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5 tips for managing withdrawal risks during retirement

It's time - finally time! - to hang up your heels, to put away your tie, and to venture into the land of the unknown. RETIREMENT!

These days, that word is so nebulous that it almost loses it's meaning. Technically, the Canaidan definition is "above age 55 AND not in the labour force AND receiving 50% of income from some sort of pension" (Perspectives on Labour and Income, Stats Canada). But one thing is pretty consistent amongst retirees (no matter how old they are and how they paint their new pictures every day) - they are somewhat (if not fully) reliant on income generated from their portfolios to keep the lights on.

If you're one of those people who gets a nice defined benefit pension at retirement - consider yourself lucky! (There are approximately 4.35 million defined benefit pensions in Canada, with about 75% of those in the public sector.) But, more and more these days, Defined Contribution (DC) Pensions are the more popular option, especially in the private sector (1.1 million compared to 160,000 in the public sector). DC pensions carry investment risk - that is, there is no guaranteed income component. The employer does not assume any risk on how much you might potentially earn from your pension during retirement. You select the investments (and level of risk you feel comfortable with) and let the results over time produce a nice pool of assets for retirement.

However, regardless if you have a DC pension, group RRSPs, or just plain old investments, you are subject to something called 'sequencing risk' once you reach retirement. That is, when you retire and start to draw an income out of your pension or portfolio, what do the returns look like? Do you start out in a bear or bull market? This can have a significant impact on the longevity of your retirement portfolio.

What is sequencing risk?

Let's take a look at two clients below, with identical amounts in their retirement accounts - $1 million. The average annual growth rate is 6% in both cases, and they both want to withdraw $50,000/year. The main difference is that Mrs. Green experiences positive returns early on in retirement, while Mrs. Red experiences negative returns. However, if you compare the annual returns over time, they are exactly the same (just reversed).

What can you do to manage this sequencing risk?

  1. Diversify across asset classes. Lowly correlated asset classes should have the effect of muting any potential market volatility during any stage of retirement. For example, bonds are typically negatively correlated to equities, meaning they carry different risks, and should give you different performance patterns over long periods of time.

  2. Consider trading a 'growth' strategy for a 'yield' strategy. What types of investments will produce passive income just by holding them, so you don't have to potentially sell your principal during down markets?

  3. Be flexible with your spending during retirement. Is it possible for you to reduce your withdrawals during times of higher volatility? Perhaps delay buying that new car?

  4. Keep a cash buffer. If you know what your spending is going to be over the next year, have that money available in a risk-free (read: cash equivalent) investment. That way, if markets turn, you don't have to worry that your grocery money is coming from the high growth component of your portfolio.

  5. Consider a life annuity. Life annuities offer a way to convert a portion of your retirement assets into your very own defined benefit pension plan. This is something I would never advocate doing with all of your money, especially if you have intentions of passing all of your money onto the next generation.


Perspectives on Labour and Income, Stats Canada, 2019.

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