As we live longer and prolong our retirement, having 70 per cent of our pre-retirement earnings, as once recommended, may not be enough to live comfortably, say experts (Getty Images/Hero Images)
When it comes to setting retirement goals, there is no shortage of information—some of which may be outdated.
Take the “70 per cent rule,” for example, which recommends you have an income of about 70 per cent of your pre-retirement earnings to live comfortably in retirement.
This percentage dates back to a time when defined benefit plans were common, including in the private sector, says CPA Robin Lévesque, a lawyer with the financial services firm Brassard Goulet Yargeau. Such plans typically provided a life annuity of 2 per cent per year of service for 35 years of employment.
But with longer life expectancies and prolonged retirement, the formula could result in pension shortfalls for employers, he warns. That’s why many organizations have switched to defined contribution pension plans. Much of the responsibility for preparing for retirement is then removed from employers and placed on employees. Employers no longer have to worry about investing the money and getting an appropriate return and making up any shortfall in retirement needs. Indeed, “the return on the pension fund’s investments, good or bad, directly affects the value of members’ accounts. In other words, the investment risk is assumed by the plan members,” explains Retraite Quebec.
“Imagine, for example, that you earned $35,000 a year. Would your goal really be to live on 70 per cent of that amount when you retire? Conversely, if you earned $200,000 annually, would you really need $140,000 in retirement?” asks André Lacasse, a Montreal-based financial planner, and founder of Lacasse financial services.
Times are changing. Although retirees no longer make contributions to RRSPs, the Canada Pension Plan (CPP) or Quebec Pension Plan (QPP), employment insurance, and so on, “seventy per cent of your earnings seems less and less sufficient,” Lacasse adds. “People don’t radically change their way of life at 65. They want the same things and the same lifestyle. Also, more and more people are still paying off a mortgage when they retire.”
Lévesque is just as skeptical over the 70 per cent rule. “There are too many factors to consider, including your family, physical and professional situation, assets and liabilities, sources of income and tax situation,” he explains. “What counts is the money that’s really available and actually spent. Although this seems obvious, it’s often misunderstood.”
So, what’s the solution? Here are five things to consider when planning your retirement.
1. BUDGET REALISTICALLY
Lacasse recommends making two budgets. One that lists your current expenses and a second that lists your projected, or forecasted, expenses.
“Maybe you’ll no longer have a mortgage to pay off or need a second car when you retire,” he says.
Of course, everything depends on your situation, as well as your needs and wants. Know thyself. If you enjoy travelling, for example, budget for it. Imagine your future life, Lacasse recommends.
“People don’t like budgeting, but I always tell them to reward themselves first,” he adds. “Planning to spend $5,000 a year on a trip? Perfect! Enter that amount ($415 a month) on the first line of your budget, and see what’s left at the end, once you add up all the other expenses. You may need to cut down on restaurants or other outings, but travel will always be there.”
2. DON’T OVERESTIMATE PUBLIC PENSION BENEFITS
Lévesque points out that Canadians often make two common mistakes: they anticipate receiving upwards of $14,000 per year from the CPP or the QPP, and apply for their retirement benefits at age 60 instead of 65. (As a reminder, the CPP is intended for individuals who work in provinces or territories outside Quebec, while the QPP is intended for individuals who work in Quebec.)
Although periods of low or no salary, of raising children and of disability can be excluded from your pension calculation and thereby increase your pension amount, “Canadians shouldn’t assume they’ll receive maximum federal and provincial benefits,” cautions Lévesque. “That’s extremely rare.”
If you apply for CPP or QPP benefits before age 65, your pension will be reduced generally by 6 per cent annually, depending on your income. However, if you wait until you are 65 or over, your pension will increase by 0.7 per cent for each month following your 65th birthday, to a maximum of 42 per cent at age 70. “Unfortunately, those who stand to gain the most by applying later fail to do so,” Lévesque says. “They don’t have the means to wait until age 65, although this additional income can provide a real boost to retirement planning.”
In 2019, the rate was 25 per cent of maximum pensionable earnings of $57,400.
In reality, although the maximum monthly CPP/QPP amount is $1,175.83 in 2020, the average monthly amount was just $672.87 in October 2019. The same holds true for Old Age Security (maximum monthly payment of $613 for eligible retirees) and the Guaranteed Income Supplement for low-income pension recipients. Under CPP/QPP enhancements which came into effect in January 2019, eventual retirees will see their maximum pension benefits increase to an estimated $24,906 under the CPP and $21,046 under the QPP. It should be noted that these enhancements will benefit mainly young people entering the workforce now in comparison to older workers with a number of contribution years under their belt. Either way, Lévesque suggests not relying too much on public pension benefits in your budget forecasts, and checking online statements to get a better picture of what you are entitled to.
