How much money do you need to retire?
Realizing that they may end up retiring earlier than they had planned, 64 per cent of Canadians are worried they’re simply not saving enough, according to Fidelity Canada’s recent 2020 retirement survey
While a few may have reason to be concerned, the good news is that most people should be able to get where they want to go. But it does take some thoughtful planning.
Figuring out whether you can afford to retire is a tricky process, because the staying power of your assets depends on so many assumptions and events. One of the key questions to answer is a rather simple one, though: Will your cash flow in retirement be greater than your expenses?
If you’re using the commonly accepted 70 per cent replacement rate – a rule of thumb that estimates what percentage of people’s pre-retirement income will be needed to maintain their future lifestyle – keep in mind that your expenses will vary throughout retirement.
Many potential retirees expect to see the cost of living drop after they stop working. But that’s not always the case. If anything, many retirees often spend more – at least in the first few years of their retirement when they’re still healthy, eager for travel and enjoying hobbies they weren’t able to pursue when they were still working.
Spending generally drops in the subsequent stage of retirement as the body slows and the desire for travel fades. Costs often creep up again in the later phase, however, as medical costs increase, including the potential costs of long-term care.
That’s why, rather than rely on any predetermined formula, it’s important to get a clearer picture of what income you live on now and what might change when you retire.
Get a handle on those expenses
The proportion of your pre-retirement expenses you’ll need to cover in retirement, and how much of that will need to come from savings, is clearly going to vary from person to person. It all depends on your retirement age, your anticipated lifestyle in retirement and what you’re able to make and save as you move toward your goal.
Not working does mean potentially lower taxes and lower day-to-day expenses, of course. Child-rearing costs are usually finished or greatly reduced, you no longer need to pay for work clothes or commuting costs, and you may have been able to pay off your mortgage.
To get a better idea of where your money goes, split your future expenses into essentials (food, shelter, transportation, taxes) that are largely fixed and discretionary items (travel, entertainment, charity, gifts) that you can play around with a bit more.
Plan for a long retirement
The age at which you expect to retire can also have a major impact on the amount you need to have on hand, and the savings milestones you need to hit along the way. Holding off a bit gives your money a longer time to grow and build up that nest egg. That’s why, rather than leave the workforce altogether, many approaching retirement choose to reduce their hours, begin consulting or find a different job with fewer shifts per week. Two-thirds (64 per cent) of Canadian pre-retirees say they expect they’ll be working in retirement, according to the 2020 retirement survey.
What’s more, the more years you work, the fewer you have to depend on when it comes time to withdraw money out of your retirement savings to live on. Your monthly government benefits, like Old Age Security and the Canada Pension Plan, can also be considerably higher if you delay starting these benefits.
That’s important, because you’ll probably be retired for considerably longer that you might think. According to the most recent estimates, a 65-year-old man can expect to live to roughly 83, while a woman of the same age can look forward to living an additional three years.
Map current versus future income
Your current salary plays a big role in determining what percentage of your income you’ll need to replace in retirement. While your cash flow will likely come from multiple sources, retirement means living mostly on a fixed income, without the benefit of the promotions or salary increases that you might have enjoyed when you were working. And then there’s the potential drop in purchasing power thanks to inflation.
People with higher incomes tend to spend a smaller portion of their income during their working years, and that may mean a lower income replacement percentage goal to maintain their lifestyle in retirement. But that’s not true for many older Canadians still juggling competing savings priorities.
Until you clearly define what it is you want to do in the future, it’s difficult to determine exactly how much money you’ll actually need in retirement. An experienced financial advisor can help you design a plan to realize your retirement goals, and help measure your progress along the way.