Pat, 63, and Maggie, 60, are about to retire. Between the two of them, they have $800,000 in RRSPs and $200,000 in TFSA assets. They are also entitled to 90 per cent of the maximum CPP pension plus full OAS pensions.
Their goal is to draw as much income as they can from their savings while being reasonably sure their money will last until their 90s. They consider three strategies.
The first is to draw only the interest each year and leave the principal untouched. This will ensure they will not outlive their money.
The second strategy is to use the 4-per-cent rule – draw 4 per cent of their assets in year one of retirement and then increase withdrawals in future years to keep up with inflation.
The third strategy is to dispense with rules of thumb and instead use an algorithm. An algorithm in this case simply means a set of calculations that solve for the optimal amount of income under certain economic assumptions.
Every retirement calculator available online or through a financial planner is based on an algorithm, although some are more sophisticated than others.
In the case of all three strategies, the economic assumptions used are (a) an investment return of 4.5 per cent before fees, (b) investment fees of 1.5 per cent a year, and (c) future inflation at 2.2 per cent a year. The chart below shows the result.
The interest-only approach ensures their savings never run out, but it doesn’t provide much income. The 4 per cent rule, which usually works, fails in this case because the net investment return is low. The use of an algorithm is the clear winner.
While the comparison will vary based on the assumptions used, the main takeaway is to employ as much science and outside expertise as you can when determining your withdrawals rather than relying on any simple rule of thumb.
Frederick Vettese is former chief actuary of Morneau Shepell and author of the PERC retirement calculator (perc-pro.ca)
