One of the basic pieces of information needed to do a retirement plan is how much you plan to spend in retirement. Most people do not know how much they are spending today let alone trying to estimate what they will spend in the future. For those who really do know what they are spending, they are the minority.
Let’s walk through three ways to help you figure out the most important assumption needed for retirement planning.
The 70% rule
Because most Canadians do not know how much money they will spend in the future, the financial planning industry has adopted the 70% rule. The 70% figure is the amount of pre-retirement income you will need to replace in retirement.
This figure came from a US based actuarial study done in 1996. However, what we are finding in Canada is the amount of replacement income is actually much lower than in the US and a big reason for the difference is the cost of health care. In data reported by Canada Revenue Agency (CRA) the replacement income for retirees was more like 45% to 62% depending on how much money you made before you retired.
The rationale behind this thinking lies in the assumption that you have higher expenses in your pre-retirement stage. For example, in retirement expenses might be lower because you will not have mortgage payments and hopefully, kids will be independent. This may not always be the case though, hence why these are called rules of thumb.
The detailed approach
Another, more commonly used term for the detailed approach is budgeting. Budgeting can be such a negative word because, like dieting, it implies restriction of a natural behavior (spending). For me, it’s more about tracking expenses and knowing not only how much you spend but also where you spend your money.
Keep track of your expenses for three months. It’s not rocket science.
Once you know how much you are spending now, go through your list and make adjustments for expenditures in retirement. For example, let’s say your dry cleaning expense totals $65 per month. You might assume that you would no longer have this expense in retirement since you no longer need to dry clean work clothes. On the other hand, you might want to get a golf membership in retirement but do not have one now. In this instance you might add $2000 as an annual expense in retirement.
Keep it simple
The easiest way to figure this out spending is to simply go to your paycheques and see check out your net pay. Your net pay is what you get deposited into your bank account after all deductions. After that, subtract any other savings you may be doing. For example if you are contributing $300 per month to your RRSPs, subtract that. Whatever is left over is what you are spending every cheque. It’s pretty simple because whatever you don’t save, you are spending. If you disagree with this figure, then go back and start tracking your expenses and you’ll probably be surprised at where you end up.
My two cents
At the end of the day how much you spend in retirement is up to you. It’s not about adhering to the norm or conforming to what everyone else is spending. Retirement is personal. It requires some key assumptions, none more important that what you plan to spend in retirement. Knowing how much you will need to save for retirement depends entirely on how much income you will need in retirement. Make sure you are informed and realistic about how much you spend. Take the time to figure this out and you will have taken the biggest step towards planning for your retirement.