule, credited to a 1994 Journal of Financial Planning paper by William Bengen, has some merit. Bengen’s rule of thumb suggests that a retiree can withdraw four per cent of their portfolio value in the first year of retirement, then increase the dollar amount of that withdrawal by inflation each year and likely not run out of money. While there are many factors that can make this rate too high, too low, or totally irrelevant, the rule provides an easy retirement-readiness barometer and it’s a simple starting point, so deserves some credit.

The four per cent rule has been challenged in recent years for being too high, especially with people living longer and spending more time in retirement. The initial research also ignored the impact of investment fees, and despite trying, few investors beat the market net of fees. It also does not factor for changes in expenses or pension income during retirement, nor does it account for the tax implications of withdrawals, asset sales or inheritances.

One interesting thing about the four per cent rule is the significant upside potential if the sequence of returns is strong in the early years of retirement. Research conducted by Michael Kitces in 2019 looked at the projected value of a traditional balanced portfolio (60 per cent in stocks and 40 per cent in bonds) using the four per cent rule. Using U.S. data going back to 1871, Kitces found that half the time (50th percentile) a retiree would have ended up with a portfolio nearly three times its starting value after 30 years. And the top 10 per cent had a portfolio value of more than six times its starting value.

It is obviously risky to count on the “best case scenario” for future returns. But there is arguably a risk in working too long, saving too much and spending too little, resulting in an unintentionally large estate value. The best approach may be to invest based on an appropriate risk tolerance, take rules of thumb with a grain of salt, and reevaluate spending and investment withdrawals as life changes over time.

Risk tolerance

It is not uncommon for risk tolerance to change once an investor is dis-saving rather than saving. Confident investors may become more hesitant. Proper preparation can prevent knee-jerk reactions and reduce the temptation to sell when stocks fall, as they inevitably will from time to time, because panicking can turn a temporary loss into a permanent one.

Since most of the anxiety around retirement concerns running out of money, investment strategies that reduce this likelihood would help calm the nerves. Stocks can be scary for investors who are starting to draw down their investments, but if a particular account is going to be depleted sooner than another, it may help to be more conservative with the funds needed soonest.

For example, if a retiree is taking large non-registered withdrawals and only modest registered retirement savings plan (RRSP) withdrawals, they may opt for more stock exposure in their RRSP and less in their non-registered account—even though it may be less tax efficient. If their tax-free savings account (TFSA) can be maintained well into retirement, they may be more aggressive with its asset allocation.

Health

Delaying retirement — or delaying doing things in retirement — can have consequences. Poor or declining health may mean some people have much shorter retirements than expected. In fact, according to Statistics Canada, nearly a tenth of Canadian seniors aged 60 and over who died in 2022 were under the age of 75.

Even if poor health does not shorten life expectancy, it may limit one’s ability to travel and do things they hoped to do (and budgeted for) before retiring. So, be careful about waiting until tomorrow to do what you want to do today.

Poor health can be costly, and this is a legitimate risk for retirees. Insurance companies offer long-term-care insurance to mitigate the risk, although the market for this product in Canada remains small.

There are benefits to deferring government pensions like Canada Pension Plan (CPP) and Old Age Security (OAS). The monthly payments rise with each month you wait. It is an unpopular and uncommon choice amongst retirees who prefer to start their pensions early to avoid drawing their investments early. Retirees who live a long life, especially those who invest conservatively, may end up with more money in their later years by deferring.

One of the reasons to consider government pension deferral is because it gets harder to make financial decisions as we age. Although this may be a difficult thing for people to face, our cognitive abilities tend to peak and plateau around midlife and decline around the time most of us retire.

According to the National Institutes of Health, research shows that “older adults had problems managing financial obligations up to six years before a diagnosis of Alzheimer’s disease or related dementia.”

This may support deferral of government pensions so that a higher proportion of retirement income comes from guaranteed, inflation-protected and, most importantly, simple sources.

End of a marriage

Despite all the talk about the rise of grey divorce, its increase needs context. Between 1991 and 2017, the divorce rate for Canadians aged 50 and older rose by 31 per cent. However, the divorce rate among those 65 and older dropped by 20 per cent in roughly the same period (1991 to 2020). With only 1.2 divorces per 1,000 married persons 65 and older, the incidence of grey divorce is in fact quite low.

The bigger risk to a marriage ending may instead be death. Whether we like it or not, every marriage comes to an end eventually.

So, in preparing for retirement, it is important to consider what would happen if one spouse died. If pensions will decrease, by how much? The survivor may end up in a much higher tax bracket with all income taxed on one return instead of two. If one spouse manages a couple’s financial or investment decisions, the other spouse should be involved in retirement discussions, including a contingency plan. If estate planning is not up to date, this is a good time to revisit it.

Takeaways

I spend most of my time helping retirees plan to live happily and healthily until age 95 and not run out of money. Although we all hope to live long and well in retirement, and making good financial decisions along the way, life does not always go as planned. Retirement math, whether based on rules of thumb or professional planning, can overlook some of the real-life implications of being a retiree. Running out of money is a risk, but so is running out of time.

Jason Heath is a fee-only, advice-only certified financial planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever. He can be reached at jheath@objectivecfp.com.