How Much Do You Need to Save to Retire?
Just poke around the internet for a while looking for answers to how much money you need to save before you retire and you’ll get answers ranging from next to nothing up to $3 million or more. It looks like some of them must be wrong, but it all comes down to your spending and pensions.
Let’s take an example. A Canadian couple, Mary and Bill, are both 65, have no debts, have no workplace pension, and are about to retire. They both worked enough to get maximum CPP benefits. Together they can expect CPP plus OAS of $3200 per month rising with inflation.
Suppose that $3200 is enough to cover their spending. Then the total savings they need is zero. Nada. Zilch. It can be dangerous to count on being able to work until age 65, to count on maximum CPP benefits, and to assume you can live on $3200 per month, but now that Mary and Bill have made it to 65, they need no savings beyond a modest emergency fund.
What happens if Mary and Bill have a more expensive lifestyle? Let’s say their spending is double their government pensions, $6400 per month after income taxes. Based on a series of assumptions, I work out that they need about $1.1 million in savings. This is hugely different from the first case where they needed no savings.
Let’s take it one step further and see what happens if they want to spend triple their government pensions, or $9600 per month after income taxes. Again, based on several assumptions, I calculate that they need about $2.4 million in savings.
No doubt others would calculate different amounts of savings needed to support the larger spending levels, but the point is that the need for millions of dollars in savings to retire comes from spending more than your pensions.
If you can live on your available inflation-indexed pensions, then you don’t need savings. If you need more money than this, your savings needs climb quickly. How much you need to save is so sensitive to how much you spend that we should never expect consensus among experts on how much you need to save.
Let’s take an example. A Canadian couple, Mary and Bill, are both 65, have no debts, have no workplace pension, and are about to retire. They both worked enough to get maximum CPP benefits. Together they can expect CPP plus OAS of $3200 per month rising with inflation.
Suppose that $3200 is enough to cover their spending. Then the total savings they need is zero. Nada. Zilch. It can be dangerous to count on being able to work until age 65, to count on maximum CPP benefits, and to assume you can live on $3200 per month, but now that Mary and Bill have made it to 65, they need no savings beyond a modest emergency fund.
What happens if Mary and Bill have a more expensive lifestyle? Let’s say their spending is double their government pensions, $6400 per month after income taxes. Based on a series of assumptions, I work out that they need about $1.1 million in savings. This is hugely different from the first case where they needed no savings.
Let’s take it one step further and see what happens if they want to spend triple their government pensions, or $9600 per month after income taxes. Again, based on several assumptions, I calculate that they need about $2.4 million in savings.
No doubt others would calculate different amounts of savings needed to support the larger spending levels, but the point is that the need for millions of dollars in savings to retire comes from spending more than your pensions.
If you can live on your available inflation-indexed pensions, then you don’t need savings. If you need more money than this, your savings needs climb quickly. How much you need to save is so sensitive to how much you spend that we should never expect consensus among experts on how much you need to save.
So my gut is telling me that you are saying that if you can live within your income levels at retirement, you should be fine, otherwise, you had better be saving? I might be reading between the lines on this one.
ReplyDeleteWhen can I retire? When you can afford it is the answer I give, but no one likes that answer?
Oh and this would have been MUCH better if there was a graph on it.
Delete@Big Cajun Man: Actually, I doubt most people's ability to guess what their spending will be in retirement. Only those close to retirement and who know what they are currently spending are likely to be able to guess accurately.
DeleteThe average CPP payment is 640.23. The maximum OAS payment is 569.95. The sum multiplied by 2 (couple) is 2420.36. That's 25% less than 3200. On the death of one spouse, the amount is reduced by at least 569.95 or 23.5%.
ReplyDelete@Anonymous: All true, but what is your point? If we're taking averages, we could add in the average workplace pension and bring income back up again. But playing with average figures is unhelpful. I chose one example to illustrate a point. That point is that if you can live within the total pension you're going to get (whatever that figure may be for you) then savings aren't needed. For the vast majority of us who hope to be able to spend more than this pension amount, savings are needed. And these savings needs grow very quickly with the monthly spending amount.
