How Much Do I Need to Retire?
An Introduction to Retirement Planning – Part 2
“It is difficult to make predictions, especially about the future.” – Danish proverb
Imagine you and your spouse are 35 years old. You hope to retire at 65. There is an almost 25 percent chance that one of you will live to 100. You therefore have 30 years to save up enough to cover your costs in retirement for 35 years. When so many people say that they are living paycheque to paycheque, is that even possible? With stock markets roiling and interest rates close to zero right now, how can you even save?
In a later post, I will have something to offer about retiring on a low income, but for this post I am going to present a sample case, using a few assumptions.
Set Your Retirement Goals
The Financial Consumer Agency of Canada has several handy guides and calculators to help with retirement planning. First, figure out where your spending goes now and what it might be during your retirement years.
Let’s assume you will not work in retirement, that your children are independent, that your house is fully paid for, and that you can now reduce your daily transportation expenses by having only a single vehicle rather than the two vehicles you needed before. Recreational expenses like travel and hobbies may stay the same as the costs shift from your children to yourselves. As you age, medical costs may also increase, but perhaps not as much as you might expect as government supports for senior citizens now apply to prescription costs.
Fifty-one percent of your current spending may seem like too steep a reduction in living expenses – typical recommendations suggest that spending in retirement is in the 60 – 80 percent range. However, if your mortgage is paid up, if you can go down to a single vehicle, and if you are no longer caring for your children, then you will see some significant savings.
Determine Your Government Pension Amounts
I am going to assume that this hypothetical couple does not qualify for the Guaranteed Income Supplement (GIS), but as both have worked throughout their careers, they will qualify for the Canada Pension Plan (CPP) and Old Age Supplement (OAS), which they will take at 65.
The amount one receives each month in CPP is based on your average earnings and contributions throughout your working life as well as the age you start receiving your pension. The standard age is 65, but you can take your pension as early as 60 or as late as 70. Taking your pension before age 65 will permanently reduce the monthly amount you receive, while taking it after age 65 will increase the amount. The earlier you take CPP the less you receive, the later you take it, the more you receive. The maximum a new 65-year-old recipient could receive in 2020 is $1,175.93, but the average monthly amount is $735.21. I will assume this average.
Assuming you fully qualify for OAS, each 65-year-old person is eligible to receive $613.53 per month. You can also defer receiving OAS to as long as age 70 again resulting in an increase in the amount you receive.
This table provides the total per month and annualized:
Determine Your Investment Income Needs in Retirement
We now have an estimate of expenses plus an estimate of income from government pension sources. Our next step is to figure out how much of your own financial resources are necessary in order to meet the shortfall. I assume that our example couple has defined contribution registered pension plans from their employer. Contributions from their employers resulted in pension adjustments which allowed them to maximize their RRSP contributions. By age 35, they had accumulated $90,000 each in a combination of pension plan and RRSP assets or $180,000 in total.
I make the following assumptions to calculate the additional savings required for this couple to meet their expenses:
- Annual inflation rate: 2.1%
- Marginal tax rate: 20%
- Nominal annual rate of return: 4.4% (this assumes a gradually more conservative portfolio over time)
- They work for 30 more years until retiring and are retired for 35 years before they die at 100
- A real return of 2.25% (real return refers to the rate of return after inflation is accounted for)
- The value of the current portfolio at retirement assumes they make no more contributions after age 35
Based on inflation of 2.1 percent, I assume that their government sources of income are nearly $60,000 annually, and that their anticipated expenses in retirement rise to greater than $78,000 per year. As these funds are held entirely in tax-deferred RRSPs or pension plans, the before-tax capital is the required figure, as tax will not be paid until the funds are withdrawn. You can see that they need to continue contributing approximately $5,000 per year, between the two of them, until they retire at age 65.
Assumption Junction, What’s Your Function?
As you can see, a lot of assumptions need to be made to calculate retirement income. The further away you are from retirement, the more loosely those assumptions need to be held. Retirement planning, like financial planning in general, is not a once-and-done proposition. For example, as 2019 ended with a fantastic year for investors, who was anticipating that, in a matter of weeks, a virus would prompt governments to shut down much of the world’s economic activity and compensate the forcibly unemployed with what amounts to a new, but probably temporary, basic income program?
Although I expected a stock market correction or economic recession would come at some point in the future, I never anticipated it to come in this fashion. More than ever, I am reminded that plans are made to be revised.
Updated: For my next post on retirement planning I will discuss some of the factors involved when one spouse is significantly older than the other.
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, accounting or legal decisions.