Variable Retirement Income (VRI) Ratio
Whether you are already retired or planning to retire in the next 10 years, the Variable Retirement Income (VRI) can help quantify how comfortable you are with your retirement income strategy. Over the past decades, companies are shifting their pension plans away from defined benefit (DB) pension plans to defined contribution (DC). Why? Companies no longer want to assume the risk and cost to guarantee your pension for the rest of your life. What has resulted is the increase in the DC plan, whereby the company funds an investment plan but the risk is on your shoulders. When you leave the workforce, you have a relatively large pot of money and must decide how to invest it to give you income for the rest of your life. One question to consider is “how much of your retirement income do you want guaranteed?” There’s no one answer to this question, so I created a mathematical formula called the Variable Retirement Income (VRI) Ratio as shown below.
A variable income source is any plan whereby the return is variable over time. These plans are typically dependent upon the performance of the stock or bond market. Here is a short list of common plans.
- Personal Savings
- Registered Retirement Savings plan (RRSP) during accumulation of assets or Registered Retirement Income Fund (RRIF) during decumulation of assets.
- Locked-in Retirement Account (LIRA) or Locked-in Fund (LIF) during decumulation of assets.
- TFSA during accumulation or decumulation.
- Non-registered accounts during accumulation or decumulation.
- Defined Contribution Pension Plan (DC)
This pension plan is becoming more common. The company contributes to a plan that you manage and when you retire, they stop contributing. These plans are typically a type of LIRA (Locked-in Retirement Account) that you may convert to a LIF (Locked-in Fund) when you wish to start income payments.
WHAT ARE THE GUARANTEED INCOME SOURCES IN RETIREMENT?
Below are several common guaranteed income sources available at retirement.
- Canada Pension Plan (CPP)
CPP pension is based upon your earnings over your working life since age 18. As such, everyone qualifies for a different CPP payment and has options when to begin.You are eligible to start CPP as early as age 60 or defer up to age 70 or any month in between.
Old Age Security (OAS)
You are eligible to begin receiving OAS at age 65 but can defer as late as age 70. It is not based upon earnings but how long your have lived in Canada since age 18. If you have lived 40 years or more in Canada at age 65, you qualify for the maximum payment.
Defined Benefit Pension Plan (DB)
The defined benefit pension plan is a company pension plan that pays a monthly pension based upon your years of service and salary earned.
Guaranteed Investment Certificates (GICs)
GICs pay interest income and return your principal at the end of the term.
An annuity, and specifically a “life annuity”, provides regular income payments for life. You purchase this product with a lump sum payment and an insurance company makes regular payments for the rest of your life. The are many factors that determine the payments such as age, sex, single or joint life. Annuities are sometimes referred to as “Payout Annuities” or SPIAs (pronounced “SPEE-ah”) which stands for Single Premium Immediate Annuity.
To better illustrate the VRI calculation, the following is a simple case study.
Fred and Wilma are age 65 and receive the average CPP, OAS plus have a RRIF with a market value of $300,000 invested in a balanced portfolio and are withdrawing the minimum RRIF payment annually. What is there Variable Income (VRI) Ratio?
Their guaranteed income sources are as follows.
- Average CPP per person as per the Canadian government website is $683.65 monthly or $8,203.8 annually.
- Average OAS per person as per the Canadian government website is $613.53 monthly or $7,362.36 annually.
- Therefore, as a couple, their total Guaranteed Income is $31,132.32 annually.
Their variable income sources are as follows.
At age 65, the Minimum RRIF Withdrawal is 4%, therefore 4% * $300,000 equals $12,000 of variable income annually.
The calculation is then
Therefore, this couple’s VIR Ratio is 28% meaning that 28% of their total income is from variable income sources.
Everyone has a different view of what “level of comfort or safety” they want for their income during retirement. If you want more safety with a predictable income in retirement, then lower your VRI ratio by selecting products that have guaranteed income like annuities or GICs. The Variable Retirement (VRI) Income Ratio is a metric I created as a discussion point with clients that I am adding to both (i) annual reviews and (ii) fee-based financial plans going forward.