Retirement math: Why you may need more (or less) than you think

I don’t like retirement rules of thumb. I think they can be deceiving. If someone says you need $1 million to retire, they may be right. Or really wrong.

$1 million in an RRSP is very different from $1 million in non-registered investments. Withdrawals from the RRSP are taxable, whereas withdrawals from the non-registered account are effectively tax-free (with tax payable on the annual income and capital gains instead).

There’s also a big difference in how much you need if you’re retiring at 55 versus 65. Or, if you have longevity in your genes and expect to live to 100. Or, if you still have debt in retirement or expect to downsize or receive an inheritance. And what about risk tolerance? A GIC investor no doubt needs more savings than someone with an aggressive allocation towards stocks.

So, while I’m reluctant to use rules of thumb when it comes to retirement planning, there are a few general retirement math mistakes I see made frequently when it comes to retirement planning that I’d like to share.

Related Article: The difference between accounts and investments.

Overestimating income tax payable

I recently met with clients who retired last year. We prepare their tax returns and they were surprised at how little tax they paid in 2017.

Their income sources include (rounded figures):

Combined Canada Pension Plan (CPP) and Old Age Security (OAS) – $25,000

Registered Retirement Income Fund (RRIF) withdrawals – $30,000

U.K. pension – $3,000

Canadian stock dividends – $28,000

Foreign dividends and interest – $11,000

Taxable capital gains – $3,000

Total income – $100,000

Despite a healthy $100,000 of combined income – a lot for a retiree – they were surprised that their tax payable was less than $3,000 for 2017. They did deduct carrying charges of about $11,000 (management fees paid to their investment advisor) as well as $3,000 of capital losses carried forward from previous years that were claimed against their capital gains. However, $3,000 of tax paid on $86,000 of taxable income is still less than 4% tax.

When they were both working, their incomes were relatively high, and their tax rate was correspondingly high. They were used to paying tax at a high rate. Generally, in retirement, people’s incomes are lower, their income sources are more tax efficient than salary during their working years, and they aren’t paying certain taxes like Canada Pension Plan (CPP) or Employment Insurance (EI) premiums. CPP and EI premiums alone may be up to $7,000 per year for a working couple ($10,000 if they were both self-employed).

Underestimating the power of compounding

People sometimes use linear thinking when they’re trying to figure out how much money they need to have to fund their retirement. If they need $50,000 per year from their investments, they figure they need $1 million to cover 20 years of spending ($50,000 x 20 years = $1 million).

This math ignores the power of compounding. Let’s assume a 4% investment return. If you withdraw $50,000 from a $1 million nest egg and draw it down to $950,000, but the remaining $950,000 earns a 4% return, that means you’ve got $988,000 at the end of the year – not $950,000.

If we ignore inflation and assume a static $50,000 annual withdrawal, a $1 million nest egg earning 4% annually would be depleted after 38 years, not 20. Most portfolios won’t earn 4% consistently each year with no volatility, but you get the point.

Related Article: 5 Realities of the Stock Market

Ignoring the impact of inflation

Taking the above example a step further, it’s not enough to assume you’ll need $50,000 each year from your investments because that’s what you need today. The cost of living rises over time. Over the past 30 years, the annualized Consumer Price Index (CPI) measure of inflation in Canada has been 2.1%. That means prices have risen by more than 2% annually.

If you needed to withdraw $50,000 annually indexed to inflation of 2% from a $1 million portfolio earning 4% per year, your capital would be depleted after 25 years (not 20 or 38).

Further, something that costs $100 at age 55 would cost $200 by age 91 assuming the same 2% inflation rate.

Misunderstanding life expectancy

Canadian life expectancy is currently about 82 years of age. But it’s important to understand what this statistic means. It’s actually the average age at which Canadians die.

When planning for retirement, retirees and their advisors should instead consider their life expectancy based on their current age.

Consider a 55-year old couple. A 55-year old woman has a 50% chance of living to age 91. A 55-year old man has a 50% chance of living to age 89. And there is a 50% chance that one of the two of them will live to age 94. The couple has a 25% chance that one of them lives to age 98 and 10% to age 101.

So, barring extraordinary circumstances, today’s retirees probably need to plan to provide for themselves well into their 90s, in order for their money outlasts them.

