How Much Will I Need for Retirement?

When preparing for retirement, this is probably the most widely asked question. The answer is actually quite simple. It depends on the lifestyle you want in retirement or the lifestyle that you have today. Everybody is different and nobody is typical.

The closer you are to retirement the more crucial the need to project your spending needs in retirement. You will also be better off trying to be more accurate in your approach.

Two methods of determining your retirement needs

There are two basic approaches to determining how much you will need. I call them the bottom-up approach and the top-down approach.

  1. The top-down approach. The top down approach is the easier of the two approaches. Essentially, you want to take your current income, account for taxes and investing to estimate your current lifestyle. For example, let’s say Sara and Dan are making about $80,000 per year combined between the two of them. They are paying about $24,000 in tax and saving $3600 per year into RRSPs. Essentially, if we assume that the rest of their income is used to support their current lifestyle, we can say that their lifestyle needs are about $52,400 per year. You could simply stop here and say that you need $52,400 in retirement in today’s dollars.The next step is to make some adjustments for expenses that will be different in retirement. The most common rule of thumb is to use a 70% ratio. This means that your expenses in retirement will be about 70% of your pre-retirement expenses. The 70% figure comes from the fact that your biggest expenses in your accumulation year’s, mortgage and dependent children will not be present in your retirement years. Hopefully by the time you retire, your mortgage will be paid off and your children will be independent.The top down approach uses a figure we call the income replacement ratio. The income replacement ratio is simply the percentage of income that needs to be replaced in retirement.

    Interestingly, for Sara and Dan, they were surprised at how much money they were spending in a year. They had no idea where that $52,400 was going. To take this step further, they looked into the bottom-up approach.

  2. The bottom-up approach. This approach is different in that you will need to be much more detailed in terms of knowing where you spend your money. If we continue from the example of Sara and Dan, the bottom-up approach requires that they understand where they spend their $52,400 and not just knowing that they spend that amount. The goal is to determine exactly how much money you are spending today by figuring out where you are spending this money.The bottom-up approach starts with tracking your cashflow. Sara and Dan needed to track where their money was being spent. Typically it is easier to categorize the types of expenses. For example, more people categorize expenses into home expenses, personal, transportation, medical, miscellaneous, financial, etc. It matters less what categories you use and more that you understand where your money is being spent. Once you have done this, you will have a better understanding of where the money is going over the top-down approach. The difference is you are ball parking your expenses into one general category in the top-down approach as opposed to understanding the specifics of where money is being spent in the bottom-up approach.The similarity to the two approaches is the need to make adjustments for retirement. In the bottom up approach, you will know exactly what percentage of income goes to cover mortgage payments, children, etc. Some expenses will go down in retirement like mortgage, children, and clothing. Other expenses could be higher like health care, travel and leisure.

There is no right or wrong as to the approach you want to take in determining your lifestyle need. The younger you are, the less accurate you will need to be since the future is more likely to change. Thus, the income replacement approach might be more suitable. The top down approach is a good way of understanding not only how much you spend but also where you spend it.

The closer you are to retirement, the more important it is to understand where your money is going and what adjustments will need to be made when you retire.

Written by Jim Yih

Jim Yih is a Fee Only Advisor, Best Selling Author, and Financial Speaker on wealth, retirement and personal finance. Currently, Jim specializes in putting Financial Education programs into the workplace. For more information you can follow him on Twitter @JimYih or visit his other websites Group Benefits Online and Advisor Think Box.

5 Responses to How Much Will I Need for Retirement?

  1. Well, I think that everything depends on a person and his/her retirement plans. For example, someone is going to travel around the world while someone just wants to be able to cover casual expenses. But in any case, it’s worth to save as much as possible. And it’s necessary to take care of our future because there will come a day when we will be unable to work. That’s why it’s necessary to take out some amount of money out of each wage and put into your savings account.

  2. I believe that OWNING your “No matter how humble” accommodation (Condo/house) is a must to a secure retirement ..Renting is a deal breaker..If you own out right and you have NO DEBTS .Then it is groceries clothing ETC..Your basic CPP/OAS would cover all the basics and leave any other amount that you have for fun in the sun.But when you really look at retirement the #1 asset has got to be your HEALTH..Without good health .Does anything else really matter?

  3. Charles you are very right regarding owning your own home/ apartment. My now deceased mother had her own apartment fully paid for at 65. She had CPP OAS and another pension about the same $$$ amount as her CPP. She lived well but was not into travel. She was certainly not a financial burden to her kids. Had she rented it would have made a big difference to her financial well being, during her almost 20 years of retirement.

  4. You can use a simple spreadsheet to track all your income and expenses for the year on one page. Your basic living expenses can be monitored from year to year, and large/odd purchases can be at the bottom with notes. I have used this “system” for about 25 years – it works great.

    Another spreadsheet can tell you what makes the most financial sense for you: buying or renting; just plug in your numbers (mortgage details, home price, repairs/maintenance, property taxes, inflation, rent, annual rent increase percentage, and ROI for spare cash invested) and you get two charts to give you a quick snapshot of what your finances will probably look like. Two scenarios are shown: assuming you don’t want to sell the home later, and assuming you do want to sell later.

    A third spreadsheet I think that you’ll find helpful is a “Pension Planner” which calculates your CPP, OAS, GIS, PRBs, Disability, RIF, RRSP, DPSP, RPP, etc. and projects your income for about 40 years; you can play unlimited “What-if” scenarios re when to take your CPP and OAS. It also has a mortgage calculator which you can use to see what’s best: paying down your mortgage or putting cash into your RRSP. The best part is a Cash Manager which lets you see the impact of switching your money between your chequing, Savings, TFSAs, RRSPs, etc for the tax effect as well as GIS impact.

    Everyone’s situation is different; don’t accept that what someone else has decided is the best choice for you. Do your homework with these spreadsheets. No one is impacted by your financial decisions more than you/your family.

    You can find more details about the spreadsheets mentioned on my website

  5. Renting vs Owning. I have owned and now rent. In the Vancouver market the value of a residence is over $600,000.

    Own: condo fees, possible parking fees, roof & other repairs (variable), grass, gutters, fences, property taxes (increases), insurance, mortgage in some cases.

    Rent: rent, possible parking fees, insurance.

    My current portfolio is much lower than $600,000 but if I had $600,000, I would generate about $90,000 (at my current rate of return) of income tax advantaged income, plus CPP & OAS. My capital would fluctuate but my income would vary very little.

    CPP & OAS are buffers that I exclude when planning; they cover extra expenses like trips or surprise medical expenses.

    Let’s say rent of a nice place in this area is $4,000 a month, about $50,000 a year. In 2014 my effective income tax rate was 2.34%, let’s say about $2,000 on the $90,000. I still have $40,000 or so left to spend.

    Oh yes! I still have about $600,000 in cash that fluctuates, but produces about $90,000 a year. And I have a lot of free time… and money.

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