DeleteI'd like to add my own dose of reality. Your three examples give saving levels of $0, $1.1MM, and $2.4MM. However, looking at current levels of wealth reveals only ~1% of Canadians posses investable assets of $1MM or more. Extrapolated data shows there may be ~2% during full Boomer retirement, then retreating to ~1% after they are no longer (millionaire population growth is also slower than general population growth).
ReplyDeleteThe point is, almost no one will save enough for retirement (including a few PFers). Shoot for the moon but don't worry too much if you come up short, math is a b!tch to beat. ;)
@SST: Your reaction is more or less what I was aiming for. Unless you're one of the few who will save a large sum, your retirement spending won't be much above your pension income. If that pension meets your needs, then you'll be fine. If it doesn't, and you don't save a lot, then you can expect your spending to be forced down to close to just your pension.
DeleteBut if you can save just enough to cover expenses for your first five years of retirement, and then defer CPP and OAS to age 70, your indexed pension income will increase by 42% for the rest of your life. A more reasonable goal to shoot for perhaps?
ReplyDelete@Garth: With this strategy, you're depleting your savings to boost your pension. Depending on a number of factors, this may be beneficial for some, but it will only make a large difference for those who are destined to simply waste their savings anyway (which may be a lot of people). It also depends on your ability to save enough to live on until you're 70.
DeleteYes you are depleting savings to boost pensions but it is reasonably safe to do so. I estimate that for Mary and Bill, that they would need savings of of somewhere around $250,000 to be able to spend 42% more (4500/month) forever. Not a bad deal.
DeleteGuaranteed to die broke though...
Just wanted to add that if Mary & Bill had saved the above $250,000 in RRSP's, that with age 65 tax credits, they would be able to withdraw the whole amount over the five years at an effective tax rate of well under 5%...now that is tax efficient!
DeleteWhat about the well documented additional costs that come with getting older? Seems to me even with a high degree of confidence that your income stream will be enough to cover basic living costs, it's still a good idea to put aside a chunk of savings to deal with unexpected health-care costs in particular (assistance at home, prescriptions, etc).
ReplyDeletehttp://business.financialpost.com/personal-finance/unexpected-health-costs-fraud-bedevil-retirement-plans-for-canadians
@Juan: Making a proper assessment of spending is critical here. Many people just look at familiar frequently-occurring costs, but this isn't enough. We need to allow for spreading out big, infrequent costs like new cars, a roof, and health-care expenses. So, even if you decide that you can live on just your pension, you need to be setting aside a few hundred dollars per month to cover big things as they come up unexpectedly.
DeleteSome retirees completely change their lifestyle after retirement.
ReplyDeleteThey move,they travel and do others things they have never done before.
Looking at previous expenses may not help much in those cases.
I suppose they would need to take their best guess as to how much things
will cost.
My "retirement" is basically just life without the day job.
So my expenses were quite predictable.
But even I put some dollars aside for those unexpected events that life as in store.
@Robert: Very true. But I still think your chances of predicting your retirement spending are best when you're close to retirement.
DeleteI expect my own retirement to involve a lot of inexpensive travel visiting family and getting away from Canada's cold.
Hi Michael, can you share your assumptions and math used to arrive at the savings number? Thanks, David.
ReplyDelete@Sustainability Matters: I'll try to list all the assumptions, but they are not central to my point. Whether someone else decides my $1.1M and $2.4M figures are a little high or a little low, the point that substantial savings are needed to spend beyond your pensions remains.
DeleteI treat the spending amounts as after-tax, so I had to take into account income taxes. I used Ontario rates. I assumed Mary and Bill had identical assets. I assumed for the $1.1M case that 90% of assets were in an RRSP and 10% in a TFSA. For the $2.4M case, I assumed their assets were 50% RRSP, 5% TFSA, and 45% non-registered. I also used an investment strategy based on 5 years of spending in GICs and savings accounts with the rest in stocks as described in the following post:
http://www.michaeljamesonmoney.com/2014/01/treating-your-entire-portfolio-like.html
I assumed that before costs, stocks would give a 4% real return and GICs would give a 0% real return. I also assumed that spending would adjust slightly up or down if returns differed from expected levels.