How much do you need to retire?
The best way to calculate that number is to create a retirement budget that estimates what you expect to spend on housing, food, travel, medical expenses, entertainment and so on. Once you have that number you can then use a retirement planning calculator to determine what you might need.
It may seem like a daunting task but it really isn’t that difficult. There are a variety of budgeting and retirement planning programs you can use to make it easier. MoneyPages offers the SmartPlanner, a web-based retirement planning software that considers all the variables that go into calculating your retirement assets and income. You can try the free demo version at http://moneypages.ca.
For some reason many people want a quick answer without much thought or effort. We’ll take a stab at that approach using a Canadian who earns an average income.
According to Statcan, the average Canadian family of working age earned about $77,000 after tax or about $38,500 each. http://www.statcan.gc.ca/daily-quotidien/150708/dq150708b-eng.htm. That would require a pre-tax income of about $51,000 per year.
However in retirement some expenses disappear. You are no longer required to contribute to the Canada Pension Plan or make contributions to Employment Insurance. In addition, a retiree who has an income at this level also receives an additional personal tax credit.
When you consider only these two factors the absolute maximum gross income needed at age 65 to equal the same after tax income is about $45,500 per year. There are other factors that can reduce the required amount even more. Dividend income is taxed at a lower rate than interest income and income from a RRIF receives preferential treatment over interest income at these levels.
There are other expenses that may also disappear. For example, if you have been contributing to a retirement savings plan that expense will end upon retirement.
For the purposes of this illustration however, let’s assume that the maximum gross retirement income requirement for the average individual is $45,500 per year.
The same Statcan survey indicated that the average Canadian family of retirement age earned about $52,500 after tax or $26,250 each. That would require a maximum gross income of only $28,500 each.
As you can see, even using the average Canadian income results in a wide range of expected income requirements. But let’s work with these two retirement budgets, a gross income of $45,500 on the high end and a gross income of $28,500 on the low end.
With the budgets now in place, it is time to look at the sources of income. First up is the Canada Pension Plan or CPP.
For a wage earner who makes $51,000 per year and has been in the workforce for 40 years, the maximum annual Canada Pension Plan benefit at age 65 will be $12,000.
The average amount received by new applicants in March 2016 was about $7,700. This can be attributed to three factors. The individual earned an income for less than 40 years, the individual earned less than the yearly maximum pensionable earnings ($54,900 in 2016) and/or the individual began drawing benefits before the age of 65.
Because the average retirement age in Canada is closer to age 63 (http://www5.statcan.gc.ca/cansim/a26?lang=eng&id=2820051), CPP benefits will be reduced if benefits begin at that age. In our example, the wage earner who qualified for $12,000 at age 65 would only qualify for $10,400 at age 63.
The second government benefit available to Canadians is Old Age Security or OAS which is available at age 65. The maximum benefit for those who have been living in Canada since age 18 is about $6,800 per year. If you are retiring at age 63, you will have to set aside an additional $13,000 to compensate for the 2 years that you will not be receiving OAS.
It is time to measure the progress of our calculations. So far we have determined that an average Canadian should have a gross retirement income of somewhere between $28,500 and $45,500 per year. They can also expect to collect about $17,200 per year in government benefits if they begin retirement at age 65.
Those with higher income requirements would still need $28,300 per year in additional income to achieve their goal of $45,500 in gross income. Those with the lower income requirements would need $11,300 in additional income.
The capital needed to create that income requires a little bit of math. The first step is to subtract your anticipated retirement age from 90. The result for someone retiring at age 63 is 90 – 63 = 27.
That number, in this case 27, is then multiplied by the required income to determine the capital (savings) needed.
- For the individual with the higher income requirement, the capital required is $28,300 x 27 = $764,000 + $13,000 for 2 years where OAS is not received = $777,000
- For the individual with the lower income requirement, the capital required is $11,300 x 27 = $305,100 = $13,000 for 2 years where OAS is not received = $318,000
In this example, it is assumed that all income will be taxed as interest income. That is the most conservative assumption because interest is taxed at a higher level than dividends, capital gains or RRIF income.
As you can see, there are a great many variables to consider even with a simple calculation. It begins with determining as accurately as possible what your income needs in retirement will be. You then must choose an age at which you expect retirement to begin and estimate what your government benefits will be. Taxes, rates of return, inflation and other factors are impossible to consider in a simplified approach such as this.
The best way to approach this task is to use a retirement planning software program like the SmartPlanner at http://moneypages.ca. In the end it might also be the easiest approach. If you can’t do that, at least create a back of the napkin plan using an approach like the one we have suggested.