A liquidity risk is related with your ability to ensure the availability of funds to meet your short term needs. An example of such a risk is when you invest a large sum of money to meet your long term obligations without having the liquidity needed to meet your immediate needs. In such a case you could expose yourself to losses or getting yourself into debt.
During your retirement, the risk related to liquidity is closely linked to your retirement savings withdrawal strategy. That risk becomes particularly relevant if you are counting on an illiquid asset, such as your house, to plan your retirement income or if you outlive your personal savings.
How can you protect yourself against risk related to liquidity?
Plan and implement a savings withdrawal strategy for your retirement
Growing your personal savings is a crucial aspect of financial planning for retirement. However, planning its withdrawal is just as important!
Once you retire, you may need additional income at times to pay for expenses, such as a new car, roof repair, or even that trip of your dreams.
A sound strategy allows you to plan for adequate withdrawals of your savings to ensure you always maintain a level of income suited to your needs. It will also promote appropriate management of other retirement related risks, such as:
- longevity, that is, the possibility that you outlive your savings
- inflation, which could lead to a gradual loss of your purchasing power
- rate of return, that is, the uncertainty associated with investment income.
The age at which you apply for your retirement pension under the Québec Pension Plan (QPP) is a key element in your strategy since it could have an impact on each of those risks.
Given that a retirement pension under the
QPP is a monthly amount that you receive until your death, it provides you with a source of income for life. That income will be greater or lower depending on your age at the time you apply for your pension. If you wait until between age 65 and 70 before applying, the amount of your pension will be greater. That increase in your
QPP pension resulting from the fact that you applied for your pension later reduces the risk that you will exhaust your personal savings if you live longer.
Furthermore, your
QPP pension is indexed annually, which protects against inflation and allows you to maintain your purchasing power year after year.
Finally, as a
QPP pension beneficiary, you do not have to shoulder a rate of return risk that you would for other savings vehicles, such as registered retirement savings plan (RRSP) or a tax-free savings account (TFSA). Therefore
QPP pensions are very advantageous in a number of ways.
Prepare for the unexpected with an emergency fund
Even if the withdrawal of your retirement savings is perfectly mapped out, unexpected events can occur. That is why you
should keep money aside that you will only use in case of unforeseen events. The amount of the emergency fund will vary according to the degree of security you want and your financial capacity. If you wish, you can invest this amount to earn investment income, but you will still need to be able to withdraw it if need be.
Keep an appropriate portion of your worth in liquid investments
It is wise to invest part of your savings in liquid investments that allow you to
withdraw at any time, with few to no penalties. However, that type of investment generally yields a lower return; therefore it is recommended to diversify your savings vehicles.
In the case of term investments, you could stagger maturity dates, which allows you to have regular access to your cash. If when a bond matures you don't need the cash, you could reinvest it to increase your retirement savings.
Use specialized products tailored to meet your needs
You own a house and you are thinking about using this asset to finance your retirement? Several of options are available to you:
- You could reduce the living space that you are using by renting out a part of your home, which would give you extra income
- You could sell your house. However, be careful, this could take some time and you may have to accept an offer that results in a loss. You will also have to plan for a new home and the costs of that will have to be assessed
- You can make an arrangement with your financial institution to cash in a part of your home's value while you continue to live there. This type of product allows you to compensate the lack of liquidity of immovable assets. Make sure that you are not charged high fees and interest and examine the requirements related to such a product.
You will not necessarily spend in one go all of the amounts raised from the sale of your home or specialized products like reverse mortgages. If additional revenue is generated, you will need to plan the fiscal impact.