Retirement Plannin - Your Vision
Simply dreaming of that idyllic retirement and hoping it will work out won’t get it done. Hope is not a strategy; a lot of planning, a disciplined approach and sometimes sacrifice are involved.
Many people spend more time planning a vacation than they do thinking about their finances. It’s not that spending time on planning their vacation is a bad thing; it is the lack of planning for their financial future that is disturbing.
The good news is that once your plan is in place, spending one hour, three or four times a year, should be enough to keep your plans up-to-date.
You can tackle this project on your own but in many cases the novelty wears off, the tasks become drudgery and important matters get set aside. If the task seems overwhelming, a financial advisor can walk you through the whole process and help you lay out a workable strategy. By doing some groundwork ahead of time, a discussion with an advisor should run smoothly and quickly.
MoneyPages provides you with a wide range of tools to help you with your retirement planning endeavours at http://moneypages.ca/page/9/retirement-planning
Begin with a Vision
The expectations of a retirement lifestyle can be as ambitious as a second home in Palm Springs or as modest as downsizing to an apartment close to the grandchildren.
When developing a retirement plan, begin with a vision of what you would like retirement to be. The vision will probably change over time and the plan could also exceed or fall short of expectations, but there are four simple questions that can be used as a starting point.
• Who will you spend retirement with? – While you may envision spending your retirement with your spouse, you might also be single and plan to retire on your own. Some retirees may still have dependents for whom they are responsible.
The question of who you will spend your retirement with will affect what you do and what expenses you will face.
• What will you do in retirement? – While you might envision a simple retirement close to family and friends, you may also want to travel or continue your education. You need to think of your daily routine, regardless of whether it is simple or full of activity. It should be a rewarding lifestyle that brings you a sense of satisfaction.
Too many people think only of what they won’t be doing (going to work) rather than what they will be doing with their time.
• Where will you live? - Will you be staying in your current home; will you be downsizing or renting; will you want a vacation property? These are all questions you need to ask yourself. You need to estimate the costs, the access to healthcare, any tax implications of a move and a variety of other factors.
• What is your state of health? – The cost of health care for retirees can be higher than for the younger generations.
The current condition of your health and the future prospects of your health are important considerations. Does your family medical history raise any warning signs? There are no guarantees when it comes to the state of our health so plans should keep our health in mind.
‘When Can I Retire?’ by Andrew Allentuck provides some great insight into lifestyle choices in retirement. Take the time to read it, if you can. Your chances of making good decisions improve with the amount of knowledge you gather.
How much do you need to retire?
Once you have decided on your vision for retirement, the next step is to calculate how to fulfil this vision.
While the first question is often “How much do I need to retire?”, it is a question that can’t be answered without having more information.
There are five major variables to consider and each has a significant impact on what the final number will be. You have some control over these first two factors:
• Knowing the level of income you want in retirement – your retirement budget.
• The age at which you hope to retire.
Three factors are out of your control and reasonable assumptions must be used:
• The estimated rate of return you expect to achieve on your investments.
• The rate of inflation (annual increase in the cost of living) during your lifetime.
• Your life expectancy.
The following guidelines can help you determine an appropriate number for each of these variables. While some of them are out of your control, you still need to make reasonable estimates or assumptions.
Your retirement budget
While many financial plans provide detailed analyses of pension benefits, accumulation of capital and rates of return, it is all for naught if the basic assumption of income requirements is inaccurate.
Some investors calculate their retirement income needs as a percentage of current income, while others have the goal of maintaining a level of income in retirement that is ‘about average’ or maybe a little better.
Both of these approaches are unfocused and lack specifics. There is a better way.
Take the time to prepare a retirement budget; you only have to do it once. After that it becomes a matter of adjustments as your vision for retirement changes. It is definitely worth the extra effort and you will then have meaningful data on which to base your decisions.
We can look at the three approaches in more detail.
First approach – Percentage of Income
One rule of thumb that is commonly mentioned in financial publications for estimating your retirement income requirements is the 70% factor. In other words, 70% of the income you earn in your final year of employment is appropriate for your first year of retirement.
The logic behind using some kind of a discount over earned income is that the retiree likely no longer has a mortgage payment; there are no contributions to RRSP accounts, no Canada Pension Plan contributions and no EI contributions. Other expenses, such as children’s education, may also disappear.
While the percentage of income approach is better than not making an estimate, it has its shortcomings.
The problem lies in the fact that few of us know what we will be making in our final year of employment. If you wait long enough until you do know, it will be too late to make any changes to your retirement plans.
