After decades of low and stable inflation, today’s rising cost of living is challenging advisors and clients to reconsider their retirement planning assumptions. Retirees, as well as those approaching retirement, worry that inflation will erode the value of their savings, and are looking for ways to protect their retirement nest eggs.
“I’ve had more questions from clients about inflation in the last few months than I’ve had in my entire career,” said Jason Heath, managing director with Objective Financial Partners Inc. in Markham, Ont., who began working as a retirement planner in 2002. “It’s a real hot topic.”
Said Mark Chan, vice-president of wealth planning with Gluskin Sheff in Toronto: “We generally plan for a long-term average rate of [inflation] of about 2% per year, so the current inflationary environment is a bit of a shock [to clients].”
Retirees who have access to defined-benefit plans that offer full or partial indexing to inflation are better positioned to withstand the challenge of keeping up with rising costs, Heath suggested. However, the “vast majority” of private-sector pensions are not indexed.
“If you have a period of high inflation for a couple of years, you might see people with unindexed pensions lose two, three or four years of purchasing power,” Heath said.
Those without access to an inflation-protected stream of income may consider deferring the start of their Canada Pension Plan or old age security benefits.
CPP payments increase by 0.7% for each month they’re deferred beyond age 65, up to a maximum increase of 42% if delayed until age 70, while OAS payments increase by 0.6% after the age of 65, up to a maximum increase of 36% if delayed until age 70. Both CPP and OAS are indexed — annually in the case of CPP payments and quarterly for OAS.
For retirees worried that inflation will persist, deferring CPP and OAS could be a favourable decision: “Pension [benefits] will be that much bigger and will be fully inflation protected through their retirements,” Heath said.
Clients approaching retirement may also be contending with investment losses due to recent market volatility. This could be challenging their retirement plans, particularly if they receive part of their compensation as equity.
“Devaluation in a company’s stock [price] could be a significant hit to our clients’ retirement planning,” Chan said. “In some cases, it could [mean clients] have to delay retirement a little bit longer to make up for that potential loss.”
Nevertheless, retirees would benefit from remaining invested in “a well-diversified portfolio that provides a combination of income and growth to offset inflation,” said Ron Hanson, senior vice-president and head of retirement with Mackenzie Investments in Winnipeg. “Retirement [can last] 20 to 25 years, so even at 2% inflation, after 20 years your dollar is worth a third less.”
Staying within the broader framework of a strategic asset allocation, retirees should consider some “tactical shifts” to the underlying portfolio that would allow them to take advantage of higher interest rates while providing a degree of inflation protection, Hanson said.
In fixed income, retirees might consider tilting their portfolio toward shorter-duration holdings, such as floating-rate debt, real-return bonds, and investment-grade or high-yield bonds, relative to sovereign debt, Hanson said.
Heath said some risk-averse retiree clients, burned by the bond market selloff in the first half of the year, might consider holding some of their fixed-income portfolio in guaranteed savings. While GIC rates remain well below inflation levels, they have been climbing as the Bank of Canada has hiked rates, and “inflation likely will not stay at 7% for the next five years,” Heath said.
“Could we have elevated inflation for the next year or two? For sure,” Heath added. “But I think, before long, you’re going to see some of the GIC and bonds yields becoming more enticing for the first time in a very long time for investors.”
In equities, retirees might consider holding more value names, dividend growth stocks, commodities, real estate and other investments in real assets, and shying away from growth stocks that tend to perform poorly in inflationary periods, Hanson said.
“You’re paying for earnings way out in the future,” Hanson said. “When rates are rising, you’re discounting those future earnings at a much higher rate, which drives down current values.”
Of course, a relatively simply way clients can manage inflation and rising interest rates is to review monthly and annual expenses, particularly in areas that are more sensitive to inflation, such as travel or fuel, Chan said. “Perhaps some tweaking to your budget is required.”
If clients have extra savings, they should consider paying down debt, especially variable-rate debt, Chan said: “It’s a guaranteed return you’re getting by foregoing that extra interest cost.”
Hanson said clients will also want to review their overall retirement planning with their advisors, such as managing the order of asset withdrawals in a tax-efficient manner. While some strategies may not offer inflation protection directly, they nevertheless help clients maximize income or mitigate expenses, which will help the client keep ahead of the rising cost of living.
“There are all sorts of levers investors can pull in any environment,” Hanson said. “But they become particularly useful in an inflationary environment.”