The purpose of saving is to achieve draw an income in addition to benefits from government schemes (that of the Pension Board of Québec or the Canada Pension Plan, for example) and private (or annuities from pension of former employers), to achieve a higher standard of living during retirement.
As we saw in a previous article , the calculation of the amount you can withdraw your savings annually should not be taken lightly. How you choose to avail yourself of your additional annual income from your savings ( "RAA" below) partly determine the likelihood that you have enough savings throughout retirement.
This probability depends on three factors. First, it depends on the composition of the savings portfolio: the higher the equity exposure, the greater the earning potential is strong, but the risk is high. Second, the fluctuations of the market, we do not control, also play: if markets are generous during the disbursement period, then the probability that the savings are sufficient increases. Finally, the probability in question depends on how you determine the SCO: do you want the increase in the rate of inflation (ie full indexation), only 50%, or not at all (no indexation)? In the first case, the purchasing power is maintained over time and in the two other cases, it decreases (but to a lesser extent for a 50% indexation for inflation). For example, if you want to take an initial APR of $ 60,000 fully indexed to inflation, and for 25 years, what is the probability that your savings are sufficient to get there?
The effects of inflation
It is this last factor that we study in this article, assessing the consequences of the choice of the indexing level on the probability of not prematurely deplete the accumulated savings. We will analyze the case of Ms Ling, who happen to retire in two years, after a successful career as an employee and independent worker in communication. She fixed her 25 years disbursement period and would like a net initial APR of tax of $ 72,000. Ms. Ling expects to have accumulated about $ 1.117 million savings, distributed as follows among the various types of accounts it holds:
- RRSPs and locked-in retirement account (LIRA): $ 730,000
- Celik: $ 62 000
- Non-registered accounts: $ 325,000
The overall distribution of Ms. Ling portfolio is as follows (assuming that it remains constant):
- Cash and certificates of deposit: 5%
- Fixed Income: 65%
- Actions : 30%.
To simplify [1], we also assume that the investments of the RRSP and LIRA consist only of fixed income securities (such as government bonds), the TFSA is composed exclusively of shares and non-registered accounts are shared between certificates of deposit and actions. We also assume that the disbursement takes place in the following sequence: Ms. Ling draws first in the non-registered accounts, then in his or her TFSA accounts and finally in his RRSP and LIRA accounts.
The following graph shows the evolution of CEOS described as the degree of indexation to inflation. We see that in the case of full indexation (which maintains purchasing power), the CEOS from 72 originally $ 000 to almost $ 110 000 in 25 years, which is an important gap to be funded from the balance of savings.
Here the impact of the choice of Ms. Ling degree of indexing on the probability that it has enough savings to touch the RAA targeted for the next 25 years:
We can see that with a full indexation, there is a little less than half the chances for it to have enough savings for the next 25 years. This probability increases to about 57% if Ms. Ling constant guard its AAR. Between the two, indexing half of inflation corresponds to a probability of success of about 53%.
Possible Solutions
Choose the degree of indexation to inflation is not the only variable that determines the probability that the savings be sufficient. To increase it, Ms. Ling might want to reduce the required initial APR (and subsequent), reduce the number of years that lasts the time of disbursement or increase its risk-taking in order to improve the yield potential of the portfolio. These alternatives have advantages and disadvantages. Decrease the RAA requires a more modest pace of life for many years. Decrease the length of the disbursement period (eg, from 25 to 20 years) implies a hasty shutdown of the CEOS, which can be problematic when a person becomes older and thus may face care costs higher health. Finally, as mentioned earlier, to take more risk in order to increase the portfolio return is another option that can look appealing, which probably will sleep worse Ms. Ling in the stock market turbulent times.
[1] Warning: this analysis is approximate because it ignores all tax subtleties. Although this is a simplification of reality, our analysis illustrates the impact of indexation of the CEOS described the likelihood of surviving his savings. The assumptions underlying the simulated future returns are available on request.