3. SAVE, AND SAVE SOME MORE
The need to save for retirement is clear. As a rule of thumb, Lacasse recommends setting aside 10 per cent of your net income. And the sooner, the better. “The younger you start, the more compound interest will work for you.” To see how long it will take for your investment to double in value, use the “rule of 72.” You just divide 72 by the return on investment (let’s say 6 per cent) to get the answer (12 years in this example).
In all cases, you need to take a long-term view and manage risks based on your investment horizon. “It’s impossible to forecast market trends or to beat them,” Lacasse says. “One of the best solutions is to build a diversified portfolio that should not exceed 20 per cent in any one investment area.”
Levesque agrees, offering a pragmatic take on saving. “In your twenties, you should try to increase your future ability to save rather than save at all costs,” he says. “Especially since the 10 per cent rule doesn’t necessarily take lifestyle into account.”
This includes, he adds, understanding the difference between investment options such as a TFSA versus an RRSP, which will serve you better taking into account your age, income, lifestyle, other financial obligations, etc.
“Investing $100,000 in a TFSA and the same amount in an RRSP are completely different things,” Lévesque says. “In a TFSA, your deposits are made with after-tax dollars, while in an RRSP, your contributions will be taxed in the future. To get $100,000, you’d have to set aside $150,000”—this is assuming a marginal tax rate of 33.3 per cent, which may vary significantly from person to person.
Lacasse also suggests taking tax implications and rules around withdrawals, dependent on the type of investment, into consideration. “Taxes and withdrawal strategies have added a level of complexity. With pension income splitting, for example, it doesn’t always make sense to defer RRSP withdrawals. It’s how you spread them out that matters. In any case, it’s always best to consult a specialist,” he says.
4. BEWARE OF MAGIC NUMBERS
We often hear about how saving a million dollars would be enough for someone to stop working. Some suggest multiplying your desired retirement income by 25 ($60,000 x 25 years = $1.5 million) or following the 4 per cent rule, which determines how much you can withdraw annually without risking running out of money. Setting aside fixed-income securities, the problem, of course, is that no investment return is ever guaranteed, and many retirees tend to invest more conservatively to avoid any undue risk.
“Believing that you can live without cutting into your principal is just fantasy,” says Lévesque. “You need to either be tremendously wealthy or live very frugally. Of course, that’s not even taking inflation and income taxes into consideration.”
We must take into account, Lévesque adds, that what costs $30,000 today, such as a new car, will cost $40,376 in 15 years. Conversely, a $30,000 pension today, if not indexed, will be worth only $22,290 in 15 years. “Some investors focus on withdrawing a fixed amount in each year of retirement. But if they don’t reassess, they’ll lose in terms of purchasing power.”
On the plus side, lifestyle costs decrease in later retirement years, says Lévesque. “People are often more active between age 65 and 75 (or 80) than in their late retirement years,” he adds. “As they age, their needs or lifestyle can decrease by 10 to 15 per cent. Still, they have to plan for their less active years beyond 90.” Also keep in mind, their needs could increase again if they need assisted living.
Last January, RBC polled Canadians to find out what size nest egg they thought they needed to ensure a comfortable financial future. The figures ranged from $427,000 in Quebec to $872,000 in Ontario and $1.007 million in British Columbia. Women had a goal of $650,000 and men, $942,000. The national average was $787,000. Meanwhile, nearly half (48 per cent) had no plan to help them reach that goal.
5. DON’T RELY ON REAL ESTATE
In today’s economy, the housing market weighs heavily on Canadians’ finances and “could hamper their ability to save, or at least transfer their savings to real estate,” says Lévesque. “Owners are often in denial about the true cost of owning a property. That’s not to say that homeownership is bad debt, but it’s a forced way of saving, with so many related expenses, such as taxes, renovations and miscellaneous fees.”
Although property values have skyrocketed in some Canadian cities, owners will cash in only if they sell their property and make the right decisions. “Obviously, you make a profit when you sell a house for $1.2 million and buy a condo for $800,000,” explains Lévesque. “However, more often than not, what we see is people squandering this profit on high rents over a 15-year period.
“In all cases, selling a property often involves a new purchase or a rental. That’s why we suggest not seeing your house as part of your nest egg in your planning” says Lévesque. You should only take it into account if downsizing is in your plans.
NEVER TOO LATE
If you think you’re too late to start planning for retirement, don’t panic. The Procrastinator’s Guide to Retirement: How YOU can retire in 10 years or less, by David Trahair, can get you on track. Other tips: attend a webinar or ask a CPA Canada volunteer to lead a financial literacy session on retirement planning in your community.