This approach also fails to take into account the kind of lifestyle someone may expect to have in retirement. Low wage earners may have grandiose dreams, while a highly-paid professional may seek a more simple life.
A study by Statcan found that people who earned over $70,000 tended to retire on about 45% of their pre-retirement income, while those who earned between $40,000 and $50,000 per year retired on about 59% of their retirement income.
Some financial advisors recommend a number as high as 80% of pre-retirement income as an appropriate guideline for retirement income. That number may serve the advisor’s goals of managing a large amount of assets better than it serves the client’s goal of having adequate savings for retirement.
Money and income is only part of retirement. The broad brush of a 70% factor does not encourage someone to visualize their lifestyle in retirement.
Thinking about how each day will unfold and what the routine will be for the next 20 or 30 years can make a prospective retiree pause. If you use a percentage of pre-retirement income, you gloss over this important aspect.
Second approach – Average retirement incomes
With the lack of a better guideline, the question is often asked, “What does everyone else live on in retirement?” It’s a question that is worth looking at.
The chart below provides a general historical picture of the average after-tax income from 1991 to 2010 for elderly families, elderly males and elderly females. For the purposes of comparison, the incomes have been adjusted to 2010 dollars to account for inflation.
As with using percentage of income, using these averages also has its shortcomings.
A retiree who has to pay rent may have higher expenses for shelter than someone who has a home that is mortgage-free. And a retiree in Toronto or Vancouver may have much higher expenses than someone who lives in small town Canada.
You may also want to ask yourself, ‘What will the average income be for retirees when I am ready to retire?’ It could be far different from what it is today.
When comparing the historical income of retired Canadians, it is important to note that each year inflation results in a cost of living that is higher than the year before. At an average inflation rate of 2.25% per year, the annual cost of living would increase by 25% in just 10 years.
A history of inflation in Canada can be seen on MoneyPages
The couple who project income needs of $45,000 in 2010 would need over $56,000 in 2020 to achieve the same standard of living. Inflation is a factor that is often given minimal attention and which can be a dangerous oversight. Where does the extra $11,000 per year come from if you haven’t planned for it? Always apply an inflation factor when estimating retirement income needs.
Using a percentage of pre-retirement income or the average income of retired Canadians are vague approaches. It is obvious that finding a method to more accurately estimate your income needs in retirement would be valuable in the retirement planning process.
Third approach – A personalized retirement budget
The first two approaches do provide some broad guidelines but the estimates can vary so much that they are barely useful in calculating an appropriate retirement income. They fall far short in recognizing the varying needs and expectations of each individual and the only person who can measure those factors is you.
The process of developing a retirement budget requires some time and thought; however, once it is complete you will have a solid foundation on which to begin. It must correspond to your vision of retirement. For each budget item, an annual expenditure must be estimated.
The good news is there are guidelines available for most budget items. Sample budgets can also help to raise awareness of items that have been overlooked.
The following example provides more detailed retirement budgets that illustrate the wide range of incomes of various individuals.
• The first budget is the hypothetical budget of a retired couple who have minimal income requirements and who live in a house that is mortgage-free.
• The second budget illustrates a couple who desire an above average lifestyle and who expect to be renting their accommodation in retirement.
Their income needs will be very different from one another.
There are an infinite number of variations that can be used as examples. The point is that there is no one number that applies to everyone and that is why it is important to define your own vision and develop your own budget.
With the completion of a budget, a more specific goal has been established and the first step in developing a retirement investment plan has been taken. The plan might have to be revised several times before it becomes feasible but it does provide you with a solid starting point. The compromises might include changing your expectations for the future or making sacrifices in your current lifestyle.
Your customized retirement budget will be the major factor used in determining how much you will have to accumulate for retirement. It is the foundation of all your retirement planning and it is wise to put a lot of thought into it.
Complex calculations involving RRSP contributions, rates of return and pension benefits are meaningless unless you know what your income requirements will be.
Despite this, so many financial planning analyses will oversimplify this part of the process and use a factor like 70% of income, without knowing whether it is even remotely accurate in assessing your needs and objectives.
Choosing a retirement age – a critical decision
Those who choose to retire early not only have to make their savings last for a longer period of time, but they also have fewer years in which to accumulate those increased savings.
Working even one extra year can allow for one more year of contributions to your savings, one more year of growth for those savings and one year less in which you will be drawing income from those savings.
In addition, many government benefits won’t be available until at least age 60, and even then they would be reduced benefits. Recent legislation will change the qualifying age for Old Age Security to 67 years by 2029. (This change has been repealed since the book was written)
The discount on CPP benefits for those who withdraw before age 65 has also increased. In the future, those who choose to begin drawing CPP at age 60 will have their annual benefits reduced by 36%. It is a big price to pay for early retirement.
