For the traditional “retire at age 60 or 65” situation, the popular advice pushed by the financial industry is to save enough to replace 70% or even 80% of your gross income during working years. Another popular notion is that you’ll need at least $1M to retire comfortably. The truth of the matter is that providing that you go into retirement with no debt (mortgage, consumer etc), and continue to live a modest lifestyle, you will likely need way less than that.
Expenses during Retirement
While every situation is different, there are a few significant expenses that should be reduced or eliminated during retirement.
These expenses include:
- Mortgage payments;
- Reduced income taxes;
- Saving for retirement;
- Childcare expenses (hopefully);
- Work clothes, lunches, commuting costs; and,
- CPP, EI contributions.
Rather than use a “rule of thumb”, I like using actual budget data to calculate anticipated expenses. I did this exercise in a popular article on early retirement, and I worked out that our family would need about 55% of our family income to retire comfortably. While family incomes may vary, many financial types agree that the average family will require between 50-60% of their pre-retirement gross income to live comfortably during their golden years.
While 55% of gross family income sounds great compared to the industry standard 80%, it gets better! A couple who has lived and worked in Canada for most of their adult life will be entitled to government income benefits during retirement. The main income benefits include Canada Pension Plan (CPP) and Old Age Security (OAS). Longevity of these income sources aside, according to Stats Canada, the average amount paid out by CPP is $7,600/retiree/year or $15,200/couple/year (assuming age 65 when commencing payments). OAS, which is paid out the government tax base and calculated based on how long the retiree has lived in Canada, maxes out at $550/retiree/month or $13,200/couple/year. Combining the two brings a couple over $28,000 a year (rounded down to be on the conservative side).
With many middle class couples with no debt able to retire on approximately $50k/yr in todays dollars, that only leaves a gap of $22k/yr to be funded by company pensions and/or savings (RRSP, TFSAs etc). If there are no other company pensions, the question now is how much savings are required to generate the remainder, or in this example, $22k per year? Using the 4% rule, which is assumed to be a “safe” portfolio withdrawal rate for a portfolio to last 30 years, simply divide the $22k (or whatever your number is) by 4% or simply multiply your number by 25. In this example, $550,000 in savings should do the trick. Even without a company pension, this is much less than the millions that we are made to believe to need.
Figuring out how much you need to retire is not as complicated as some make it out to be. It’s pretty much a four step process:
- Work out a budget of expected expenses during retirement.
- Calculate how much the Government will provide you during your retirement years. You can use the Canadian government calculator here.
- The difference between 1 and 2 is how much income from savings (and/or company pension) that you will need.
- Take the number calculated in step 3, and multiply by 25. That is the amount you will need to have saved (in todays dollars). If you have other sources of income, like from company pensions or rental properties, then reduce step 3 by the other income amounts, then multiply by 25.
Note that this is an extremely simplified version of approximately how much you will need to retire. To get an accurate picture, you will need to account for taxation (which depends on how you structure your investment accounts). In addition, there is uncertainty in the availability of government programs when looking at drawing from them decades away. In my opinion, it’s best to be as conservative as possible when estimating your “number”. In a future article, I will review how much you need to save today to hit your future “number”.
In any case, when you are ready to invest your savings, here is a comparison of the top discount brokers in Canada.