How much will you really need to retire?


Arriving at that ideal number for your retirement is more than just deciding on a large number with many zeros. It takes an understanding of factors that can affect the spending power of your retirement income.

Four top factors to consider

Retirement planning is more than just putting money into a RRSP, TFSA, or defined benefit pension plan (but keep doing that). It also requires an understanding of how much annual income you’ll need during retirement.

“When I’m speaking to clients, everyone has a different opinion on what they want to achieve and on how long they need to plan for,” says David Fraser, an investment advisor at Mawer Investment Management Ltd. “One of the things I ask my clients to do is really picture their retirement. Does it involve gardening in the backyard all day or does it involve jet-setting around the world on luxury vacations? This exercise demonstrates how different and diverse retirement plans can be and where a specific investor falls on that spectrum.”

He tries to get his clients to figure out what sort of lifestyle they’re looking for in retirement, how costly it’s going to be, and how much they need to save to make it a reality.

People might assume they will spend as much as they are spending now with some adjustment for age-related expenses, but while that might be a starting point, it’s not the best way to plan your retirement spending. There are four things to keep in mind that can help you ensure you have enough money to spend once you reach your golden years.

Inflation

Prices generally go up and that means a dollar will buy less and less as the years go by. As you’re calculating how much annual retirement income you need, that amount should be inflated or increased each year to maintain the same level of spending power. According to Mr. Fraser, while this is not top of mind for most Canadians, people are generally aware that they need to save enough to keep up with inflation.

Whether people know explicitly what inflation is and what it’s likely to be, they may not know the nuances,” he says. “But there are tools available that factor in inflation rates, or they can work with an advisor who will work in an average inflation rate.”

Most of these tools, he notes, use an inflation rate of 2.5 to 3 per cent in the calculations because inflation rates have a historical average of 3.2 per cent. But he cautions that inflation rates can vary widely, so his advice is to understand that these tools only provide a loose estimate.

He also suggests doing some what-if scenarios. “Depending on the individual, this may include selling the holiday home and investing the funds or going on two vacations per year rather than one. Given their unpredictable nature, different rates of inflation and rates of return should also be input to provide a better awareness of the range of possible outcomes. All [of] these variations give a sense of what could happen and help you prepare for the worst and hope for the best.”

Consumer Price Index

The cost of a fixed “basket” of goods and how it changes over time is represented in the Consumer Price Index, or CPI. This basket of goods is an average look at what Canadians spend their money on. The Canadian CPI shows a breakdown of approximately 40 per cent related to shelter and other household costs, with just over 5 per cent allocated to health-care spending and 2 per cent to travel and accommodation. If you’re spending habits aren’t aligned with the CPI, you may not want to rely solely on this inflation indicator when determining your retirement spending needs. For example, perhaps you plan to spend more on areas such as luxury travel or healthcare. If this is the case, you could be subjected to higher inflation rates and would need to adjust your retirement income accordingly.

Gross or net income

You might think that your current salary is the amount you will need to withdraw annually during retirement in order to maintain your present lifestyle. The reality is that you don’t live on your gross annual salary; you live on your net income (income after taxes). What’s important is understanding how much your tax situation might change based on your retirement needs and your spending habits.

“People understand that their expenses are likely to change,” says Mr. Fraser. “But does anyone really have a good grasp on what those changes are going to look like and accurately pin it down?” The general rule, he notes, is to plan on withdrawing 70 to 80 per cent of your working-life income on an annual basis, but that’s just a benchmark. The true number will vary widely depending on the individual.

Changing spending patterns

“How much in medical expenses you’re going to need is really unknown,” Mr. Fraser points out. “Some expenses, relating to things like travel and your hobbies might increase. And on the other side, transportation, parking, and taxes may be reduced, as you’re not earning as much nor are you travelling to work on a daily basis.”

The first step is to calculate your current budget. “Determining your retirement expenses is very hard to do if you don’t know what you’re spending today,” he says. There are many money manager apps available which means that it has never been easier to get an idea of your monthly spending habits. After you determine your current expenses, you can then attempt to extrapolate how these will change in the future.

Other factors to consider are that you might not have a mortgage when you retire or might not be supporting children, which will affect your spending habits—and how you calculate your annual retirement income needs.

It’s important to be realistic about estimating your retirement income and planning your retirement. Mr. Fraser recommends factoring in as many variations as you can, whether it’s to do with health, inflation, or the sale of your home. The closer to retirement one gets, the more frequently he or she should review these assumptions and factor in more current, real world data to provide a more accurate perspective.

“The best position to be in,” he says, “is one with as many options as possible to allow for flexibility if things don’t work out according to plan.”