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Rules of Thumb for Retirement Planning - What Are They, When They Are Helpful, and When they are Hurtful Thumbnail

Rules of Thumb for Retirement Planning - What Are They, When They Are Helpful, and When they are Hurtful

Many people work hard for the majority of their life in order to reach a retirement where they can relax, travel and find time to do things that they truly enjoy. Everyone has different goals for retirement, and nobody knows how long they will live, so how much do you need in order to live comfortably during your post-work years?

While every retiree has a different lifestyle and vision for retirement, it may be helpful to note that the average household expenditures for those 65 and older is around $64,461.1

Whatever your goals for retirement may be, there are a couple of helpful guidelines you can follow to better determine how much you may need. This by no means replaces the individualized guidance a financial advisor can offer, but it does give soon-to-be retirees an idea of where to start.

Guideline #1: Four Percent Withdrawal Rate

When utilizing the four percent withdrawal rule, the idea is to build up a retirement portfolio that can provide income annually at a four percent withdrawal rate. 

For example, say you’ve determined you’ll need around $60,000 per year in retirement. Following the four percent rule, you’d want to do some quick math: $60,000/4% = $1,500,000

In order to follow the four percent rule, you’d need around $1,500,000 in savings before you retire.

The idea behind the four percent rule is that your annual withdrawal plus inflation are accounted for in your portfolio’s market returns. This assumption is based on historical market performance, meaning there is never a guarantee of future performance. While this strategy may work for those retiring at a younger age as well, remember that younger retirees may not have access to certain steady streams of income like pensions or other retirement benefits.

Guideline #2: 70 Percent of Your Working Income

Some believe that saving between 70 and 100 percent of your pre-retirement income is a good rule of thumb to follow. The exact percentage will vary based on your financial obligations. For example, if you are no longer paying a mortgage and don’t plan on having one in the future, you may be able to get away with preparing to have less in savings for retirement. 

Following the 70 percent rule, if you earned $100,000 a year before you retired, you’d want to prepare to live on around $70,000 annually in retirement.  Using the 4% rule above, you would need $1,750,000 saved up for retirement.

When Rules of Thumb Break Down

Rules of thumb can also be misleading for some people - here are some scenarios:

1) Other Income Sources In Retirement - You may have income from Canada Pension Plan (CPP/OAS), a company pension plan, passive income, or part time working income.  These income sources will reduce the amount that you need to have saved in investment portfolios

2) Your income needs may change as your retirement progresses - You may see your spending levels change as your retirement progresses.  The popular adage of the "go-go years vs. the slow-go years vs. the no-go years" comes to mind.  David Blanchett wrote an article(2) that looked at spending patterns of retirees as their retirements progressed.  He observed an initial spending pattern  that went up in the early years of retirement, dipped in the middle portion of retirement, and then increased again in the latter portion of retirement.  He termed this the "retirement income smile".  It's possible that your spending won't necessarily go down as your retirement progresses, but to assume that it will stay exactly the same throughout may be worth re-examining.  

3) You may have more tools in the toolkit than you think - if you own your home in retirement, you may have more options for creating cash flow as you age.  Your home equity can be turned into cashflow via a line of credit or reverse mortgage(3).  I believe these should be viewed as "last resort" options vs. looking at them as primary options for retirees.  But, they are part of your wealth plan nonetheless and should not be ignored.

When it comes to your retirement, it’s crucial that you are diligent in your planning so that you can live out your final chapter the way that you deserve. If you are used to living a particular lifestyle and want to continue doing it once you are no longer working, planning ahead and working with a knowledgeable advisor is imperative.

  1. https://www150.statcan.gc.ca/t1/tbl1/en/cv.action?pid=1110022701
  2. https://retirementresearcher.com/retirement-spending-smile/
  3. https://www.moneysense.ca/save/retirement/how-does-reverse-mortgage-work/

This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.