When can I retire?
An Introduction to Retirement Planning – Part 1
In the middle of this extraordinary COVID-19 pandemic, many of us may feel like we have been forcibly retired. Our governments have shut down large swaths of the economy in order to enable the physical distancing that, we hope, will starve the virus of new hosts and give the people in healthcare enough room to care for the sick, as well as give scientists the necessary time to develop a vaccine.
Eventually, however, those still of working age (defined as those aged 15 to 64 by the OECD), as well as others who still desire to work, whether out of necessity or personal inclination, will likely be returning to their occupations. There may be some who had planned to retire this spring or summer who now find themselves wondering whether 2020 is the best year to be permanently eliminating their employment income. That may especially be the case if you had an aggressive investment portfolio and now find it to be down substantially.
Choosing to retire?
It used to be that retirement was mandatory at age 65. For the most part, compulsory retirement has faded from the scene in Canada, although in some rare cases, enforcing a specific retirement age can be justified as a “bona fide occupational requirement.” That means that, generally speaking, you will not be forced to retire before you decide to.
Until recent years, the trend was toward early retirement. An insurance company even named a division of their business Freedom 55 Financial™ to indicate that, with their advice, you can aspire to retirement at age 55. According to Statistics Canada, the median retirement age in 1999 for all retirees was 60.7. In 2019, it had risen to 64.6.
Statistics Canada does not provide an explanation for this trend. I will speculate and suggest a couple of reasons.
One might be that since people are living longer, healthier lives, they don’t feel ready to retire. They enjoy their jobs, whether the work itself or the camaraderie with their co-workers. And of course, they appreciate the income.
This leads me to my second suggestion. Perhaps people are working longer because they cannot afford to retire earlier anymore. Housing, for example, has gotten more expensive over time, resulting in larger mortgages. Low interest rates, even lower now thanks to the pandemic, have made long-term mortgage payments more palatable. Our first mortgage, which we got in 1996, was for five years at a fixed rate of 7.2 percent. After a quick look online, I found a five-year fixed-rate mortgage for 2.49 percent. That’s today, in April 2020.
Whatever the reason, eventually people will either choose to stop working or be forced to because of circumstances beyond their control. Retirement will begin. But can you afford it? Or perhaps, when does retirement become affordable?
So Many Variables!
The problem with figuring out when to retire is that you cannot control three very important variables in retirement planning:
- How much you have in existing retirement savings;
- The inflation rate; and
- How long you will live.
Let’s look at these three in turn.
How much you have in existing retirement savings
Let’s imagine that you are a married couple in your 40s. Typically, a person starts working full-time in their 20s and retires in their 60s, so you are probably about halfway through your working career and have about 20 years until retirement. Thanks to the magic of compounding, the earlier you start saving for retirement, the less you need to save. Based on 2019 guidelines provided by FP Canada, a certifying body for financial planners in Canada, a balanced long-term portfolio could return about 4 percent annually after expenses. Let’s suppose that your average household earnings were about $50,000 per year and at the beginning of each year you were able to set aside 10 percent, or $5,000 for your retirement. This table gives you an idea of what that might look like.
You can see what a significant difference it makes to start saving earlier. Now, let’s see where you might stand in another 20 years, that is at age 65, your planned retirement age. You are still contributing $5,000 at the beginning of each year with a 4 percent annual return.
All is not lost. Let’s suppose that at age 45, you were in a situation where you could stop saving for your children’s education and that both of you were now back at work full-time. What would it take to catch up with the household that been setting aside $5,000 since they were 25?
Yes, almost $14,000 is a lot more money, but if you had two children and had been setting aside $5,000 per year for their education, that means you can now save $10,000 per year for your retirement. If you also have two full-time incomes in your household, then another $4,000 or so per year may not be that difficult.
While you may not be able to control what you have saved until now, you do have a choice as to what you will save in the future.
The Inflation Rate
I don’t pretend to be an economist. I can say, however, that we have had low inflation for many years. As of 2019, FP Canada has projected a long-term inflation rate of 2.1 percent. When the Great Financial Crisis hit in 2007-2009, central banks around the world dropped interest rates dramatically. There were fears that inflation would rise dramatically once the economy came back. It didn’t happen. And now, after a small increase in rates in recent years, the governments have dropped rates again. This makes it much less expensive to borrow money, which is a pretty good thing because governments are cranking out money like crazy to support a society that has been told to go home and stay home until it’s safe again.
What can people who are saving for retirement do in the face of inflation? To quote those economic geniuses, the Talking Heads, it’s the “same as it ever was.” You will do well to hold a diversified portfolio, made up of a mix of equities (stocks) from Canada and around the world, along with fixed income (bonds).
How long you will live
I have an uncle who turned 102 years old last month. My mother died before she turned 73. Healthy young adults have died from COVID-19 while seniors in their 90s have survived. Someone with chronic health problems may reasonably think that they will die in their early 70s at best, and so they spend most of their retirement savings during their first ten years of retirement only to find that they are still alive at age 85. We really don’t know how long we will live.
The work of actuaries and statisticians can help us get a sense of our longevity, however. Data from these sources has been adapted by FP Canada to provide a Probability of Survival table. Here’s a small sample:
To explain this a little, if you are 40 years old right now, and are a male (M), you have a 25 percent chance of living to age 94 and a 50 percent change of living to age 89. If you are a female (F), you have a 25 percent change of living to age 97 and a 50 percent change of living to 95. Finally, if you are in a household consisting of a male and a female (M/F) who are both 40 years old, there is a 25 percent chance that one of you will live to age 98 and a 50 percent change that one of you will live to 95.
For financial planning purposes, the recommendation from FP Canada is to “assume a projection period for clients where the probability of outliving their capital is no more than 25%.”* That means that, for most of us, you should plan from the assumption that you are going to live into your mid-90s. Therefore, if you expect to retire at age 65, consider what 30+ years of retirement might look like. If you don’t think that’s going to work for you, then consider working longer before you retire.
*Projection Assumption Guidelines. FP Canada Standards Council. Effective Date: April 30, 2019
For my next post, we will look a little more closely at how much is necessary to be able to retire.
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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.