ETFs to generate Retirement Income

By Mark Seed, myownadvisor

Special to the Financial Independence Hub

Let’s dive in!

My retirement income plan and options

I’ve been thinking about my semi-retirement income plan for some time now.

Months ago, I captured a list of overlooked retirement income planning considerations that remain very relevant.

There are obvious ways to generate retirement income but I suspect some might not appeal to you for a few reasons!

• Option #1 – Save more. Sigh. I doubt most people will like this option, I don’t! However, more money saved will help combat inflationary pressure, rising healthcare costs and longevity risk.
• Option #2 – Work longer. Double sigh. If you didn’t like option #1, you might not like this one! Working longer into your 60s or potentially to your 70s might be the reality for some with a low savings rate.
• Option #3 – Spend less. Spending less than you make seems simple but not easy!

Meaning, the path to a well-funded retirement is usually (always?) spending less than you make, investing the difference, and growing that gap over time. This has largely been our plan – to let the power of compounding do its thing – but that does take discipline and time. Investing patience is a virtue.

Our semi-retirement income plan has us leveraging a mix of income streams in a few years:

1. Earn income from part-time work – to remain mentally engaged but also to fund some income needs and wants in our 50s.
2. Spend taxable (but tax-efficient) dividend income from our basket of Canadian stocks.
3. Make strategic Registered Retirement Savings Plans (RRSPs) withdrawals in our 50s and 60s.

We’re not quite “there” yet in terms of having 1, 2 and 3 running smoothly to meet our semi-retirement income needs yet, but we are getting there and making some lifestyle choices accordingly…

We hope to semi-retire sometime in 2024.

We have been working hard to build up our taxable dividend income stream for about 15 years now.

We continue to max out our TFSAs as our first investing priority every January (and we’re saving for that again in early 2023).

We have been maxing out contributions to our RRSPs, and we’ll continue to do so for the next couple of years.

What are my retirement income needs? 

In a nutshell, we figure once we can earn close to $30,000 per year from a few key accounts (for example, from our taxable account(s) and TFSAs x2), and then make those strategic RRSP withdrawals on top of that, we should have enough to start part-time work.

Here are some estimated very basic expenses in semi-retirement:

Add in other spending/miscellaneous spending to the tune of $1,000 per month on top of that, and our semi-retirement budget is likely at the basic-level about $4,000-$4,500 per month.

What are your retirement income needs?

Until the end of time, I suspect one of the most popular retirement planning questions will be: how can I generate retirement income?

That’s a HUGE quesiton to answer. I mean, we have rising inflation, higher interest rates, and the need to make your money last to fight any longevity risk, higher taxation and the need to cover essential healthcare costs as you age. This also makes how you can generate retirement income a VERY important question to answer.

Passionate readers of this site will know I’m a big fan of investments that generate meaningful income. Sure, you can invest in real estate, private equity, run a business into your 60s and 70s but for many people: the stock market is a common vehicle for average people/average investors to be long-term business owners.

This makes the hope of capital gains or getting paid today via dividends an interesting paradox.

As I get older, while the best total returns are always the goal, I’m more concerned about the tangible income my portfolio can (and will) generate moreso than hoping for stock market prices to work in my favour.

Full stop: I like investments that generate income. I like individual stocks as investments that pay ever growing income!

While I believe in (and own) low-cost, passive Exchange Traded Funds (ETFs) for total portfolio growth, a major portion of my portfolio rewards me to be a shareholder. I am attracted to investments that pay dividends or distributions. You may wish to consider the same for your meaningful retirement income needs.

Should you use ETFs to generate your retirement income needs? 

I believe so, at least a consideration if you’re not going to be an owner of some individual dividend-paying stocks!

While I invest in many Canadian and U.S. individual dividend-paying stocks for income and growing income, today’s post is about those lower-cost income-oriented ETFs you can own in certain accounts to avoid individual stock risks.

Some readers are wary of individual stocks. This post is for them.

While not all ETFs are created equal (far from it!), there are a couple of key advantages to owning income ETFs to generate your retirement income vs. individual stocks.

1. An ETF is a pooled investment – ETF units are bought and sold on a stock exchange – it can include a nice mix of stocks, bonds, commodities or a mixture of these. You can avoid individual stock selection or individual company bias by owning a basket of stocks.
2. An ETF can help you avoid portfolio turnover or churn; lower churn can lower your transaction costs and potentially increase your overall returns since you are not dabbling in and out of ETF products continually.
3. An ETF can offer diversification right out of the box – American economist and Nobel Prize winner Harry Markowitz was quoted in saying: “Diversification is known as the only free lunch in investing.” This means investors can reduce their risk by spreading their investments across different asset classes, like stocks and bonds, but also across geographic regions. This is an essential concept as part of long-term investing success because we don’t know which investments in what countries will perform well in the future, including decades from now. So, holding a variety of assets across different countries can help boost returns while decreasing risk.

With more than 1,100 ETFs now available in Canada, I believe it’s very easy to succumb to some paralysis by analysis but there are some ETFs that make strong considerations to own to generate your retirement income.

ETFs to generate retirement income

Before I share some of my favourite ETFs, and why, remember that personal finance and investing will always be personal.

For example, some folks wish to pay down their mortgage before investing.

I provided my thoughts on that here.