Related Article: How to save for retirement: Saving for retirement is simple, not easy

Why you can't rely on rules of thumb

However great it is to have quick answers for financial questions to keep things simple, it simply isn’t enough to rely on retirement rules of thumb. Everyone is different and retirement planning is an art that reflects this fact.

If nothing else, take into consideration some of the retirement math mistakes above. Try to avoid them and it will help you better plan for retirement, whether on your own, or with a professional.

Written by Jason Heath

Jason is one Canada’s approximately 150 advice-only, fee-only Certified Financial Planners (CFPs). He does not sell any products or receive any referral fees. He has a particular interest in working with clients with complex financial planning issues, including Canadian expats in other countries, but works with single people, seniors and families at all planning stages seeking to take control of their financial lives. Jason is a Certified Financial Planner at Objective Financial Partners in Toronto and works via Skype with clients across Canada and internationally. He is also a personal finance columnist for the Financial Post and MoneySense.

36 Responses to Retirement math: Why you may need more (or less) than you think

  1. Love your articles, very informative. Do you ever do financials checks on people if they are on track. I am told I am but I would like a second opinion? If you ever want to do an article on that let me know.

    • hello I can’t wrap my head around such a low amount of tax on the couple with 100,000 (86000 after deductions) income. Is this tax after the amount withheld on rrif payments. A quick calculation on a 65 year old couple with 60000 of income comes to approximately 3500 combined. calculation were done using taxtips income tax calculator

  2. I just wanted to write to say that I read your article, “ Retirement Math” posted on Retire Happy this week, and I can’t tell you how much I related to it.
    Anyway, just wanted to drop by and say how much I loved your work. Looking forward to seeing what you write next for your column!

    Best,
    Aleem

  3. It seems that all these financial sites think you will need the same $$ when your 89 as you will when you are 65. I just do not understand this. Everyone I know who is currently over 80 (mother, mother in-law, etc…) only need enough to cover monthly bills, some groceries (far less than they used to eat), and a few dollars for grand kids/great grand kids. they really spend nothing else at all. Therefore, I believe you will need the $50k annually until you reach 80, then it starts to drop each year……so 1 million dollars if tons even using 4% returns and 2% inflation. Hoping you can provide your thoughts.

    • I find it’s all over the map, Paady. Generally speaking, spending tends to drop in the early years of retirement, but not as much as some may think (or hope). If only we knew how long we’d live, or if we’ll need long-term care as we age, it would make retirement planning much easier.

      I think the key is to absorb info like this and anything else you read and then personalize it. It helps to have perspective, but retirement planning is much more art than science.

      • Agreed, more info always helps. I’m 3 years into retirement, and live it. Figure our house ,(which we own) will cover and medical later if needed.

  4. Agree with Paady completely. I saw this with my parents, once they were over 80 their spending decreased significantly: food, gas, utility bills, personal care, property taxes and not much else. No travelling, no spending on renovations, little spending on clothes.

  5. Very nicely written and a break from traditional retirement thinking. I struggle with this concept a lot. To save a bit in taxes, am I trading prime years of my life? Is lonely fancy cruise down the Rhine river with aching knees better than a cheap party trip to the Caribbean now with friends? Again only an individual can answer. One cannot predict life expectancy, future health, desire to enjoy, inflation or state of economics. What is certain is today. Not saying don’t save , but don’t save it all. I wish I can practice what I preach, but my problem is I save too much.

    • It really is a dilemma! If you wait too long to retire, you may never enjoy retirement. Or not in the way you might have hoped.

      It makes a case for a mid-life retirement year or sabbatical, but not many people can do that.

      They say youth is wasted on the young. But is retirement wasted on the old?

  6. Loved the straightforward, easy to understand concepts and at the same time reminding us how personal financial decisions are based on our own situations.

  7. I did not realize when you retire you pay less tax. I retired in June and I am working casually and try to monitor my income to make sure I pay extra tax so I don’t have to pay income tax next year.

    • Often, you do pay much less tax in retirement. It really does depend on your sources of income though.

      One thing to watch out for though in your case, Elaine, is that with a half year of work at a higher income, your casual work may be taxed at too low a rate.

      For example, say you’re only working a few hours a week. The withholding tax will be based on your earnings for that week and may be in line with what the tax liability would be if your weekly earnings were earned x 52 weeks. But with 6 months of full-time work, your tax withholding at source on the part-time work may be low.

