There are many risk areas that could affect your financial net worth, cash flow, quality of retirement, and lifestyle. In many cases, you can eliminate, minimize, or control each of these risk areas by knowing about them, doing research, and making prudent decisions. Statistically, if you retire at 55 years of age, you can expect to live to 85 and have 30 years of retirement–almost as long as your working life. Planning to have enough funds to meet your lifestyle needs is obviously very important. Some of the following potential risk areas are interrelated, but they are considered separately because they should be specifically identified as risks. They all have financial implications, directly or indirectly. By obtaining customized financial planning advice from objective and qualified tax professionals, you should be able to anticipate and neutralize many of the following risks.
Currency risk
This is a particularly important issue if you are a Snowbird or travel a lot. If the Canadian dollar drops in value relative to the U.S. dollar, you will obviously notice an increase in the cost of living due to the reduced purchasing power of your Canadian money when you convert it to U.S. currency. The value of the Canadian dollar is dependent on many variables, both national and international. If it goes down five per cent, you have lost five per cent of your purchasing power in the United States.
Inflation risk
This is one of the most serious financial risks to those in retirement. Although both Canada and the United States currently enjoy very low inflation rates, that can quickly change. As you are probably aware, inflation eats away at your purchasing power. Inflation at five per cent will reduce your purchasing power by 50 per cent in less than 15 years. If you have investments that have interest rates or value that changes with the rate of inflation, or if you have annuities or RRIFs indexed for inflation, then your purchasing power would at least remain constant. If you have a fixed income, the inflation issue is especially critical.
For example, with Canada Savings Bonds, inflation would erode the purchasing power of the bond as well as the interest. You also have to look at the real rate of return on your money after tax and inflation is factored in. If you were earning 3 per cent interest and were taxed at 35 per cent, your net return would be 2 per cent. If inflation were 3 per cent, you would actually be losing purchasing power with your money, in real terms.
Deflation risk
If there is a severe or prolonged economic downturn or recession, the value of your assets could drop accordingly.
Interest rate risk
Interest rates in Canada and the United States have been very volatile over the past 15 to 20 years on any type of interest-sensitive financial investment. In the early 1980s the prime rate was in the double digits, even up to 22 per cent. This was of course attractive for people with interest income from term deposits, mortgages, or bonds. By the mid-1990s however, rates had plunged to the low single digits, sometimes down to two per cent, which happened in the last several years. Interest rate risk can cut both ways, however. For example, if you set your lifestyle needs based on high interest rate returns, your lifestyle will be negatively affected when rates fall. Or if you lock yourself into a fixed-rate bond when rates are low and then interest rates increase, the value of the bond investment will go down when you try to sell it. Another example is a locked-in annuity bought at a low interest rate. If rates go up and there is inflation along with it, your purchasing power and lifestyle will be affected.
Government policy risk
The Canadian and U.S. governments are constantly changing the tax or pension laws, depending on the political philosophy of the party in power and economic pressures. For example, Old Age Security (OAS) pension payments are lowered if the recipient’s income exceeds a certain amount. This amount could become lower and lower over time. The Guaranteed Income Supplement (GIS) could be reduced, or the eligibility criteria tightened up. Federal and/or provincial income taxes could be increased.
