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How much do you have — and how much do you need?
Having enough to retire the way you want.
- Having enough to live and enjoy life, and
- Leaving a legacy, perhaps to our families or favourite charities.
But few of us realize how much the quality of life we live in the future depends on what we contribute in the present.
Try to match the retirement picture in your head with what your savings are telling you. Don’t want to go there? You’re not alone. Many people avoid linking dollars and retirement in the same thought – retirement may seem too far off, or the financial realities are just too stressful.
Take Ray and Sarah. They don’t spend a lot of time or effort on their retirement finances. Both are in their early 40’s and earning a good income. They are making enough to save for their kid’s university, and hopefully pay off the house in the next five years. Although they live well today, they want to ensure they will live well tomorrow.
With retirement still about 20 years off, Ray and Sarah thought that with the money they were making, maintaining their lifestyle in retirement would be a breeze. By then, the kids would be self-sufficient and mortgage payments would be a thing of the past. And they felt comfortable about their future finances, as they had been contributing to their RRSPs for about 15 years already.
One night Ray and Sarah went to a retirement party for Stephen, one of Ray’s colleagues at work. Stephen was 59, retiring, and eagerly anticipating it. Stephen’s wife, Dorothy, was excited about the exotic places she wanted to go and experience. And Stephen couldn’t wait to hit the high seas in the new boat he was going to buy.
Driving home after the party Ray and Sarah were infused by Stephen and Dorothy’s sense of excitement. They talked about their own retirement and agreed, once again, to enjoy their retirement years to the fullest.
Six months after Stephen’s retirement party, Ray was surprised to see his friend walk in the office bright and early one Monday morning. Assuming Stephen was just visiting his former co-workers, Ray was shocked to learn that Stephen had come back to work full time.
Stephen explained that the lifestyle he and Dorothy had envisioned for themselves was not attainable with the money they had put away. So, they had both decided to go back to work for a few more years.
When Ray got home that night, he told Sarah of Stephen and Dorothy’s plight. Right then and there, Ray and Sarah called their financial advisor to make an appointment, and started to do some research into how much money they would actually need to retire the way they wanted.
Choosing a Retirement Style
What Ray and Sarah found out is that the most important factor in determining how much money they would need to retire comfortably is the lifestyle they chose. Would they want to work part time, pursue a hobby, volunteer, or travel frequently? Every choice of activity could either add to, or take away from their savings.
When thinking about your own retirement, do you see yourself living moderately, comfortably, or well? These general categories can be used as guidelines in determining the type of lifestyle you want to live.
- Moderately = 60 – 70% of your pre-retirement income required in
retirement
- Comfortably = 70 – 85% of your pre-retirement income required in
retirement
- Well = 85 – 100% of your pre-retirement income required in
retirement
Inflation Bites
The most insidious force that can eat away at your savings is inflation. You can expect this to rise every year. You may begin retirement thinking that everything is fine, only to run out of money later due to increased costs of living. Since, historically, inflation has averaged three per cent per year, plan to have your income increase by about three per cent during your retirement.
Over a 20 year period costs will double. When calculating your projected expenses in retirement, it is important to adjust your numbers to incorporate the effects of inflation.
And that’s not all….
Inflation may be the first in line to take a bite out of your savings, but there are others waiting their turn. Consider:
Lack of company health benefits – When you finish working, your company benefits may no longer pay for your prescription medications, new eyeglasses, or the dentist. Medical expenses can turn into a major expense, especially as you get older and require more health care.
Retirement homes – As we get older, many of us will need in home nursing care or will need to reside in retirement and nursing homes for a period of time. The expenses of these types of health care are staggering.
Typical Home Care Costs
- Registered or auxiliary nurse, $30 to $38 per hour
- Medical services aid, $14 to $19 per hour
Typical Long Term Home Care Costs
For certified facilities with government subsidies:
- A private facility may cost $2,000 per month
- A semi-private may cost $1,750 per month
- Ward facility may cost $1,500 per month
Determining how much you will need
There are two ways to calculate how much income you will need in retirement. As we mentioned earlier, choosing a retirement lifestyle is just the first step.
1. Income Replacement Ratio Method. The income replacement ratio is the percentage of working income that you will need to maintain the same standard of living in retirement, usually 60 – 100 per cent.
The income replacement ratio method simply calculates how much of your pre-retirement income you will need in retirement. To figure this out, start with your current income, subtract what you pay in taxes and investing income. Then multiply by the income replacement ratio that corresponds with your current lifestyle.
Current Income - Taxes and Investing X Income = Retirement
Income Replacement Income
Ratio Required
(after tax)
For example, let’s say you have a total annual income of $100,000. You pay $30,000 in taxes and contribute $5,000 every year into RRSPs. Using the first half of the simple formula stated above, you would end up with $65,000. Then adjust for expenses that will be different in retirement by using the income replacement ratio that corresponds with the lifestyle you choose. For a comfortable lifestyle, let’s choose 70 per cent.
Your required retirement income would be $45,500 after tax.
2. Tracking cash flow. Tracking cash flow is a more detailed examination of not
only how much you spend, but where you spend it. This method is extremely useful the closer you get to retirement.
You may want to categorize your expenses (home, financial, medical, etc.) but the important thing is that you understand where you spend your money. That way you know exactly how much is going towards your mortgage and children now, and will be able to more accurately adjust for other expenses such as health care and leisure activities, which could be higher in retirement.
Live the retirement you want.
With all the information you now have, it may seem a daunting task just to keep a roof over your head once you retire. But the picture is not all that grim. There are things you can do right now to live the retirement you want.
Planning – Don’t get stuck at 55 without a plan. Make decisions and act on them today to ensure tomorrow. The earlier you start the better.
Take advantage of RRSPs – Retirement savings plans are one of the most effective methods to save for your future. If you start early, contribute regularly and maximize your contributions, you will be a giant step ahead in the game.
Consider other sources – Take your whole financial picture into account. You probably have a few other sources of income, such as non-registered investments and real estate holdings, which will ease the financial burden in retirement.
Talk to your planner– Your financial planner is your resource for a wealth of valuable information. He can give you the advice you need to capitalize on all your sources of income most effectively.
This article is an excerpt from Solutions Magazine by Manulife Investments. If you would like a free copy of the magazine please send us an email with your request.
This article was prepared by Terry Fay who is an Investment Advisor with Dundee Securities Corporation, a DundeeWealth Inc. Company. This is not an official publication of Dundee Securities and the author is not a Dundee Securities analyst*. The views (including any recommendations) expressed in this article are those of the author alone, and they have not been approved by, and are not necessary those of Dundee Securities.
The particulars contained herein were obtained from sources which we believe reliable but are not guaranteed by us and may be incomplete. The opinions expressed have not been approved by and are not those of DundeeWealth Inc., its subsidiaries, or its affiliates, including, but not limited to Dundee Securities Corporation, Dundee Private Investors Inc. / Ltd., Dundee Insurance Agency Ltd., Dundee Bank of Canada and Dundee Mortgage Services. This website is not deemed to be used as a solicitation in a jurisdiction where this Dundee representative is not registered.
Insurance products provided through Dundee Insurance Agency Ltd.
Only securities related products and services referenced are offered through Dundee Securities Corporation.
Dundee Securities Corporation, Member CIPF, is a DundeeWealth Inc. Company
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