The biggest challenge in designing retirement portfolios is making sure clients don’t run out of money — a real danger, given our longer life expectancy.

To avoid this possibility, advisors need to make realistic projections of how much money a client can count on each year until age 90 — or even age 100, if the client comes from a long-lived family — given his or her investible assets and other sources of income. If the amount is less than the client thinks is needed, then plans have to be developed to reduce expenditures and/or increase investible assets.

What advisors shouldn’t do is start with how much the client thinks is needed, and then chase returns in an effort to generate that income. That can increase risk beyond what the client is willing to assume. As Nancy Cobban, a portfolio manager at RBC Dominion Securities Inc. in Toronto, puts it: “I prefer to work with clients when we let the risk tolerance drive the process.”

Ways to increase investible assets include downsizing the principal residence, selling other assets or borrowing on whole or universal life insurance policies, with interest taken out of the principal. A reverse mortgage on a principal residence is another possibility but is usually a last-ditch measure; such a step means all other assets are gone and there’s no flexibility for unexpected expenses in the future.

A retired client who persistently overspends is an advisor’s worst nightmare. The advisor must tactfully convince the spendthrift client that this habit could lead to serious problems later in life. One solution is to build a margin of safety into the financial plan, based on the retired client not spending all of the available income and growth, says David Christianson, a fee-only registered financial planner at Wellington West Total Wealth Management Inc. in Winnipeg. Cobban achieves this safety margin by using higher inflation and lower investment returns in her projections than would normally be used.

Be warned: clients often underestimate what they will spend in retirement. They think living costs will decline once they retire — but it frequently doesn’t, and may even go up.
Increased travel and leisure activities in their early retirement years and higher health-related costs when they get older can make for higher costs.

One technique, says Cobban, is to ask clients what their income has been over a number of years and how much they’ve been able to save. The amount left after the savings are deducted is what she assumes they will spend in retirement.

Most advisors recommend retirement portfolios hold some equity, including from foreign sources. Clients need to invest at least 20% in equities if they are to offset inflation, says Lynne Triffon, an RFP and vice president of fee-only firm T.E. Financial Consultants Ltd. in Vancouver.

But equities shouldn’t make up more than 60% of a portfolio if the client is living on the assets, Triffon says. The exact amount depends on the client’s needs and risk tolerance.

Whether a retired client should have a portion of the portfolio in foreign equities also depends on the client. Dunnery Best, an investment advisor and portfolio manager at CIBC Wood Gundy in Victoria, recommends no more than 10% foreign content, saying there’s no need to take on currency or political risk when there are world-class Canadian companies in which to invest. He, however, doesn’t have clients who spend part of the year in another country.

Triffon, Christianson and Cobban all have clients who live out of Canada for part of the year; all three advisors like to have as much income generated in the relevant currencies as is consistent with risk and risk tolerance. Historically, having 40%-60% in foreign investments has produced the lowest risk and greatest return, but, Christianson says, he wouldn’t go that high with retirees — unless they spend a lot of time outside of the country.

Cobban encourages clients to decide on foreign content by looking at a number of factors — their future liabilities in foreign currencies, the fact that 20%-25% of what they buy will be imports affected by foreign currencies and the opportunities that can exist in foreign stocks.

Triffon recommends a three-way split — one-third each in Canadian, U.S. and international equities.

@page_break@Daryl Diamond, principal of Winnipeg-based Diamond Retirement Planning Ltd. , recommends advisors ensure that any disbursements of capital come out of low-volatility assets, such as fixed-income. Advisors don’t want a situation in which a client sells units of a balanced mutual fund to provide income, because equities may end up being sold when markets are down.

Christianson uses a running two-year plan of expected expenditures for which he maintains liquid and short-term investments at all times. When depleted by unexpected expenses, it is replenished by income production or realized capital gains. This provides for periodic or unusual expenditures, such as major house repairs, the purchase of a new car or help for the children.

An advisor can also enhance a client’s retirement returns by focusing on tax efficiency, says Diamond. As soon as a person retires, this becomes critical — partly because no more assets are being gathered, but mainly because of the tax pitfalls for seniors. A major example is a client being pushed into a higher income tax bracket after turning 69, converting an RRSP into a RRIF and beginning to take a certain amount out each year.

Part of Diamond’s solution is to move as many of the assets out of registered plans each year as is possible without pushing the client into a higher tax bracket. This makes the additional income the client has to take at age 69 as small as possible. The assets that are removed and that are not needed for current expenditures are invested in tax-favoured or tax-deferred assets.

The aim is to have income up to the first tax bracket generated by fully taxable assets, and the rest by a mix of tax-favoured and tax-deferred assets. This minimizes clawbacks for old-age security, guaranteed income support and the senior personal tax exemption, all of which kick in, along with the Canada Pension Plan, at age 65. IE