Rob Dawson, a reader in Waterloo, Ont., asks, “Will I have enough money when I retire? I’m in my 50s.” Ian McGugan, The Globe’s Report on Business investment editor says the right ratio of what you earn now compared to what you’ll need in retirement is dependent on how much you make now, how much you spend now, and what your ambitions are for life after work. “The good news,” McGugan says, “is that retirement is likely to be more affordable than you think.” He explains:
Most people find they need a retirement income that is 50 to 75 per cent (called the replacement ratio) of what they made while working. Financial planners will tell you vanishing expenses like mortgages, daycare costs, tuition bills, and RRSP contributions eat up at least a quarter of your income during your working years. Therefore, planners typically recommend a replacement ratio of 75 per cent of your previous income will allow you to live in retirement much as you did while working.
But a 75 per cent replacement ratio is a guess, and one that tends to err on the high side. People who examine the facts on the ground often conclude that middle-income couples can live happily on 50 per cent to 60 per cent of what they were making during their earning years.
For instance, Russell Investments Canada analyzed Statistics Canada’s 2007 Survey of Household Spending and found that, for most retirees, a replacement ratio of 47 per cent of their working income was sufficient to cover the bare essentials, while 60 per cent of pre-retirement income was enough to cover both essentials and “lifestyle” expenses such as travel and dining out.
Focusing on the specifics of your own situation is important. Here are three questions to ask:
1) How much are you saving now? If you’re a single renter who’s never had to sweat a mortgage and is used to spending every penny you make, then buckle up. You’ll notice a painful drop in your standard of living in retirement even if you manage to replace 75 per cent of your working income.
If that describes your situation, consider what you can do to ease your path. That may mean saving more now or finding ways to work after official retirement age.
2) What expenses will vanish in retirement? On the other hand, Mr. and Mrs. Average Canadian often wind up with more spending money in retirement than they had while they were working and raising a family. Their disposable income soars because so many of their expenses disappear.
A financial situation of this type is quite common:
- A couple makes $120,000 a year.
- Taxes consume $20,000 of that.
- Another $10,000 vanishes in child-related expenses.
- A further $25,000 goes to the mortgage.
- Another $10,000 is directed into RRSP savings.
- Work-related expenses — ranging from clothes to lunches to commuting expenses – eat up another $5,000.
Total up all the expenses and the couple are spending only $50,000 on themselves – less than half their gross income. But many of their largest expenses will disappear when their kids graduate, their house is paid off and they start collecting from their RRSPs rather than contributing to them.
If they manage to a achieve a 60 to 70 per cent replacement ratio in retirement, they will find themselves living better in their golden years than they ever did in their working, child-rearing decades.
3) What type of retirement do you want? If you have big ambitions to travel, or buy a vacation property, or join an expensive golf club, you’re going to have to adjust your plans accordingly.
It’s also important to calibrate replacement ratios to reflect your income level.
If you’re not making a lot now, chances are you’re already devoting most of your income to essentials. As a result, you’re not going to have a lot of room to cut spending in retirement and your replacement ratio will be quite high – 70 per cent or more. Keep in mind though that government transfers – Old Age Security, Canada Pension Plan or Quebec Pension Plan, and Guaranteed Income Supplement – should go a long way toward replacing your working income.
On the other hand, people who make exceptionally large incomes can often get by just fine on a smaller replacement ratio. It’s not that difficult for most people to go from a working income of, say, $250,000 to a retirement income of $125,000. (Or, at least, it’s more difficult for the rest of us to feel sorry for them!)
A touch of realism may help here: Statistics Canada calculates that the median senior family had after-tax income of $49,300 in 2011, about half of which came from government transfers.
Despite the widespread anxiety about retirement, a 2010 survey of Canadian retirees by Russell Investments found that 90 per cent rate their financial health as “good”, “very good” or “excellent”. Retirees are generally a happy lot – which suggests that most of us will do just fine, whatever our replacement ratio might be.
Do you have a question about retirement, RRSPs or personal finance in general? Globe columnist Rob Carrick is taking over the Report on Business Twitter account to answer your questions live, on Tuesday, Feb 23rd. Tweet your question with #AskTheGlobe