      It all depends, but most people tend to be pleasantly surprised with lower tax rates in retirement. Those who are hit with higher rates tend to be the ones with $75k+ of income who are subject to clawback on their Old Age Security pension. That’s a fairly high income in retirement and most retirees don’t have to contend with that.

      Anyway, it reinforces the benefit of planning.

  8. I’m three years into retirement and put into practice a lot of what I have read here. I’ve found its about spending not earning. I’m making good use of compounding interest. What’s before me is how much rrsp do I take out before I no longer have a choice at the expense of loosing social benefits.

    • If your income is low enough to qualify for Guaranteed Income Supplement (GIS), so below $18,096 for a single retiree or $23,904 for a couple, it may make sense to defer RRSP/RRIF withdrawals (see: https://www.canada.ca/en/services/benefits/publicpensions/cpp/old-age-security/payments.html).

      It depends how large your RRSPs are though, because deferring withdrawals until after age 71 may very well put you into a much higher tax bracket in your 70s and 80s and cause your lifetime tax to be much higher – all to save a bit of tax today.

      Low spending in retirement, as you elude to John, can certainly make retirement planning a lot easier.

  9. As usual a great article. We are lucky to be able to ask someone who is a CFP.

    My question is what would be a good decumulation strategy using percentages for future retirees that have different products such as.

    DC pension-DB pension, RRSP, TFSA, investment accounts, OAS, CPP and other products or accounts.

    • Thanks, James.

      I’m afraid there’s no rule of thumb, especially given the various sources your describe.

      It depends onw how much your DB/CPP/OAS pensions will be; how much is in taxable, tax-free and tax-deferred accounts (non-reg, TFSA, RRSP); your age; life expectancy; risk tolerance; expected inheritance; planned downsize; etc, etc.

      Scenario analysis can help, but even then, building a retirement plan is really more art than science and finances can be fluid. If you build a plan and your portfolio rises or falls 20% over the next year, no doubt it has an impact.

  10. Is there a site where individuals share their experience with retirement planning they have been successful with and want others to learn? I find all the information is based on hypothetical information and not much on actual life experience.
    This article touches on the fact many factors will apply differently for all, but what about the ones that have actually experienced it and have the hard facts to back up what it actually does cost. Nice to see a different angle to this very puzzling part of life. Thanks

    • I can’t think of a specific site, Tom. But one thing I can say having worked with thousands of aspiring or actual retirees in my career is that everyone is different.

      So absorb this article and anything else you read with a grain of salt.

      Absorb discussions at a BBQ with a grain of salt.

      And whether you do some rough calculations on your own or work with a professional to build a retirement plan, either can help, but neither is a guarantee.

      Planning for anything, especially retirement, is not a linear exercise.

  11. Hi,

    My wife is over 60 years of age and receiving her old age pension as well. Myself I am receiving my OAS/GIS ….1078$…but from last month she started to receive an amount less what expecting 740$ instead of 1076.15$ as usual. Can you advise on this matter

    Regards

    Ray

    • Hi Ray. Old Age Security (OAS) and Guaranteed Income Supplement (GIS) are means-tested pensions. That means your pension this year is based on your net income from line 236 of your tax return last year.

      The most likely reason for a decrease in your wife’s pensions is that her income or your family income exceeded a certain threshold and resulted in a reduction.

  12. Great article. The industry certainly makes Canadians feel like they need millions. With low or no debt and modest spending plans, retirees might need much less than what gets thrown around by investment houses and the banks.

    And in retirement we’re all snowflakes, all with unique circumstances that change and fluctuate.

    • So true, Dale.

      And I agree, I find the “rule of thumb” advice out there tends to overestimate how much people need.

      I’m not sure if that motivates people to save more or discourages them from paying attention to their finances.

  13. Hi Jason and thank you for the great article that really demonstrates the uniqueness of everyone’s situation. I’m about 5 yrs into retirement and loving it. I do an annual expenses budget including everything except car depreciation, income taxes and travel. I then compare it to our annual income and it helps answer questions life, can we travel this year, can we buy a new car, can we help our kids/grandkids, etc. Happily, my net income continues to rise!

    One of the pleasant surprises in retirement was the ability to split my RRSP income with my wife once I converted it to a RRIF. It saved us a lot of taxes.

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