Posted by Robert on January 10, 2011
This is a guest post by Robert, who lives in Calgary and works as a financial adviser. He is married, has three kids and plans to retire at age 35. Robert and his wife then plan to return to school and become teachers, eventually living and working overseas.
I occasionally have people ask me, usually in the context of financial planning, “So, how much do I need to retire?” I’m tempted to give the easy answer: $1 million, but that wouldn’t be honest. Instead, I always start my answer with: “It depends.” That probably feels like a cop out, but it’s entirely true.
How much do you spend in a typical year? This varies greatly from person to person. If we assume that a couple owns a home and has no mortgage, they can probably live on anything more than $1500 per month. And most people could realistically spend as much money as they have available. This question is almost always ignored in discussions about pension reform. Much hand-wringing attends headlines such as: “Canadians not saving enough for retirement,” or “2 out of 3 boomers worried about retirement.” How do we know how much Canadians will spend in retirement? My answer is that we don’t, since we haven’t asked them.
What will you do with yourself in retirement? Do you want to spend as much in retirement as you do now? Will you spend less on clothes, lunches and gasoline/transit by not going to work? Will you spend more on hobbies, social clubs and travel? In retirement, some people will spend significantly less. A rule of thumb sometimes used in financial planning is that 70% of pre-retirement income is adequate. That may be true, but some people may prefer to save more and spend significantly more.
How do you invest your savings? Whereas most people I’ve spoken with have little idea of how much they spend in a given month and many have never thought seriously about what their ideal retirement lifestyle will cost, most of them can tell you how they invest their savings. Some buy only GICs, and can expect less growth than those who invest in a mix of bonds and stocks (or mutual funds) and a different level of income (and part-time work) than those who invest in real estate. Investment choices dictate the level of return that can be expected and the amount, dependability and taxation of income available in retirement.
How long will you live? This is the hardest question of all, with no answer. If a retiree knew he would only live 12 months after retirement, and I’ve heard a number of stories where this was the case, he would blow it all. On the other hand, if a retiree expected to live past age 100, she would have more savings and be more conservative with her spending plans. Since we can’t know, we can only plan to never run out of money, then design a will to handle our excess assets, just in case.
Let’s look at a quick example. A couple wants to retire with $3000 per month of income (not including . We’re planning that this income will last as long as they live, so they require a sustainable withdrawal. They will have roughly equal income, or $18,000 per year each. This will attract almost no taxation. Suppose they invest in only dividend paying stocks, with a current yield of 4%. They plan to live on the income, without realizing capital gains except as a backup plan. $36,000 (total annual income) is 4% of $900,000, so that’s how much this couple will need to retire.
In the end, it doesn’t matter whether a person wants to retire at 65 or 55 or 45, if you want your income to last indefinitely. First, decide how much the ideal retirement lifestyle will cost. Next, determine how retirement funds will be invested, and plan a withdrawal rate accordingly. Then it should be a simple matter to find out how much capital is require to produce the desired amount of income. How much do you need to retire? If you don’t know, it’s probably $1 million.