Using good retirement planning assumptions
At last, there is good news for retirement savers.
Almost everyone worries about how much is needed for a comfortable, worry-free retirement? It may be much less than you think.
Determining how much retirement income you’ll need is difficult, and incorrect retirement planning assumptions can lead to wildly inaccurate projections – and a nasty surprise. For this reason, it isn’t recommended that you use one of those online calculators.
A retirement plan will indicate things such as how much you need to put away, your required rate of return to achieve certain goals, potential stumbling blocks that could derail your plan and how you can protect your family from those financial pratfalls. A retirement plan is important, but an inaccurate plan isn’t much better than none at all.
I’m going to take a shot at my industry here. Lazy advisors may use rules of thumb that often miss the mark. The most common says that retirees need 70 percent of their pre-retirement income.
Related article: Ways to figure out how much you will spend in retirement
In fact, many retirees can live well on much less. I contend that advisors and financial institutions sometimes inflate that number to scare folks into investing more.
Pension expert Malcolm Hamilton—the closest any actuary will come to be a media superstar—has long challenged the 70-per-cent figure. Now, in their book, The Real Retirement, Fred Vettese, and Bill Morneau agree that many Canadians will need much less than the numbers often tossed around.
Vettese introduces what he calls the neutral retirement income target (NRIT) to provide a more accurate estimate. The authors carefully analyze the numbers with a large helping of common sense to conclude that the real target is often closer to 50 percent.
The NRIT determines how much of your current work income goes to day-to-day consumption, then estimates the retirement income needed to meet that level of spending. Vettese found that retirees sometimes enjoy the same level of consumption on much less than has been thought. Retirees spend less and enjoy tax benefits that working people don’t.
Vettese uses a couple with income of $110,000 who contribute 3.8 percent of their income to RRSPs, spend $1,100 a month on child-rearing and have mortgage payments of $1,633. Deduct income taxes and payroll taxes (CPP and EI premiums) leaving $46,600 to spend.
In retirement we no longer contribute to an RRSP, are raising children or paying down a mortgage. There are no payroll taxes and far lower income taxes. We often need less insurance and fewer vehicles.
As a result, Vettese’s sample couple needs an income of just $48,300 for the same consumption level as while they were working, only 44 percent of their pre-retirement income.
“The good news,” the book states, “is that if Canadians take the time to plan properly, most will be just fine, and many may actually be better off in retirement than they were during their working lives.”
Of course, income needs can vary widely. While I’ve seen some folks manage on 40 percent of their pre-retirement income, some require as much as or more as their work income. Please don’t just base your plan a 50-per-cent NRIT, as your number may be lower or higher.
It depends on what you want to do in retirement. Homebodies will need far less than someone who wants exotic travel. Also important is your pre-retirement income. A family with a $200,000 income may be able to make do with 40 percent, while a couple with $40,000 income may need 100 percent.
Don’t forget health-care costs and the possible need for long-term care in your plan.
With many Canadians carrying far too much debt and socking away nothing, no one wants to tell people to save less. However, Vettese makes a strong case that many families who are paying off their mortgages and saving modestly may do just fine on far less retirement income than what most advisors preach.
If you haven’t already done so, work with your advisor to do a written, goal-oriented retirement plan. Read this book first as it will help you prepare using good retirement planning assumptions. If your advisor tells you to save 70 percent, have him read the book also.