Under these conditions, many plan members may find themselves revising their retirement plans, factoring in a few more years of accumulating assets before leaving the workplace and moving to the de-accumulation phase.
However, this scenerio is based on the premise that the choice is not being made by someone else. Unfortunately, employers faced with difficult economic conditions may be pushed to downsize at an inopportune time for plan members.
As a CAP member or sponsor, what can you do? Here are three possible options to consider.
Phased retirement: This can work for both partners in the CAP deal. When times are tough, employees can transition gradually into retirement, supplementing their retirement income with at least a partial paycheque to help bridge the gap before full government pensions and supplements can kick in. On the other hand, when times are good, employers can keep knowledgeable staff around a little longer—at least long enough to ensure an orderly transfer of knowledge to the next generation entering the workforce.
A variation on this idea is the arrangement in which an employee retires but is hired back as a consultant, which serves the same function of smoothing the transition for both parties.
A tried-and-true risk-controlling financial instrument: No one knows for sure where the economic cycle is headed, so timing is never easy. But retirement need not be a complicated process of market and economic analysis, calculations and projections, and complex simulations. If there is a shortcut to retirement security, it’s a simple, proven alternative: the insured life annuity.
Insured annuities are the epitome of the dull, safe and boring products of the past. In recent years, they have fallen out of favour as low nominal interest rates make them seem unduly expensive. They are also criticized for lacking the flexibility and inflation protection associated with registered retirement income funds (RRIFs) and life income funds (LIFs). Indexing options are available, but at a significant cost. Banks are not authorized to sell life annuities, limiting how they are distributed to those with a licence to sell insurance.
An annuity will lock in the current fixed income rates, which may be perceived as quite low at present. However, it is important to remember that the rate is positive and guaranteed. This becomes a real plus when the returns of market-based RRIFs and LIFs go south.
Real education: Another long-term solution to consider is an active and sustained campaign to address the financial literacy of employees. Financial education can change employees’ attitudes about retirement, improve their understanding of the consequences of their decisions and help them to have realistic expectations. Real education comes from a source that has no conflict of interest in the subject—in other words, an organization that does not make money from the decisions that employees will ultimately make.
How can you use education to influence behaviour? Let’s look at the situation objectively. Although it sounds counterintuitive to retire just as an economic recession is confirmed, this may, in fact, be the best time to retire—for those who are prepared.
Crucial Exit Strategy
Multiple simulations using historical data illustrate the important impact of timing the transition from accumulation to de-accumulation. The first few years after contributions cease and withdrawals commence can make a critical difference to the long-term sustainability of a retirement portfolio. Making withdrawals during a few negative years can seriously damage the nest egg that was slowly built up over decades. When answering the question, Do I have enough?, it’s vital to consider the timing of the market’s cycles.
No one can predict with 100% accuracy when the market is at its peak or its trough, but it’s fair to say that the chances of a decline are much greater when the market has experienced a long run of positive results. Just as everyone begins convincing themselves that the bull market will never end, savvy investors are preparing for the inevitable bear market.
The point is that retirees leaving the workforce when things could not look rosier are actually begging to be disappointed early in their golden years when their portfolios suddenly shrink, the values of their homes fall and widespread turmoil undermines all of the assumptions supporting their new lifestyle.
The good news is that the opposite is equally true. If they can retire comfortably after their portfolios have been beaten up by a nasty bear market, the surprises are likely to be on the positive side as conditions improve. In such a case, the portfolio can rebound nicely and can sustain a higher withdrawal rate and a more generous standard of living than initially planned.
Perhaps the pre-retiree’s question should be rephrased. Instead of, Do I have enough?, perhaps it would be better to ask, Do I have more than enough? A retirement nest egg should be robust enough to support the desired standard of living through all phases of the economic cycle.
With real education, plan members can appreciate how the other tactics—such as buying an annuity or phasing in retirement— can fit into an overall financial and lifestyle strategy. Too often, they feel they are faced with an all-or-nothing, either/or choice that lacks the subtlety and sophistication to truly meet their needs. In fact, a combination of instruments may be the answer. This may include an annuity for basic living costs, a RRIF for those big discretionary purchases, such as the trip of a lifetime or a new car, and insurance for the legacy to the grandchildren or that favourite charity. Without adequate financial literacy, CAP members are unable to ask the right questions and confidently take charge of their own destinies.
Whether or not your CAP has matured enough to produce the hoped-for outcomes may soon be tested. You’ll know if the retirement dreams of your employees don’t come true when your phone starts ringing.
Christopher Cartwright is vice-president of The Financial Education Institute of Canada. ccartwright@feic-icef.ca
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© Copyright 2008 Rogers Publishing Ltd. This article first appeared in the October 2008 edition of BENEFITS CANADA magazine. //<![CDATA[ //]]>