With the changes to legislation it is clear that we are being encouraged to postpone retirement to age 65 or later. The financial incentives are significant.
Working a year or two longer can make a substantial difference to the level of income you can draw in your retirement years and it may provide you with the freedom to enjoy a far more comfortable lifestyle. It may even allow you to pursue dreams that once seemed out of reach.
Choose your preferred retirement age carefully. You may have to run several projections to find a retirement that suits your financial situation and provides the compromise between earlier retirement and higher income. It is important that you give this decision serious consideration.
Age of Retirement – detailed analysis
The age at which you retire is one of the few variables under your control.
Sixty-five was commonly used as the ideal age for retirement, perhaps because it coincided with some of the mandatory retirement ages that were put in place years ago. It also fits in nicely with Canada Pension Plan (CPP) and Old Age Security (OAS) benefits.
“A Portrait of Seniors in Canada” published by Statcan in 2006 http://
www.statcan.gc.ca/pub/89-519-x/89-519-x2006001-eng.pdf discovered the following trends:
“The median age of retirement has fallen dramatically in the past two decades. From the mid 1970s to the mid-1980s, it hovered around age 65. But in the late 1980s, it started dropping quickly, and continued to do so until hitting a low of 60.6 in 1997, and then fluctuating around that level in subsequent years.
“This decline was most likely initiated in 1987 by lowering the minimum age at which one could begin to draw benefits from the Canada Pension Plan – from age 65 to 60, with reduced benefits.”
In addition, vibrant investment markets that existed during the last decade of the twentieth century created the illusion that these markets could easily support a long and pleasant retirement.
An advertising campaign launched by London Life several years also may have helped to change perceptions with the catchy slogan of ‘Freedom Fifty-Five’. It was a campaign that caught on quickly and it planted unrealistic expectations in the minds of many.
Like the books that promised an easy path to fame and fortune, the advertising campaign told people what they wanted to hear. It could be done and it wasn’t that difficult. A long and idyllic retirement was within our grasp.
The following chart taken from that study shows the trend of retirement age among Canadians since 1976. As a society we never got close to Freedom 55 and, in fact, that dream seems to be getting farther away.
Source: Statistics Canada, Cansim Table 282-0051
Another variable is life expectancy and many people make the mistake of underestimating how long they expect to live.
Despite the cruelty of cancer, the tragedy of Alzheimer’s and the sudden grief caused by a fatal heart attack or stroke, Canadians are generally living longer.
This admirable trend has had its consequences. It means our retirement money must now last longer.
Those who expected retirement to last only ten or fifteen years may find that they are living longer than expected and their retirement portfolio has been depleted. In that situation there aren’t many alternatives other than accepting an austere lifestyle.
When we are young we may attach very little importance to what our lifestyle at 80 years old will be but that will change as we approach that age. More Canadians than ever are active well into their eighties. They golf, dance, travel, go to concerts and want modern, comfortable accommodation.
Independent living accommodation can cost $3000 per month per person or more. Life does not necessarily get less expensive later in life and we are living longer.
When creating a retirement plan, choosing an appropriate life expectancy is an important decision. It is one more of those variables over which there is little control. Underestimating your life expectancy can lead to an inadequate commitment to savings, resulting in an impoverished existence and loss of dignity in a person’s final years.
The best alternative is to refer to reliable research that has been done on the subject. A website with a lot of valuable information is www.worldlifeexpectancy.com.
Canadian females who were 60 years of age in 2011 had an average life expectancy of 86 years, while for males the corresponding numbers are 79 years and 83 years. In other words, approximately one-half of the females currently aged 60 will live beyond age 86 and one-half of the males currently aged 60 will live beyond age 83.
There are a wide number of variables and consulting the World Life Expectancy website can be helpful. For those who find the website overwhelming, a rule of thumb for both men and women can be applied for retirement planning purposes.
• Women may want to use a minimum life expectancy of about 90 years.
• Men may want to use a minimum a life expectancy of about 87 years.
If those numbers look higher than the average life span it is because they are. You could be in that half the population that lives longer than average and should plan for that eventuality.
Using a higher number than the average life expectancy helps to build in a cushion. Sound planning would be to consult the life expectancy tables and bump that number up by three or four years just to have an insurance policy against good health.
That might sound a bit strange but when someone is in their 80s there is very little opportunity to supplement their retirement income from other sources if they live longer than expected.
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