I’ve recently read a book called HOW TO RETIRE HAPPY, WILD, AND FREE. It’s a non-financial look at thinking about and preparing for what you will do and how to get the most out of life in semi-retirement or retirement. Included are examples of people who have retired anywhere from age 27 to age 80. It’s a worthwhile read no matter how old you are now, whether you are thinking about retirement, already retired, or just starting a career.
Studies show that people who have thought through both the financial and lifestyle aspects of their retirement, who have developed a good sense of who they are outside of work, have identified the interests and passions they will pursue after work, and have set aside enough money to live comfortably, are happier in retirement.
I’ve compiled a list of the best sources of passive income (income generated without your having to work for it), how much you can expect from each source, and how risky each is. Here are ten, roughly in order of most secure to most risky:
- Canada Pension Plan (CPP) – CPP can be taken as early as age 60. The maximum amount payable for 2016 at age 65 is $1,092.50 per person per month, and the average amount actually paid out is $643.11. This is reduced by 7.2% a year if it is taken before age 65. And it is increased by 8.4% a year if it is delayed to as late as age 70. CPP payments are indexed to rate of inflation.
- Old Age Security (OAS) – The maximum payment is $573.37 per person per month at age 65. The OAS claw-back starts at about $73,000 of taxable income, which means that you have to repay the government 15% of all amounts of your taxable income over that threshold. Deferring to as late as age 70 increases the OAS monthly benefit by 7.2% a year. OAS is also indexed to rate of inflation.
So potentially, between two spouses, you could, at age 65, have a government paid income of as much as $39,980, indexed to inflation, depending on how much you paid into CPP and how long you have lived in Canada. A nice income base!
- Annuities: These often generate the highest income of any solution, and that income is guaranteed for the rest of your life. Most people wait until they are in their sixties before buying an annuity. And an annuity should only be for a part of your overall savings. As of July 1, 2016, a $100,000 annuity for a male aged 65 would generate $525 a month for life, and for a female 65, $467 a month. Unfortunately, women get less because they live longer on average. Annuities can be indexed to inflation – wherein the income starts lower but grows over time – and they can be set up to guarantee a lifetime income until the last partner in a couple passes away.
- Insurance companies offer a product called a Guaranteed Lifetime Withdrawal Benefit (GLWB). On a $100,000 investment held for 10 years, the best of these guarantees that your minimum annual income would be at least $500 per month for life at age 65. There is no downside assuming that no withdrawals are made other than the planned withdrawals at age 65. And your guaranteed lifetime income could be higher if the stock market does well or if you delay your withdrawals to age 70. If needed, you can withdraw your money early, but that would affect your guaranteed income level later.
- Preferred Shares: A portfolio of North American investment grade preferred shares currently yields about 5.5% or $460 a month on a $100,000 preferred share portfolio. The dividends from Canadian preferred shares are treated favourably in terms of taxation in non-registered accounts. There are many unique features to preferred shares and one has to understand what one is actually getting before buying individual issues. Many preferred shares reset their rates every five years (up or down). There are also perpetual, retractable, redeemable, and floating rate preferred shares. All are very interest-rate sensitive. Between November 2014 and February 2016, the underlying value of a preferred share ETF (Exchange Traded Fund) fell by 15%. Their dividends are, generally speaking, more secure than those of common shares, but preferred shares do not participate in the increased profits like common shares do, so there is less possible price appreciation in preferred shares.
- A systematic withdrawal plan (SWP) from a typical balanced portfolio of 60% equities and 40% bonds. The average compound annual growth rate of a 60-40 global portfolio has been 4% – 5% over the last 10 years. Experts say that you can safely withdraw between 3-4% of the value of a portfolio like this, which is between $250 and $350 a month from a $100,000 portfolio, increasing it annually by the inflation rate. The bond component makes this portfolio fluctuate about half as much as the stock market index, which means that the underlying value of a $100,000 portfolio could go down by as much as $25,000 or even more in a given year. This type of income plan is also subject to “sequence of returns” risk. In other words, if your portfolio performs poorly in the early years of your retirement, you are likely to run out of money sooner, or may have to live on less.
- High Yield Bonds: Below investment grade bond portfolios currently generate yields in the 6% to 7% range. So a $100,000 investment in a high yield bond portfolio might generate $540 income monthly. Generally more stable than stocks, their underlying value can be volatile in a financial crisis or recession. The underlying value of high yield bonds dropped about 26% in 2008, so a $100,000 portfolio would have declined to $74,000. But they have generally been much less volatile than stocks with a similar long-term return, and they do recover as the economy recovers. Interestingly, most investment funds in this category have beaten the high yield bond index in the past.
- Dividend growth stocks currently yield in the 1% to 5% range. The advantage of having some of these in your portfolio is that dividends may rise over time, thus protecting you from inflation. While you are working, you can own these and have the dividends re-invested in a Dividend Re-investment Plan (DRIP) and then stop the DRIP and take income when you need it. The underlying value of this type of stock will fluctuate a little less than the stock market in general. For example, the S&P 500 Dividend Aristocrats Index (which includes common shares of companies with track records of consistently increasing dividends) fell about 36% during the bear market from October 11, 2007 to March 6, 2009, (so $100,000 would have fallen to about $64,000), compared with a 46% decline in the S&P 500 Total Return Index for the same period.
- A portfolio of Real Estate Investment Trusts (REIT) currently yields 5% to 6%, so $100,000 invested in REITs would yield between $400 and $500 a month. Generally real estate is more stable than most equities, but can be volatile in a financial or real estate crisis. In the crisis of 2007 – 2009, the underlying value of Canadian REITs fell by about 56% ($100,000 would have fallen to a value of $44,000) but have more than fully recovered since then. They are interest rate sensitive in that if interest rates rise, REITs generally fall.
- Borrowing to invest – If you understand the risks and rewards, you can increase your returns through the use of leverage. Here is an example. If you were to borrow $100,000 at a 3% annual interest rate, and put that together with $100,000 of your own savings to buy a portfolio that generates a current yield of 5%, you would as achieve a 7% return on your $100,000 investment. Your net income in this scenario might be $580 a month. Here is the risk: If the investments were to decline in value, and you were to sell at that time, your losses would likewise be magnified. There are tax benefits to borrowing to invest as the interest on what you borrow to invest is tax-deductible. This is the most risky strategy but also generates the highest return. A thorough discussion on the risks and benefits of this strategy with a qualified financial advisor would be required before borrowing to invest.
There is no one right strategy to generate income after you semi-retire or retire. A combination of the above strategies would generally be less risky and generate a more secure lifetime income than relying on one strategy only.
The above sample returns are for illustration purposes only and are no guarantee of future returns. Before implementing any of these strategies, you are advised to consult with a qualified Personal Financial Consultant. Tim Weichel 416-230-2703 or 705-798-0062 firstname.lastname@example.org