Can your RRIF survive the stress test?

4.5% withdrawal rate will still keep RRIF afloat

Investing your registered retirement income fund in stocks and bonds will produce some troubling losses every so often, but you have little choice these days if you want to achieve a decent long-term return on your investments.

The question is, just how unstable will returns be in a portfolio that includes stocks? We can get a good idea of how a RRIF portfolio might behave by looking at historical returns achieved by Canadian pension funds. Over the 54-year period 1960-2013, the average equity weighting in pension funds would have hovered in the 50% to 60% range with the rest invested primarily in bonds.

As for investment results, here is what happened to the median Canadian pension fund since 1960:

Only once were fund re- turns negative two years in a row (1973-74).

The worst cumulative loss over any two-year period was 14.6% (in 2007-2008).

The worst cumulative loss over any three-year period was just 4.1% (2006-2008).

In any given decade, we can expect one or two calendar years of net losses.

Every decade has included at least two, and as many as seven, years with returns of more than 10%.

The average annual return was about 8%, after fees.

I will use these facts to make projections for the next 25 years for the purpose of “stress-testing” a RRIF.

For the sake of conservatism, I will assume the next 25 years will include more severe losses than we have seen since 1960, as well as lower returns. Here are some specific assumptions that I used in my projections:

Annual returns over the next 25 years will range from -15% to +23%.

Every 10 years will include a two-year period when the cumulative loss is 19.25%.

Every 10 years will include a three-year period when the cumulative loss is also 19.25%.

In spite of this, the average compounded return after fees will average 5.5%.

We assume the RRIF-holder has $325,000 in assets at age 70, of which she will spend 4.5% in that year ($14,625). Since the government forces her to withdraw 5% at 70, we will assume that the .5% difference, net of tax, will be redeposited in a TFSA.

In future years, this RRIF-holder will increase her spending a little each year to cover part of inflation. For example, she spends $14,770 at age 71. Any mandatory withdrawals from the RRIF in excess of that spending rate will continue to be deposited each year in a TFSA.

Even though I assumed the RRIF’s investment performance will be all over the map, our RRIF-holder ends up in good financial shape, in spite of her spending a little more each year until age 95. Her RRIF never runs out of money, and while it has only $74,000 left in assets at age 95, she also has the TFSA that she used to hold the excess RRIF withdrawals. The TFSA balance would have grown to $145,000 by age 95, on which no income tax would ever have to be paid.