Best practices for calculating retirement income needs

“Am I going to be OK?”  

It’s a question most people approaching retirement ask themselves.   

But as Julie Seberras points out, “OK” looks different for everyone.  

“It’s really important that clients understand what their OK means and have a conversation with an advisor,” said Seberras, head of wealth planning and practice management with Manulife Wealth in Toronto.  

“Because what you don’t want is that you are now at retirement and you realize you don’t have enough money.” 

Here are some best practices for retirement income planning. 

Tailor the plan to the client 

To get clients thinking about their ideal retirement, Seberras suggests asking clients a simple question: “What are you retiring to?”  

For example, she noted the cost of spending leisure time in one’s city or town could vary tremendously from the cost of travelling part of the year.  

“Often people have heard you need 70% of your pre-retirement income in retirement. That may be the case for somebody, but if you’re somebody who wants to travel six months out of the year, that might not be adequate for you,” Seberras said. 

Rick Lachine, a financial planner and founder of RLA Financial in St. Thomas, Ont., said he starts off by asking a client their cash flow requirements. If they don’t have a clear idea of how much they need, he asks his clients their take-home or after-tax income. 

From there, he uses his “G-O-A-L” strategy to figure out where their money is going each month. G stands for giving, or the amount of money a client donates; O stands for owing, or the payments the client is making on debts and loans; A stands for accumulating, or how much the client saves; while L stands for how much the client’s lifestyle costs. 

“This is either going to create a surplus or a deficit on a month-to-month basis,” Lachine explained. “But if they really don’t know [these monthly breakdowns], I just go back and we’ll use their after-tax income that’s coming in currently as a benchmark.”  

Once this benchmark is created, Lachine discusses investments with the client. 

Daryl Diamond, chief retirement income strategist with Dynamic Funds in Winnipeg, said he goes through a step-by-step process which involves asking what a client is looking for in their retirement, helping them figure out what they want to do with their time and how much it will cost, and setting aside money for things such as inheritances and donations. 

“Every situation is unique and specific. As a result of that, cash flow needs are unique and specific and the investment alignment has to be tailored to accommodate those differences,” Diamond said. “There really is no one size fits all in this equation.”  

Keep calm and stay invested 

Market volatility can be stressful for any investor, especially someone who’s approaching or in their retirement years. But it’s an advisor’s role to help their clients navigate the ups and downs of markets. 

Lachine said he uses a formula to allow his clients to meet their retirement income needs without stressing out over changes in the markets. To come up with a client’s liquidity needs, or what he calls their safety allocation, he calculates three figures:  

1. Half of a client’s annual pre-tax income 

2. A client’s monthly after-tax income required or expenses, multiplied by 12 

3. The current value of a client’s liquid invested assets at a rate of 4% (assumed rate of return) multiplied by three 

The largest of those numbers will be the client’s liquidity or safety allocation, which is the amount a client would want to have in safe, non-fluctuating assets to use as needed and weather storms in the market, Lachine said.  

Using these figures, he then categorizes the client’s money as follows: 

1. Today money, which equals about three months’ worth of a client’s after-tax monthly income or expenses 

2. Tomorrow money, which is the safety allocation minus the today money (together, the today and tomorrow money make up the safety allocation) 

3. Future money, which is put in the client’s investment portfolio and depends on their risk profile and capacity (this is the total amount a client has invested in liquid assets minus the safety allocation)  

4. Legacy money, which is money or assets the client wants to pass on to their family or heirs or donate to charity 

Lachine said this formulaic approach separates a client’s short-term retirement income from their long-term retirement income, allowing them to keep calm and stay invested. 

“It takes their focus off of the future pile, which is their investment portfolio, and puts the emphasis on treating money as today, tomorrow or future so they’re not looking at their portfolio all the time,” he said. 

Moreover, seeing these categories takes the emotion out of investing.  

“The money that they need to live on a day-to-day basis or over the next one to three years, we’ve already allocated into the safety allocation, it’s already steady, it’s not going to fluctuate and then people don’t become very, very concerned,” Lachine explained. “Then we just say, ‘You don’t need the money in your future pile for [at least] three years, so just let it fluctuate.’ And then people are more apt to take their focus off of that and concentrate on their today and tomorrow. It’s kind of like a financial behaviour hack.” 

In the meantime, an investor can take advantage of a dip in the markets by allocating some of the money in their today and tomorrow money piles to their future pile if they wish. If their portfolio has done well, they can take money out of the future pile and put it into their today and tomorrow piles to fund their retirement income in the short term, Lachine said. 

“From an emotional or behavioural standpoint, it creates a heck of a lot more peace of mind and actually puts a portfolio in a longer time horizon than the money that they may need today or tomorrow,” he added. 

Diamond suggested putting money in income-generating investment funds or ETFs to form the basis of — if not completely form — the source of retirement income a client needs. That way a client can avoid being reactive and selling securities in down markets.  

“We found that if people just stayed invested, even if the account values went down, they rose back to where they were previously. It just needed time to recover, but in the interim, they’re having their cash flow provided by the income generated by these investments,” he said. 

Seberras recommended advisors to implement the cash-wedge strategy to help their clients avoid making withdrawals from securities in down markets. 

“When you’re a retiree and you need to be taking money out because this is money you need to live on, … if you can take it from an investment, such as cash or fixed income, where it’s not impacting your portfolio, that’ll help with the longevity risk of not running out of money,” she said. 

Stress testing  

It’s equally important to talk about what would happen if a client’s retirement doesn’t go according to plan, especially while they still have the capacity to have those conversations, Seberras suggested. Having emergency savings is also beneficial.   

“Often [with] retirement planning, we assume everybody’s healthy, we assume everybody’s mobile, we assume they’re living in their home, they’re living to life expectancy,” Seberras said. “We don’t often factor in things like death, divorce and disability. And I think it’s really important to stress test your financial plan for those types of things.” 

Diamond said he revisits a client’s retirement income strategy at least every five years or whenever a client experiences a life event such as a death, disability or children moving back home.   

“We just don’t know how long someone’s going to live. You can have all the plans and want to travel the world, but if your partner falls ill, all of the hopes you had are dashed. And now what do you do?” he said. “You’re continually navigating change.” 

In terms of investments, Seberras recommended stress testing for things such as lower returns than assumed, multiple years of negative returns and different rates of inflation.  

“A lot of times retirement planning is more art than science,” she added.