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anadians today are facing two major newrealities. First, we are retiring earlier and liv-ing longer. A few generations ago, workinguntil age 65 or later, with a life expectancybarely over age 70, was the norm. But times

have changed and the period between retirement anddeath is increasing. Second, many major corporations havemoved from a defined benefit (DB) to defined contribu-tion (DC) pension structure or simply no pension at all.In both cases, the responsibility of building a retirementincome stream has been passed from the employer to theemployee.

That responsibility is enormous. We can no longer relyon the government, the employer or the union to take care

of us when our working days are done. We must takecharge of our own retirement. Yet many Canadians mis-understand the risks threatening their retirement and lackthe tools necessary to construct a successful retirementincome plan on their own.

Let’s get started by taking a closer look at some of thereal risks of retirement income planning. The challengesfaced by retirees today are different from those faced bytheir parents and grandparents. In particular, a healthyretirement income is threatened by a unique set of risks:• longevity — outliving retirement savings;• inflation — erosion of purchasing power; and• sequence of returns — poor investment returns in early years.

Most of us dream of living to a ripe old age — and enjoying everylast minute of it. However, without a sound financial strategy, somecould be spending their golden years working at the “GoldenArches.” Michael Callahan explains how the new realities of longerlife expectancy and more restrictive pension plans will require finan-cial advisors to better understand the risks and provide suitableoptions for their clients

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LONGEVITY RISKSimply stated, longevity risk is the risk of outliving your money.In order to plan for a successful retirement, we must have someidea of the time frame involved. Yet, when asked about typicallife expectancy, many Canadians have only a vague idea of wherethey stand. Life expectancy in Canada (for both sexes com-bined) has recently passed the 80-year mark and, as of 2008,the official number is 80.4 years.

But those figures are misleading since they represent lifeexpectancy from birth. Currently, the average retirement age inCanada is 62. The life expectancy of a 62-year-old is drasticallydifferent from that of an infant. In fact, the joint life expectan-cy of a non-smoking 62-year-old couple is 92 years. In otherwords, at least one spouse will still need an income 30 years afterleaving the workforce. Advisors and their clients need to takeinto account these figures when forecasting retirement income.

INFLATION RISK In recent months, many clients close to or in retirement havebecome much more conservative with their investment strate-gies. Could this be to their detriment? Unfortunately, being tooconservative can in itself be a risky strategy.

In investment circles, the word “risk” is often associated(almost exclusively) with loss of principal. This can lead investors

RETIREMENT PLANNING

to believe a portfolio consisting of GICs (or similar instruments)is “risk free” because principal is guaranteed. While it’s true thatprincipal is indeed guaranteed, this type of investing greatlyexposes the investor to another type of risk: inflation risk.

When looking at a retirement spanning three decades, wemust consider what happens to the cost of living over that peri-od of time. The consumer price index (CPI) offers a good esti-mate for this measurement. According to Andex Associates Inc.,CPI has increased at an average annual rate of 3.9 per cent since1950. Although 3.9 per cent may not seem too threatening, itmeans the cost of living will over triple over 30 years. In orderto protect against this risk, retirement income must be designedto grow with the cost of living.

The good news is that there is a fairly straightforward rem-edy. Using the S&P 500 index as a guide, we can see that, his-torically, equity-based investments have provided a great hedgeagainst inflation. Yet, conservative clients accustomed to fixedincome investing are often quite reluctant to take on equityexposure in their portfolios. “We all know that clients must haveequity investments to cover off inflation and longevity risks,”says Dessa Kaspardlov, financial advisor with Kaspardlov Lavertyand Associates in Windsor, Ontario. “However, getting them toincrease or at least maintain that exposure is difficult, especiallyin times like these.”

SEQUENCE OF RETURNS RISKWhile proper asset allocation and a healthy equity/fixed incomebalance can certainly go a long way in helping investors staveoff inflation and longevity risk, it cannot protect against thesequence of returns risk. Severe market downturns, like the onewe’re currently experiencing, can be devastating to most anyinvestment portfolio, especially those in the withdrawal phase.

“When a pool of assets is left untouched, no withdrawalsand no contributions, the sequence of returns is irrelevant tothe end result. If the portfolio experiences poor returns in earlyyears and much more favourable returns in later years, the end-ing market value will be the same as if the sequence of returnswas reversed. The same cannot be said during the withdrawalphase,” says Moshe A. Milevsky, Ph.D., associate professor offinance at the Schulich School of Business at York University inToronto and executive director of The Individual Finance andInsurance Decisions (IFID) Centre.

According to Milevsky, withdrawing regular income from aninvestment that has declined in value immediately after retire-ment could mean a depletion of savings much sooner than expect-ed. Ultimately, poor performance in early years can be devastat-

In recent months, many clients closeto or in retirement have becomemuch more conservative with theirinvestment strategies. Could this beto their detriment? Unfortunately,being too conservative can in itselfbe a risky strategy.

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ing. Advisors and their clients need to find ways of protectingagainst these risks in order to secure a stable retirement income.

GUARANTEED PRODUCTSCommonly referred to as a Guaranteed Minimum WithdrawalBenefit (GMWB), products such as Manulife’s IncomePlus andSun Life’s SunWise Elite are fairly new to the Canadian mar-ketplace. Targeting the needs of baby boomers transitioningfrom working to retirement, these products have become wild-ly popular in recent years. GMWB products usually include ablend of options, which can sometimes be confusing to clientsand advisors alike. Let’s take a closer look at some of the morepopular features and benefits and how these products can beused to help protect against the risks of retirement.

