Posted by Dave on December 28, 2010
This is a guest post by Dave, who is also looking to retire no later than 45, but unlike Tim has no kids and doesn’t want any. Dave is from Ontario and is working towards his CGA certification.
Over the past few years, I have changed the way I look at money. When I got out of school and got my first “real” job, the money that I made bought me “stuff”: lots of video games, some fancy toys and other things that I don’t remember and really have nothing to show for it. Now, the money I make from my job is used as a tool – the majority of income I make is ear-marked for debt repayment (mortgage) and the rest is either saved for longer-term savings, for purchases such as cars, vacations or other “wants”.
The difference between past years and currently is that I now have a buffer. I don’t necessarily need to work at the job I currently work, in fact I could probably live comfortably on approximately ¼ of what I currently make, it would just mean I could have to work until I was around 60 instead of being able to stop working in my mid 40s (which still seems like a long way away). I have prioritized my spending to reflect things I really like and value rather than spreading my spending around until there is nothing left.
This more focused and thoughtful spending provides a peace of mind that I really didn’t have previously. I know that even though I have to work at something, I’m not necessarily “trapped” at my current job because I could quit and find something else to do if I wanted to. The flexibility, even if not utilized (I like my current job) makes waking up in the morning easier, the difficult days I do have while working are not the end of the world – it’s generally just a less stressful lifestyle.
If I were to live like a lot of people I know and not have savings, if I “needed” 100% of my paycheque to make it through the month I think I would be significantly more stressed on a day-to-day basis. Money, rather than something that my wife and I discuss once a month or so would be something that we’d be battling or worried about constantly. I know many people that live this way and I really don’t know how they do it – if they missed even one paycheque, they are at risk of falling behind on several debt obligations and not really able to make this up anywhere.
So, even though I am not currently financially independent of my job, and will have to continue to work somewhere for the foreseeable future, having a financial plan and prioritizing my spending has lead to a much easier, less stressful lifestyle. The end result of living the way I am will hopefully be retirement at 45, but on the way there, I am enjoying the way I currently live.
What would you change with your current spending? How much less could you earn and still maintain your current lifestyle?
Posted by Robert on December 27, 2010
Tim’s post on pension reform struck a chord with me. I agree with him that the proposals by government for expanding the CPP are a bad idea. I have three major problems with this idea, only one of which I will explore in detail. First, the idea that Canadians aren’t saving enough is based on too many assumptions for me to be convinced. It’s also the result of a conflict of interest, in that the CPP investment board would rather manage more funds. But whether or not the conclusion is correct, my second problem is that $127.6 billion (or more) is too much money to entrust to the care of a small group of people. Third, CPP doesn’t offer Canadians a good deal. This is the idea that I want to explore.
Let’s begin by looking at how much is saved each year on your behalf. The total contribution, employer + employee, is 9.9% of your pensionable income (maximum of about $47,200). That is an increase from 3.6% in 1985. For 2010, the maximum contribution (for anyone earning over $47,200) is $4672.80 (for self-employed people, or split equally between employer and employee). Benefits are calculated based on 25% of average pensionable earnings, so for this example we will assume that the maximum was saved each year.
For the purpose of this example, let’s assume an individual graduates from university at age 22 and begins working with an income of $47,200 (or more) and maintains at least this level of earnings over their career. They retire at age 65, having worked for 43 years. We will use constant dollars, ignoring the effect of inflation since benefits are adjusted for inflation. This means that the 22 year-old graduate will contribute, either personally or from the employer, $4627.80 each year for 23 years. The total contributions will be $107,474.40.
The resulting amount of capital, $107,474.40, includes no investment return. To see what rate of return is implied by CPP benefits, let’s look at the current cost of annuities. (Disclaimer: this uses data for a female, whereas an annuity for a male at the same age would cost less, implying a lower return from CPP.) At age 65, a woman can expect an annuity to pay out interest and capital at a rate of about 6.84% per year. This will last to the end of her life, with no value at death. In this way, it works exactly like CPP. At age 65, the maximum CPP benefit is $960.00 per month. This is the amount of the benefit that would be earned in the example given above. In order to buy an annuity with a similar benefit, assuming a 6.84% payout rate, would cost $168,421. An indexed income, which CPP provides, would cost somewhat more than this.
Now it’s time to complete a future value of money calculation. Saving $4627.80 each year over 23 years and finishing with $168,421 implies a rate of return of 3.95% per year compounded. Add to this the fact that CPP may be around 20% funded, with the goal of being 30% funded by 2075. The fact that the fund is transitioning from pay-as-you-go (ie. current workers pay for current retirees) to a hybrid structure (ie. partly funded by current workers saving for their own future benefits) explains the low rate of return. The difference between this and the expected (market) return is what increases the funding level and the stability of the plan.
Personally, I expect not to rely on CPP. I can get a better return than 3.95% and I can take responsibility to save for my own retirement. And it’s a good thing, since I won’t even have the option of paying into CPP if I have no earned income. When I retire early and begin to rely on investment income (or move abroad), my contributions to CPP will end and my expected benefit at age 65 will stop increasing. People who are self-employed also have this option. If they take their income as dividends instead of salary, they don’t contribute to CPP and are wholly responsible for their own savings.
I don’t believe CPP is a bad idea. It provides a minimum income so that elderly Canadians are less likely to live in poverty. A couple who receives maximum CPP for a single spouse and OAS for each spouse should receive around $2000 per month. But it doesn’t mean we should expand CPP. It provides only a safety net and, as was mentioned in the comments to Tim’s prior post, different people prepare themselves in different ways. Who am I to say that choosing to reduce your spending, choosing to move to a lower cost country or choosing to reverse mortgage your house aren’t equally valid ways to deal with the need for income in retirement.
How do you feel about CPP? Do you appreciate the safety net it provides? Should people be forced to save more? Is it the government’s place to help us retire?
Posted by Canadian Dream on December 24, 2010
I just wanted to take a moment to wish you all a Merry Christmas/Happy Holidays/Other Appropriate Greeting. Thank you for a wonderful year and I hope you have an excellent 2011. Also this is to advise you that I’m on vacation from now until Jan 10, which basically means I will still be posting, but potentially later in the day than normal (I’m working without an alarm here). Also it might take me a bit longer to get back to answering comments.
Take care,
Tim
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