Interest rates in Canada continue being lowered as The Bank of Canada cut rates by an additional 25 basis points in early September to 4.26 per cent.
It is the third time since June rates have been cut and the first time the central bank has made three consecutive cuts since 2009.
To that end, however, challenges remain when it comes to generating retirement income in a low-interest-rate environment. As a result of future cuts, as expected by economists, this could bring rates to 4 per cent by October in what BNN Bloomberg describes as “an effort to stimulate lackluster economic growth.”
In a survey conducted by the Healthcare of Ontario Pension Plan and Abacus Data for the year 2024, survey results indicated that more than half of Canadian women have less than $5,000 in savings, while most Canadians don’t feel prepared for retirement.
“The results of this year’s survey demonstrate that persistently high interest rates and a rising cost of living continue to have a significant negative impact on Canadians’ ability to save and manage the cost of daily life, threatening their retirement preparedness,” the pension plan stated in a news release.
The survey’s findings also revealed that 42 per cent of the respondents are counting on the sale of their home for retirement funds.
With that being said, it’s important for current and future retirees to have options that can provide an alternative income source to balance risk and reward.
Key strategies in balancing retirement income
To maintain a plan for retiring comfortably, several key strategies must be kept in mind so retirees can continue generating income.
Covered calls
Using covered calls is an investment strategy when an investor owns an underlying stock and then sells an option against that stock.
To do so, an investor that has a long position on a stock sells call options in that asset to generate revenue.
Cash-secured puts
Another option is cash-secured puts, which are options that give investors the potential to buy stocks at lower prices.
In other words, a cash-secured put is writing a put option and then setting funds aside to buy back the stock at a discount should it be assigned.
As a result, a cash-secured put acts similar to an insurance policy in that the buyer pays a premium and the seller commits to purchasing the stock should it reach a specific lower price within a predetermined time frame.
Selling put-spreads
Put-spreads, or bull put-spread are credit spreads that are sold by way of a put option and then purchasing a put option at a lower price. This strategy is used when investors want to capitalize on an asset’s price increase before it expires.
Put-spreads are less risky than naked puts. Naked puts are more risky because the selling investor doesn’t hold a short position in the security. A naked put option strategy also works under the assumption that the security will fluctuate in value, with a particular price increase over a one-month period.
With that in perspective, put-spreads offer more security because the seller benefits as the underlying security increases in price.
Buy-write strategies
Buy-write strategies intend to enhance returns on long stock positions. In line with this, an investor buys a security with options available on it and then sells a call option on that security.
The goal is to generate income from option premiums, which is the price paid by the buyer to the seller for the rights conveyed by the option.
A buy-write strategy assumes the market price for a security will fluctuate minimally with the potential to increase from its current levels before expiration.
Should the security decline in price or does not increase substantially, the selling investor keeps the premium received from the options sale.
Buy-writes are generally low-risk options where investors own an underlying security while writing selling options on it.
Mitigating risks
Like any investment strategy, it’s important for retirees to understand the importance of diversification.
When it comes to a retirement portfolio, diversification is key so one is not reliant on one specific investment or aspect of a portfolio.
Having a diversified portfolio also reduces the level of risk, which is especially important when it’s money you’re relying on.
In line with this, this also means that appropriate risk tolerance levels should be in place. Risk tolerance is essentially understanding how much loss one is willing to take to realize potential gains. The lower the amount, the lower the risk tolerance; the higher the amount, the higher the risk tolerance but also potentially larger funds.
And before retirees or investors make any decision when it comes to the previously mentioned strategies, it’s important to understand the potential downsides and risks of each so a balanced portfolio is maintained.
Tax considerations
Just like employment income, retirement income is also taxable, so it’s key to understand the impact of options trading in retirement income taxes.
As TaxTips.ca describes, gains and losses from call and put options are taxed as capital gains. However, if stocks are bought and sold, gains and losses from options are treated as income.
Gains and losses for a seller of a naked option are also treated as income, however Canada Revenue Agency will all allow these to be treated as capital gains as long as that practice is followed on a consistent basis.
Perhaps the easiest route is using tax-advantage accounts for retirement such as Registered Retirement Savings Plans (RRSPs), which are tax-advantaged savings accounts used to save for retirement. These accounts are tax-deductible and reduce taxable income for each year to which you contribute.
A tax-free savings accounts (TFSAs) is also another option that allows Canadians to save and invest money tax free. However, contributions made to TFSAs are not tax deductible. Money can be withdrawn from a TFSA at any time without any taxes.
Keeping all of this in mind, it’s important to remember that tax laws change regularly and, as such, have implications. This year, for example, the federal government made changes in the 2024 budget related to capital gains taxation in order to make the country’s tax system more fair.
In conclusion
When it’s time to retire, you still need to have some kind of cash flow to maintain a lifestyle that you’re comfortable with.
This is why options are valuable to generate retirement income. Like any other investment strategy, planning carefully and mitigating risks are crucial to avoid financial stress.
If you’re ready to make that step and start, consider applying these strategies with a BMO InvestorLine Self-Directed account. You can also consult a financial advisor who can help tailor strategies that fit your individual needs – and remember, a balanced portfolio is key.
Explore these and other options trading strategies with BMO InvestorLine Self-Directed.
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This article is prepared as a general source of information and is not intended to provide legal, investment, accounting or tax advice, and should not be relied upon in that regard. If legal or investment advice or other professional assistance is needed, the services of a competent professional should be obtained. Information contained in this article does not constitute and shall not be deemed to constitute advice, an offer to sell/ purchase or as an invitation or solicitation to do so for any entity. The content of this article is based on sources believed to be reliable, but its accuracy cannot be guaranteed. BMO InvestorLine Inc. and its affiliates, sponsors and employees do not accept responsibility for the content and makes no representation as to the accuracy, completeness or reliability of the content and hereby disclaims any liability with regards to the same. Any strategies discussed, including examples using actual securities, quotes and price data, are strictly for illustrative and educational purposes only and are subject to change without notice. BMO InvestorLine Inc. is not responsible for the information provided and disclaims all liability with regards to the same.
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