Based on what works for us, I’ll share list of rules or guidelines we follow to help build some of our growing retirement income:

1. To repeat, we max out contributions to our TFSAs, first, every year, and then invest in our RRSPs after that. We invest in taxable accounts only after TFSAs and RRSPs are contributed to. This is because I have a bias to earning and growing tax-free income (TFSAs) first, then growing tax-deferred income (RRSPs), before earning taxable dividend income.
2. We own only equities in our personal portfolio. While you can generate some retirement income with bonds, I have little use for bonds these days. I like owning some cash instead to manage market volatility. 
3. I like and we own ETFs for extra diversification beyond the individual stocks I/we own. Meaning, I anticipate most of our dividend income will come from our dividend stock portfolio but just in case, I own thousands of stocks from around the world via a few ETFs that invest in stocks beyond Canada and the U.S.
4. We tend to buy and hold only dividend-paying stocks for income stability and income growth. We typically own companies that raise their dividends every year. We also own companies that tend to Beat the TSX. If you are not comfortable with owning individual stocks, no problem, then my list of ETFs for generating retirement income was produced today for you to consider!

Here are some ETFs to consider in key accounts:

Why these specific ETFs to generate retirement income?

You’ll see beyond a few REIT ETFs, I have selected a slight bias to dividend ETFs, both from Canada and the U.S. – to deliver meaningful income.

Overall, dividend ETFs from North America may be considered for risk-averse investors who are looking for income from their portfolio: ETFs that hold established companies. Dividend ETFs may be appealing to many retirement-age investors since you don’t have to deal with any stock selection. Many well-constructed dividend ETFs will save you the time and effort you might otherwise spend on researching individual stocks, figuring out where value may lie, etc. The packaged ETF has done all the work for you.

These are some of my *favourite Canadian-listed dividend ETFs for Canadian stocks:

1. iShares S&P/TSX 60 Index ETF (XIU)
2. iShares S&P/TSX Composite High Dividend Index ETF (XEI)
3. BMO Canada Dividend ETF (ZDV)
4. Vanguard Canada FTSE Canadian High Dividend Yield Index ETF (VDY)

*There are others to consider as well.

XIU is probably my favourite. XIU is the oldest Canadian Dividend ETF with an inception date in 1999. I’ve always liked XIU given its very low MER (0.18%), it has 60 blue-chip holdings (companies that always seem to make lots of money!), and this fund is very tax-efficient for your taxable account. I recall all XIU distributions paid have historically been eligible for the Canadian Dividend Tax Credit – covered here.

This is why XIU (along with some other Canadian-listed funds) are in my taxable column in the table above.

These are some of my favourite U.S.-listed dividend ETFs: 

1. Vanguard High Dividend Yield ETF (VYM)
2. Vanguard Dividend Appreciation ETF (VIG)
3. iShares Core Dividend Growth ETF (DGRO)
4. iShares Core High Dividend ETF (HDV)
5. Schwab U.S Dividend Equity ETF (SCHD)
6. State Street SPDR Portfolio S&P 500 High Dividend ETF (SPYD)
7. ProShares S&P 500 Dividend Aristocrats ETF (NOBL)

I would have a bias to owning any U.S.-listed ETFs inside my RRSP or LIRA. This way, I avoid foreign withholding taxes.

What about Canadian-listed dividend ETFs that hold U.S. stocks or ETFs?

Well, should you wish to avoid any Canadian dollar to U.S. dollar currency conversions work with Norbert’s Gambit, here are some great considerations to own:

1. iShares US Dividend Growers Index ETF (CAD-Hedged) (CUD)
2. Vanguard U.S. Dividend Appreciation Index ETF (CAD-Hedged) (VGH)
3. BMO US Dividend ETF (ZDY)

What about international ETFs to generate retirement income?

I think international markets are best owned via growth ETFs vs. dividend ETFs due to mainly the lower cost structure involved.

These are my top-3 favourite international ETFs to own:

1. iShares Core MSCI All Country World ex-Canada Index ETF (XAW). XAW covers the global stock market outside Canada all in a single ETF. (I own it.) With almost 10,000 positions, it includes the entire US market (~60%), developed international markets (~27%), and a smaller portion of emerging markets (~12%).  If you have a significant amount of Canadian exposure and want some diversification, XAW is a one-stop-shop!   
2. Vanguard FTSE Global All Cap ex-Canada Index ETF (VXC). VXC is Vanguard’s version of XAW that covers the global stock market outside Canada (ex-Canada).
3. iShares Core MSCI EAFE IMI Index ETF (XEF). If you already have Canadian and U.S. exposure, then you may want some developed international market exposure owning the largest companies outside Canada and the U.S.

What about some longevity funds?

Meh. Not sold on them.

Have a review of this post here to review some pros and cons for the Purpose Investments Longevity Pension Fund.

VRIF is another popular and newish product but I wouldn’t own that either.

Covered call ETFs? Well, I don’t think they deliver as much long-term value as some investors believe they might.

ETFs to generate retirement income summary

As always with investing, it depends.

Your approach to generating retirement income might come from real estate, private equity, the stock market, or another investing interest. All good!

Should you choose to invest in the stock market to generate some retirement income, then my list of income ETFs should assist.

Furthermore on your retirement income planning journey: the same principles for asset accumulation might also apply in asset decumulation:

1. Keep your money management fees, low.
2. Avoid trading/swapping funds.
3. Take advantage of our Canadian dividend tax credit when you invest in taxable accounts.
4. Consider owning investments beyond Canada for diversification.

If you have a favourite dividend income or income-oriented ETF, let me know about it. I will be happy to review it, have a look, and offer a personal take.

Thanks for reading.

Mark Seed is a passionate DIY investor who lives in Ottawa.  He invests in Canadian and U.S. dividend paying stocks and low-cost Exchange Traded Funds on his quest to own a $1 million portfolio for an early retirement. You can follow Mark’s insights and perspectives on investing, and much more, by visiting My Own Advisor. This blog originally appeared on his site on Aug. 8, 2022 and is republished on the Hub with his permission.