Written by Clarence Bick
“When can I retire?” and, “How much do I have to save to retire?”
These are two of the most common questions I get when I meet with clients. Both questions are good ones to ask, but when it comes to retirement income, there really is no common answer for either.
Instead, I like to ask a different question: Would an average retirement income actually have any meaning? It’s not as if anyone wants to be “average,” anyway!
Planning for your retirement should never be about what others want — it should be about making your own plans. Here are some basic tips on retirement planning and an example that will show you how your plan will play out over your lifetime.
How do I prepare a retirement budget?
The most common approach to retirement planning is to prepare a budget. But in my experience, this will just give you an inaccurate figure for retirement, because most people don’t know the dozens (or hundreds) of things they spend money on. That’s not to mention that trying to figure out what all of these things are can be time-consuming — time that can be better spent elsewhere.
A simpler and more accurate approach is to take a look at your current expenses and determine what will no longer be an expense at retirement. For the majority of people, there are three expenses that disappear when they retire:
- Debt payments — Assuming you’ve paid off your mortgage and any other debts at retirement, you’ll no longer be making any debt payments.
- Children & dependants — If your children are financially independent when you reach retirement, there will no longer be any costs associated with them.
- Retirement savings — Once you’re retired, your current level of pension or RRSP contributions no longer have to be made.
By subtracting these three expenses from your current income, you can get a reasonably good idea of the income needed to maintain your current lifestyle (if you were retiring today without those expenses). We would call this your current “discretionary spending power.”
Of course, this is not a perfect calculation, but I’ve found it has generally proven to be more accurate than a budget.
What does a successful retirement plan look like?
To help illustrate what a successful retirement plan might look like for you, here’s an example. Obviously there are many other factors and the numbers will differ for everyone, but a general strategy is reflected here.
Let’s assume each person in a couple makes about $80,000, for a household income of $160,000. If each puts $15,000 a year into RRSPs, that’s a reduction of $15,000/person or $30,000 from income required. That leaves $130,000 leftover.
Different studies suggest raising two children costs $20,000/year, but you first have to earn about $30,000 and pay your 33% or $10,000 of tax to have that $20,000 to spend each year. Let’s say this couple has two children. There’s another $30,000 gone per year, leaving you with $100,000.
Finally, if you’re making $2,000/month in mortgage payments. That’s $24,000/year after tax, requiring you to earn $36,000 and pay $12,000 in tax. We’re now down to $64,000.
The reduction from taxable income, per year, is $96,000 in total. Here’s the breakdown:
- RRSP payments at $30,000
- Raising children at $30,000
- Mortgage at $36,000
As I mentioned above, these are three payments that will no longer need to be made at retirement. This means that if this couple only changes these three expenses, and their expenditures and lifestyle in retirement for everything else stays exactly the same as it is now, then only $64,000 income retirement income will be needed.
This is a starting point that gives a good estimate of your current standard of living. You can use this number to plan for retirement with, though you may want to add some extra retirement expenses for travel, leisure or other expenses.
How do I save income for retirement?
So how do you get enough saved to have $64,000 in yearly income ready at retirement? Let’s continue with the above example.
In today’s terms, the Canadian Pension Plan (CPP) will pay out $13,000/person, and Old Age Security (OAS) will pay about $7,500 per person at 65, for a total of $41,000 per year. If $64,000 is the income target, $23,000 has to come from assets.
Don’t forget inflation, either. The Bank of Canada’s target is 2%, which means prices double in 35 years. So, if this couple is 30 and wants to retire at 65, it would be reasonable to assume that the costs will double, CPP and OAS will double, and $46,000 will have to come from assets.
Finally, if you’re investing $30,000/year into RRSPs, and put it into GICs that earn 2% for 35 years, you’ll have $1,530,000 when all is said and done. $46,000 per year is only 3% income to start, but that annual income should be indexed.
If you could earn 5% (The Financial Planning Canada Standards Council recommended target for stock investing) for 35 years, there would be $2.8 million at retirement. You’d have almost twice the investment assets, allowing a higher retirement income — and earlier retirement — or some combination of the two.
Investment advice pays for itself at retirement
As you can see, when you can retire will depend on…
- When you start saving.
- How you invest.
- What your personal retirement income target is.
Thinking too far into the future can be a bit overwhelming. No matter what stage of the process you’re at, the team at Bick Advisors can help you plan for your future.