Income planning 101: What happens to your income in retirement?
Retirement is supposed to be the best years of your life. We are living longer, healthier, and more active lives. For you to enjoy the fruits of your labor, you must understand where your income will come from and how much you will need to live comfortably.
If we take a look at the basics of retirement income planning we can describe something called the retirement income pyramid. The retirement income pyramid allows us to look at the different sources of retirement income.
The foundation of income planning lies in government benefits. In Canada we have Canada Pension Plan (CPP), Old Age Security (OAS), Guaranteed Income Supplement (GIS), and the spouses’ allowance which makes up the benefits you will receive from our government in retirement. While there are some concerns over the longevity of these benefits, it is important that you understand how they work. The most you will receive from the government is $19,943.64 if you have no other sources of income and only $14,084.88 if you have other sources of income. Clawback and contribution rules may reduce these amounts. Don’t count solely on government benefits for your retirement!
You may work for a company that has a pension plan. A pension can be a very significant part of your retirement income if you stay with a company for a long period of time. Today, pension benefits will depend on whether you are part of a defined benefit pension plan or a defined contribution pension plan. The best pension plan will usually replace 70% of your pre-retirement income assuming you stay with this company for 25 to 35 years. With so much mobility combined with early retirement and fewer available pension plans these days, it is rare to see maximum pension plan benefits.
Registered Retirement Savings Plans
The next layer in the retirement pyramid is the RRSP. It is predicted that this will become one of the biggest sources of retirement income in the future. RRSPs provide a tremendous amount of flexibility. You can take out as much as you want subject to the government-regulated minimum amounts. You can change income, investment options and tailor income to your specific needs. Good retirement planning will incorporate the best way to draw RRSPs for your income needs.
Investments outside the RRSP provide the most flexibility. Investments in this layer include stocks, bonds, GICs, mutual funds, investment real estate, etc. The after-tax implications of non-RRSP investments are crucial to your total retirement income plans. For most people, contributing to CPP, Pension Plans and RRSPs will make it difficult to accumulate a significant amount of non-RRSPs.
In some areas of Canada, housing prices have grown astronomically. As a result, in areas like Toronto and Vancouver, your personal residence can represent a significant asset. Because much of the resources have been used to pay off the home, little is left over for retirement income planning. The Reverse mortgage allows Canadians in this predicament to draw income from their homes once it is paid off.
Good planning makes all the difference!
Generally, the priority of income withdrawal occurs in the same order as the retirement pyramid. Sometimes there can be debate over which has priority, the RRSP and the non-RRSP. This is where a good financial plan can make all the difference. Whether you are just starting your career or whether you are already in retirement, understanding the retirement income pyramid will help you to build the foundation of planning for the future.