A GMWB allows the investor to withdraw a specified mini-mum percentage of the total investment each year for a set num-ber of years, until 100 per cent of the investment has been recov-ered. Many companies offer provisions to lock in investmentgrowth, thereby extending the withdrawal period and/or increas-ing the withdrawal amount. An example would be a guaranteedminimum withdrawal of five per cent annually for 20 years.

A variation of the GMWB, the Guaranteed LifetimeWithdrawal Benefit (GLWB) also allows investors to withdrawa specified minimum percentage of the total investment. However,the main difference with GLWB is that instead of lasting for aspecified number of years, the withdrawal is guaranteed for life.

RETIREMENT PLANNING This lifetime guarantee is typically conditional on the investor’sage, for example only available to those over age 55.

The Guaranteed Minimum Accumulation Benefit (GMAB)gives investors the opportunity to protect their principal whileestablishing a minimum annual investment return. This fea-ture works by either locking in growth periodically or accept-ing the guaranteed minimum return during an established peri-od of time, such as 20 years. At the end of that time frame, thevalue of the underlying investment account will be either theactual market value of the investment or the guaranteed min-imum, whichever is greater.

THE VALUE OF PROTECTIONProducts such as Manulife’s Income Plus and Sun Life’sSunWise Elite offer a blend of all these features. It’s easy to seewhy they’ve gained so much popularity in retirement planning— they help protect retirees against those risks that threatenretirement income. By utilizing such products, investors cansecure a guaranteed cash flow, thereby protecting against thesequence of returns risk and offering insulation from invest-ment losses in the early years of retirement. Lifetime payoutensures protection against longevity risk, while the guaranteedminimum performance allows the investor to maintain ahealthy equity exposure in order to combat inflation risk andthe erosion of purchasing power.

Of course, added features are rarely free, and the additionalprotection offered by these programs comes at a cost. Is the pro-tection worth the cost? That’s a decision each investor has to

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make based on his or her own personal situation. But it’s notalways an easy one as some companies are moving towards mak-ing guaranteed products more expensive and with less features.

For example, Sun Life has already made recent changes totheir SunWise Elite program, reducing the maximum allow-able equity exposure from 90 per cent to 70 per cent. “Thereare a number of insurance companies scaling back in terms offeatures. You can only slice a pie in so many pieces,” saysMilevsky. So, should advisors still recommend these productsto their clients? “Of course they may still be suitable for certainclients and in certain situations. But in general, when insur-ance companies start trimming features and increasing costs,the resulting products will be of a reduced value to investors.Less risky for the company usually means less beneficial to theclient,” adds Milevsky.

A BIG PICTURE APPROACHMore than just successful investment management, retirementplanning involves other considerations as well, such as insur-ance planning. For example, how do critical illness and long-term care insurance fit into a client’s retirement plan? Whileproper planning can’t prevent illness or death, it can certainlyhelp prevent those things from turning your clients’ financiallife upside down. “As advisors, we need to make sure that ourclients have hedged their risks. I don’t want my clients takingmoney out of investments when markets are down in order tofund medical expenses. Talk about compounding losses,” saysDessa Kaspardlov.

According to Milevsky, it comes downto a simple issue: “Can the client afford toself-insure against these risks? Not every-one should have the product. But every-one should at least have the discussion.”

In this sense, many advisors realizethe importance of providing compre-hensive solutions for clients, and thevalue of designations such as theCertified Financial Planner (CFP).

“In the past, the financial servicesindustry was divided into two very dis-tinct groups who focused on very dis-tinct aspects of a client’s own personalsituation. One group is the stockbrokers,who focused solely on the asset side ofthe balance sheet — looking at whatassets a client has and then deciding onhow best to invest those assets. The otheris the insurance agents, who focusedsolely on the liability side of the balancesheet — looking at protecting againstsuch risks as the loss of life, loss of work,etc. We need to close that gap, and thenext generation of advisors is gettingthere. Advisors today are becomingmuch more well rounded, able to offeradvice and guidance in areas such as taxand estate planning as well as insuranceand investments,” adds Milevsky.

BOTTOM LINECanada’s aging baby boomers account for close to one-thirdof the country’s 32 million people. “This is a huge part of themarketplace and these people need some security in a worldwhere there seems to be little,” says Dessa Kaspardlov. “Mypersonal experience is that they really do not know how muchmoney they need or that longevity risk really is a factor. Manywant the good life, a place in Florida so that they can golf allwinter. But they do not really understand how many yearsthey can actually afford to do this or what needs to be doneto make sure that this kind of a retirement is sustainable. Ibelieve advisors need to help their clients ensure the correctamount of pension-type income, even if they have to pay theprice to buy this from an insurance company. As individuals,clients can’t afford to take on this risk personally and insteadneed to insure against it, just as one does by insuring their life,home or car.”

The retirement planning landscape is ever-changing. Newproducts are increasingly complex and navigating through amaze of options can be frustrating for even seasoned investors.The average citizen simply does not have the ability to con-struct a successful retirement income program alone. This iswhere a trusted professional is critical to success. Advisorstoday, more than ever, need to work with clients to help builda retirement income that lasts.

MICHAEL CALLAHAN can be reached at callahan_michael@yahoo.com.