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Retirement
in Canada
In
Canada, traditionally, 65 years has been considered as the
normal retirement age. This is the age when some
government benefits kick in [Read
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Column:
Wuzz
up dude ?
So
what’s up ? Well, let’s see. DJ Industrial is down...
DAX is down ...Nikkei is down...and oh yes, good
ole
London is down about ... Our home Toronto (TSE300) is down
about ... and finally, to crown it all,
dear
ole Bharat (BSE200) is down! [Read
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Retirement
in Canada
In Canada,
traditionally, 65 years has been considered as the normal retirement age.
This is the age when some government benefits kick in; tax treatment becomes
slightly different etc. However, from financial planning perspective,
‘retirement’ is really a stage in life when one has accumulated financial
assets sufficient (and more) to provide for future life style income needs. At
that point in time one may choose to retire to a rocking chair or pursue
favourite alternative career, hobby etc. Thus, conceivably, one could retire
at 50 or still not be retired at 70.
So what are
the sources of retirement income in Canada? Well, some of the sources are:
1. Employer
sponsored pension plans
2. Registered
Retirement Savings plans (RRSP)
3. Non-registered
savings
4. Canada
Pension Plan (CPP)
5. Old
Age Security (OAS)
6. Government
Income supplements for individuals/couples with low incomes
Let’s take the ‘employer sponsored pension plans’ first.
Generally these plans come in two flavours.
Defined
Benefit Plans: Your
pension at retirement is based on a pre-determined formula (defined benefit),
which is basically like this:
Annual
Retirement Pension=Years of service x Employment income at retirement x
Pension factor, X
X is a
percentage, generally, in the range 1 to 2%. So if you work for a company for
20 years and your employment income at the time of retirement is, say,
$60,000/yr, then assuming X to be 2%, your annual pension (at age 65) would
be:
Annual
pension at 65 =20 x 60000 x 2/100
=$24,000/yr
Both the
employer and the employees fund these plans. The employee’s contribution is
fixed at a certain percentage of the employment income. However, the employer
carries the burden of funding the plan adequately, so that the future
liability related to the employee’s pension is met. In this sense, these
plans are excellent from the employees’ point of view (you know what you are
contributing and you also know what you are getting). However, these plans
place an additional financial burden on the employers and for this reason,
many employers choose to move away from such plans. Also, in the recent times
it is becoming increasingly difficult to visualize a scenario where an
employee will stay for twenty or more years with one single employer. In order
to enjoy the full benefits of such plans, a long length of service is very
important.
Defined
Contribution Plans:
In
these plans both employer and employees contribute at a predetermined rate
(usually a percentage of employment income). The employee is offered a range
of investments within which both the employer and employee contributions may
be invested. Usually the employee has the responsibility of making the
investment decision. Naturally the pension income that may be derived from
these investments will depend on the size of contributions, investment rate
achieved and time period. In other words, in these plans you know what you are
putting in (defined contribution) but you don’t know for sure what
you are going to get. Naturally such plans suit the employers since now they
don’t have to promise you a future pension. For the employees, these plans
bring the element of uncertainty in their retirement plans. Well, that’s
life!
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Wuzz
up dude ?
So
what’s up ? Well, let’s see. DJ Industrial is down 5% this year. DAX is
down 9%, Nikkei is down 10% and oh yes, good old London is down about 12%. Our
home Toronto (TSE300) is down about 15% and finally, to crown it all, dear ole
Bharat (BSE200) is down about 25%! Pardon me for not mentioning a few
exceptions like Mexico, Australia etc. that have actually posted positive
numbers this year. In short, globally the markets and consequently, the
investors have been ‘depressed’ for over a year now. Considering that
prior to that we were having a great Bull market for a very long time, the
arrival of the Bears has ruined the party for a large number of investors.
So when did it all begin? Last summer with the onset of Technology sector
meltdown? Did it have anything to do with the preceding breathtaking rise in
the darling of technology stocks the NASDAQ composite? You remember someone
referring to ‘irrational exuberance’? Then there was that changing of
guards between the ‘old economy’ and the ‘new economy’. The global
village tied together with the internet, linked with super fast
communications, and of course the biotechnology revolution…..all that was
going to change our lives the way we know it.
What does all this do to our financial plans and investment strategies? Have
the market forces undergone a fundamental change and if so, should we discard
our old financial tools and invent new ones? To understand this let us do a
quick recap of what financial planning is all about. Your Net Worth (assets
less liabilities) represents where you are today, financially speaking. This
is what you have managed to accumulate so far. Let’s call this point
‘A’. You have some financial goals….retirement, children’s university
education ($10-15k/yr in Canada), reduce taxes (we are one of the highest
taxed countries and we are working hard to be number one!) etc. Each goal
would have a time frame (retire in 30 years) and a dollar cost ($5000 per
month income at retirement) associated with it. Let’s call one of these
goals as point ‘B’. A financial plan would examine these goals in light of
your current financial situation (Net Worth & Cash Flow) and suggest
workable strategies for achieving those goals. This effectively is the path
that takes you from point ‘A’ to point ‘B’. Some of these paths may
involve investing money such that the future value of these portfolios is
sufficient to meet the cost of the particular goals. For each of these
investments the ‘time frame’ is a critical factor.
Why is ‘time’ a critical factor for investments? Well, time represents
your ‘investment horizon’. Every investment has a time horizon associated
with it. For example, money deposits with banks etc. guarantee you your
principal and may be suitable for investments with a short time horizon. At
the other end of the investment spectrum we have investments related to stocks
(oh those wonderful tech & biotech stocks) which do not guarantee the
principal but do promise (not legally enforceable, unfortunately) considerably
higher returns on your investment. These investments are ‘volatile’
meaning that over short periods of time their prices may fluctuate
dramatically. Which means that such investments may not be suitable for an
investor with a short investment horizon. For example, if you had bought
Nortel, Canada’s pride & jewel, last year at $120 hoping to make a
‘quick buck’, you would be lucky to get $15 today. In other words you are
out of luck. On the flip side you would have learnt the value of picking
investments consistent with your investment goal.
So what is an investor to do in this stock market? Back to basics.
Fundamentals. Simple as that. Do you have a workable financial plan? Why are
you investing? What is your investment (time) horizon? Do you have the time
and the financial wherewithal to weather the storm? For short-term goals
(buying a car in 6 months) use simple guaranteed investments. For long term
(e.g. retirement for people south of 60) consider stocks related investments.
If you like a new sector in it’s infancy (biotech?) and you have a long term
horizon (and the appetite) then consider mutual funds instead of individual
stocks. And always ask yourself ‘Am I an investor or a Speculator?’ If you
are an investor odds are you’ll get through the mess we are in today. If you
are a speculator, you may want to search the net for keyword ‘Prozac’.
*Ashok
Raturi is an Electrical engineer from IIT Delhi. He completed his MBA from IIM
Bangalore with specialization in Finance. After pursuing Project Management
for some time, he moved into the field of Financial Planning 8 years ago. He
now has his own financial planning practice for individuals & families
where, in his words, he ‘happily dispenses advice, financial &
otherwise’. He may be contacted at ashok@rifp.net.
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