Managing your risk of survival

GUEST EXPERT. In financial planning for retirement, there are several risks to consider and manage: risk of volatility of the chosen investments (risk of loss), risk of inflation (if the chosen investments do not generate enough return), risk of loss employment or disability (which would affect the ability to save), risk of divorce (which could have a very negative impact on retirement savings) …

Among all these risks, there is one that is frequently forgotten or ignored: the risk of survival. It may seem counter-intuitive to speak of a risk of survival, and the risks mentioned above surely appear more… risky! However, if a good portion of your retirement income comes from your own assets, you should absolutely worry about the risk of survival, that is to say the risk of depleting your retirement savings before death, therefore of surviving your savings.

The risk of survival is mainly managed in two ways:

• increasing the proportion of retirement income from guaranteed and recurring sources

• planning according to an appropriate age for capital depletion

Increase the proportion of retirement income from guaranteed sources

Not everyone has the privilege of participating in generous defined benefit pension plans. If not, there are still two options available.

The first is to convert a portion of his savings into life income. Such a conversion can be done by acquiring a life annuity. These annuities are payable as long as the person remains alive. The 2019 federal budget presented a new possibility in this sense: the deferred life annuity at an advanced age (RVDAA). Payment for this RVDAA could begin as late as 85 years of age. This same federal budget also presented a new option reserved this time for participants in defined contribution pension plans: the variable payment life annuity (RVPV). Finally, be aware that acquiring a life annuity can be a good strategy, but it can prove to be relatively expensive in the current context of very low interest rates.

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The second option is to defer payment of benefits from government pension programs such as the Quebec Pension Plan (QPP) and the Old Age Security (OAS) pension. These two benefits can be deferred until a maximum age of 70 years. Their deferral will increase their amount by 7.2% per year of deferral for the VPS and up to 8.4% per year of deferral for the QPP (beware of those who have contributed few years to the QPP, the effective improvement will be lower). If you postpone the payment of these benefits, you will certainly have to withdraw larger sums of your own savings during the first years of retirement to compensate, but you will then be able to count on income for life, for a larger proportion of your income of retirement.

Appropriate age of capital depletion

In retirement planning, one assumption will be fundamental to the calculations: the age of capital depletion. One might think that life expectancy should be used to establish the age at which retirement capital will run out, in financial projections. Life expectancy is a statistical data which is based on a future age at which 50% of the members of a homogeneous group (same age reached, same sex) will have died. For example, if we say that the life expectancy of a 65-year-old man is 24 years, it means that out of a group of 1,000 65-year-old men observed today, 50%, therefore 500, should be died at 89. If we were planning the retirement of an infant, which should still be quite rare, we would use life expectancy at birth. As this rather theoretical exercise would have little value,

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However, using life expectancy as the target date for exhaustion of assets exposes some risk (or certain risk!), Since, statistically, 50% of people should exceed this period. This implies that retirement planning based on life expectancy would essentially have a one in two chance of not keeping up. Survival therefore really constitutes a financial risk to consider for retirement.

To manage this risk, it would be prudent to add a few years to life expectancy in retirement planning. This new duration is the reasonable disbursement duration. It represents an age at which 75% (and not 50%) of the members of a homogeneous group (same age reached, same sex) will have died. A retirement planning based on the reasonable duration of disbursement rather than on life expectancy would only have 25% of the probabilities of not staying on track and therefore, conversely, 75% chance of staying on track.

Do you want to know a little more about life expectancy and the reasonable duration of disbursement, and even calculate your own? The IQPF has an online tool for that!

In conclusion

Death is obviously a risk, but at the time of retirement, survival (or too long a survival) is also a risk that must be managed. Think about it: would you prefer to still have savings when you die, or spend the last years of your life without savings and with a greatly diminished standard of living?

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