Recently I wrote an article about how you need less than you think for retirement which turned out to be a very popular topic. There was a lot of discussion in that post specifically about taxes and inflation. Personally, I like to keep things simple. To summarize on how to calculate “you number”:
- Work out a budget of expected expenses during retirement. Don’t forget to include income taxes, albeit reduced, as an expense. Here is an example budget.
- 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.
The Retirement Expenses
In the article I wrote that many debt-free middle class couples would be able to comfortably retire at 65 on an income of $50k per year in today’s dollars. While $50k may not seem like a lot of money, it works out to be quite a bit when you don’t have debt servicing payments, RRSP and other retirement contributions, childcare costs (assuming the kids have left the nest), work related expenses (commuting, work clothes, lunches etc), and CPP/EI contributions.
While $50k is a nice round figure, it’s best to work out your own budget number. Calculate what you are spending now on a monthly basis, add in any extras you expect during retirement (travel, medical etc), then subtract the pre-retirement expenses mentioned above. I did this calculation back in 2007 and I worked out that we would need around $45k annually during retirement (including 10% contingency). However, this does not include larger items like significant home repair, large gifts, or large trips (only $6k/year for travel budgeted).
More recently however (2013), I did a calculation of our recurring expenses which worked out to be around $58k annually. While we currently don’t have a mortgage payment, traditional retirement would reduce our expenses in vehicles, groceries, insurance (we have medical insurance through small pensions), and the kids (hopefully). This would bring our total recurring expenses to approximately $35k a year, add in $15k a year in other costs such as travel, home renovations, helping out with weddings etc, and $50k a year should do the trick – at least for us.
The Retirement Income
Once expenses are calculated, the next big question is where the income sources come from. If you are retiring in the relatively near future, then government programs are likely safe. The average Canada Pension Plan (CPP) and Old Age Security (OAS) payout for a couple is $28,000 but could be more or less depending on your circumstance. If you expect a defined benefit pension, then add the annual payout to the government benefit number (note that some pensions include CPP in the payout). If you have a few decades left before retirement, you may want to be a bit more conservative as government programs may not be as generous as they are today.
In the case of requiring $50k annually, assuming $28k/year in CPP/OAS and no pension, $22k is the remaining annual income to be covered by savings (RRSP, TFSA, non-reg, etc). Using the 4% withdrawal rule results in $550,000 in savings required at age 65 ($22k * 25 or $22k/4%). Note that the 4% withdrawals can increase with inflation (ie. 4% the first year, 4.12% the 2nd year and so on..), but you will need to keep at least 50% of your portfolio in equities.
How Much Do You Need to Save Today?
The question remains, if you need to generate $22k annually from savings in todays dollars, how much do you need to save today? The answer is that it depends on the assumptions that you make. Where some get confused is that the $22k is in todays dollars, but realizing that they’ll need more in the future due to inflation. The simplest way around it is to make your portfolio growth rate assumption after inflation, in other words, the real return rate.
For instance, instead of using the a long term return of 7% or 8% on your portfolio, use an after inflation growth rate of 4% which is slightly lower than the lowest S&P500 return over any 30 year period since 1950. Using an online savings goal calculator (like this one), with a $550,000 goal in 30 years and using a 4% after inflation growth rate, results in saving about $800/month or $9,600/year in today’s dollars. In this scenario, it’s a little less than maxing out two TFSA’s.
I created a table to give you an idea on what you would need to save monthly to reach your “number”. Note that the numbers below assume a reasonable 4% after inflation portfolio growth rate. It’s also a good idea to increase your savings annually as much as you can but at least the rate of inflation. What’s the best way to invest to achieve this return rate? That topic is for a later article, but I’ll give you a hint… index.
Monthly Savings Required to Reach Your Number (Assuming 4% real-return growth rate)
|Required Savings||Monthly Savings (retire in 25 yrs)||Monthly Savings (30 years)||Monthly Savings (35 yrs)||Monthly Savings (40 yrs)|
Another option is to buy your own defined benefit pension by purchasing an annuity. How does an annuity work? An annuity is where an retiree gives an insurance company a lump sum, and in return, the company gives the retiree a monthly cheque until his/her last breath. While an annuity may not be a great deal at today’s low interest rates, they may be more favourable in the future.
I’m interested in hearing about your expected (or real) expenses during retirement. If you are comfortable, it would be very helpful if you would share your “number” in the comments.