REACHING YOUR FINANCIAL ‘TIPPING POINT’
If you are a typical Canadian 65-year-old couple, you have a 10 per cent chance that at least one of you will live to age 101. Living to 100 is no longer in the rare category. This is now in the land of quite possible. For a financial planner, this is very important information.
If you are living off of an everdeclining asset pool, the fear of living too long can be very scary. Even if one of you does not live past 100, there is a 50 per cent chance that one of you will live to age 94.
This is the data that we have in 2017, but the speed of change in life expectancy suggests that more and more Canadians will live past 100. To get a sense of these changes, here is an overview of life expectancy in Europe since 1800.
1800: 33.3 years
1850: 36.3 years (a gain of 3 years) 1900: 42.7 years (a gain of 6.4 years)
1950: 64.7 years (a gain of 22.0 years)
2001: 76.8 years (a gain of 12.1 years)
2017: 81.0 years (a gain of 4.2 years)
Is it possible that the average life expectancy will be 100 years by 2050? With changes in genetic testing, and advanced genome work, maybe the next 30 years will see the kind of increase that took place between 1900 and 1950.
If you think this is scary for your personal financial world, imagine how scary it is for pension plans that used to pay out most plans for 10 or 15 years after retirement, and now sometimes need to pay out on plans for 40 years.
On the personal front, what does this mean? How can you manage in a world where living to 100 might be part of your future?
In my financial planning work, to provide peace of mind on the question of life expectancy, one of the most important items we try to answer is whether a client is at or past their financial “tipping point.” The concept is very simple, but it has profound implications.
The best way we can understand the tipping point is when we look at someone’s likely estate value year-by-year. If the estate value is going up the longer they live, then they are past the tipping point. They are on the green light side.
If the estate value is going down in their retirement years, then they are on the wrong side of the tipping point or on the red light side. If it is staying fairly flat year over year, they might be at the tipping point, or in the yellow light zone.
While everybody’s situation is different, we find that many people are past the tipping point — even if they think otherwise. The main reason for this is real estate. Often people will own a house or condo, but outside of this real estate, their financial assets are declining. However, when they factor in their real estate, they may be past the tipping point.
For example, if someone owns a $1 million house, and it goes up 4 per cent in a year, that would be the same as adding $40,000 to their annual “income.” While it may not be liquid at the moment, there is a good chance that the house will be sold at some point later in life, and it will help to put them past the tipping point on a liquid basis.
The implications of being on the green light side of the tipping point are significant. It effectively removes the fear of outliving your money. In fact, the longer you live, the richer you will be. Clearly this is a place of greater financial peace of mind.
While your financial future is still not guaranteed by being past the tipping point, it can be pretty close if you are properly diversified, and the assumptions for investment growth, real estate growth and inflation are conservative. Here is an example for a retired couple:
Annual after tax expenses = $85,000
Government pensions (CPP and OAS) = $35,000
Corporate pensions = $25,000 Investment assets of $800,000 growing at 5 per cent = $40,000
Income taxes on the $100,000 of income = $14,000 due to income splitting and some Canadian dividend and capital gain income.
Therefore, $86,000 a year after tax is coming in while expenses are $85,000.
That would suggest that the couple is in the yellow light zone. This means they are matching their annual income plus investment growth with their expenses.
Now, if they also have a $1 million house that grows at four per cent a year, then there is another $40,000 added to their net worth. This is above and beyond their expenses.
If at some stage they sell their home, and add it to the investment portfolio at five per cent, it would continue to add possibly $50,000 to their net worth every year, and put them comfortably past their tipping point on not only a net worth basis but also on a liquid basis.
Getting past the tipping point is what I would suggest families aim for, especially while they are still working and considering their retirement planning. It used to be that people would try to work toward their “magic number.” This number was a similar concept, but more likely an amount that you would build toward and once you reached it, you could retire and begin drawing down on the pile.
The tipping point is a little loftier to reach as this is an asset level that should not only provide you enough to live off, but one that should grow every year. While the magic number makes some sense, what if you live to age 100 instead of age 90? This is going to happen more and more.
Nobody needs to get richer every year in retirement, but it certainly puts you in financial control. At some point, as you get older, it may make more sense to gift money to children or grandchildren, even if it puts you into the yellow or red zone, because at that point you will likely know that you will not outlive your money. The key is that you are the one in charge of those decisions, and you will not have any fear of being dependent on your children or of desperately trying to make ends meet in your later years.
At the rate things are changing, living to 100 will be the “way of the future.” If you are past your financial tipping point, you will be in much better shape to enjoy the ride.