Juan retired a few years ago from his job as an executive. He turned 71 earlier this year. His wife passed away many years ago.
Juan's sources of income include an Old Age Security (OAS) pension and a Canada Pension Plan (CPP) retirement pension. His former employer did not have a company pension plan. He supplements his pensions by withdrawing money from his registered retirement savings plan (RRSP).
Juan is healthy and his family has a history of longevity – his father was 96 when he passed away. Expecting a long life in retirement, Juan is concerned about maintaining a comfortable standard of living.
A diversified portfolio made up of:
- Laddered GICs. Retirees such as Juan can manage interest rate risk by holding investments which mature over time as and when the money is needed for spending. An example would be a GIC ladder with a GIC maturing in 1 year, another in 2 years, another in 3 years, and so on.
- A bond ladder. A bond ladder can be built in the same way as laddered GICs. Each year, a bond will mature and the proceeds can be used to pay for the year's spending.
- Annuities. Many retirees face longevity risk, which is the risk of outliving their savings. Juan is protected from longevity risk to a certain extent because OAS and CPP pensions are payable for life. Juan supplements his pensions by withdrawing money from his RRSP. He may wish to use a portion of his RRSP to buy an annuity. This will provide an additional source of payments for life.
- Common shares. Although Juan is a retiree, he should hold some common shares in his portfolio. His investment horizon could be more than 25 years and he needs the long-run return potential of shares. Shares will also provide a measure of protection against inflation risk, which is the risk of loss of purchasing power over time. OAS and CPP pensions provide some protection against inflation. Annuities may or may not be protected against inflation, depending on the terms of the agreement with the insurance company. Cash and bonds are fully exposed to inflation, except for real return bonds issued by the government. In the long run, common shares provide good protection against inflation.
What to avoid
- Holding all his investments in cash and bonds. Juan cannot lose money by holding cash. It is also unlikely that he will lose money by holding the bonds of a credit-worthy issuer to maturity. However, cash and bonds are vulnerable to inflation.
- Illiquid investments, for example, exempt market investments. The problem with illiquid investments is that Juan will be locked in. He may not be able to access his money when he needs it.
- Juan turned 71 earlier this year. By December 31, he must withdraw the money from his RRSP, transfer it to a registered retirement income fund (RRIF) or use it to buy an annuity.
- Withdrawing the money all at once is undesirable because the amounts withdrawn will be fully taxable.
- No tax will be payable if the money is transferred to a RRIF. A RRIF is similar to an RRSP except that Juan will need to withdraw a minimum amount each year.
- No tax will be payable if the money is used to buy an annuity. An annuity is an insurance product. If Juan purchases an annuity, the insurance company will pay him a regular amount for as long as he lives.
- Juan should monitor his portfolio regularly and rebalance it as needed. This will ensure that the risk of the portfolio stays within his risk tolerance.