Though retirement may seem like it’s years away for some of us, life moves pretty fast, and if we don’t set attainable retirement goals, we can put our future selves at risk. That’s why, in our third Financial Literacy Month blog, we’re covering retirement goal setting.
This article is for anybody who is currently working and looking to prepare themselves for retirement. Although it’s tough to fit everything you need to know about retirement goal setting into one blog, we’ll be covering the basics, including:
- The importance of retirement goal setting
- How much you should plan to set aside
- What accounts you’ll need to get started
- How Evermore can help make investing for retirement as easy as possible
Fail to plan = plan to fail
When planning for your retirement, there are many moving parts, no matter how old you are when you start planning. Maybe you’re fresh into your career and you’re deciding how you’d like to start saving on a small scale, or perhaps you’re ten years into your job and you’ve just started a new role with higher pay, prompting you to think about how you can start saving for the future.
So how do we start? Think about the lifestyle you would realistically like to have in the future. Maybe you’re not sure exactly what you want to do, but you know at least you would prefer not to be living under financial hardship. So that is our initial building block, a financial situation that allows you to maintain a comfortable life after you stop working. But how much money will you need?
Before we get into that, we should define two terms:
Saving = Money not spent. This is the money you put aside. Your “savings” can also refer to your nest-egg.
Investing = Putting your savings to work. If you want to grow your savings for the long-term, those savings need to be invested.
How you invest your savings depends specifically on the goals of the savings. An emergency fund can sit in a high-interest savings account, but your retirement savings need to consider the time horizon. Making money decisions based on goals is called “goal-based investing” and you can learn more about that here.
How much should you save?
Although everyone’s retirement plan is different, it’s a good idea to have a general understanding of how much you’ll need to set aside to successfully retire. Understanding what your expenses will be during your retirement years is crucial. If you’re wanting to pick up new hobbies, do some traveling, or continue working on a smaller scale, it’s imperative that your retirement dreams align with what’s feasible for you.
We will need to do a little “back of the napkin” math with an assist from some online tools to come up with an estimate. We’ll work using “today’s dollars”, meaning that we aren’t adjusting for inflation in the future. We can do this for a few reasons: 1) Canada Pension Plan (CPP) and Old Age Security (OAS) programs are indexed to inflation and will grow each year, 2) We can use “real rates of return” for the growth of your investments, which is the return after inflation is considered, and 3) your expenses will also generally increase with inflation.
Step 1: What should your income be in retirement?
There are two approaches to estimating the amount of annual income you’ll need in retirement.
One quick way is to use the “replacement ratio” stated as the percentage of the income you are earning right before you retire. You may have come across “the 70% rule” which states that a good estimate of annual pre-tax income in retirement is about 70% of your income in your near-retirement years. It’s important to remember that this rule-of-thumb comes from US based sources that incorporate the higher cost of healthcare. Canadians on the other hand are more likely to make things work for a lot less, perhaps even as low as 40% to 50%. Remember, we are setting a baseline here and trying to establish a financial plan that fits the threshold to achieving your goals.
The other approach to estimating your annual income requirements in retirement is by listing your expected expenses. Go over your current monthly budget. If you don’t have a household budget, we have a free template linked in this article that will walk you through the process.
Which expense or debt payment items are likely to be different for you in retirement? For instance, will your mortgage be paid off? Children all grown-up and moved away? Will you be downsizing? Once you have an idea of your adjusted expenses in retirement, add in new expenses like travel, activity memberships, and entertainment. Don’t forget to include an estimate for miscellaneous expenses.
Then finally, to consider income taxes, divide your estimated retirement expenses by 1 minus your estimated total tax rate, and this is your pre-tax income requirement.
For example, if your estimated total annual expenses in retirement are $60,000 and your estimated total tax rate is 20%, then $60,000 / (1 - 0.2) = $60,000 / 0.8 = $75,000. You will need $75,000 per year before taxes to meet your $60,000 in expenses.
How does your retirement income compare to your current income? How does your replacement ratio look?
Step 2: How much should your retirement savings be by the time you retire?
Now that you have an idea of how much you’ll need every year, we need to figure out how much you will need to be pulling from your investments for your income.
First, the federal government may provide you with an income stream in retirement through the Canada Pension Plan (CPP) and Old Age Security (OAS) programs to a degree depending on your qualifications. This Government of Canada provides a retirement income calculator to help you understand what you might expect from these programs in retirement. For purposes of this example, let’s suppose that CPP and OAS combine for $20,000 per year in today’s dollars. But again, this will depend on a number of factors
Second, do you have a defined benefit (DB) pension from an employer? How much will be coming from that source? Any other additional sources of income, like a rental property? For purposes of our example, let’s assume you don’t have any additional sources.
So far, we have:
Target Retirement Income = (CPP + OAS) + DB Pension + Other Income + Target Income from Retirement Investments
Using our example numbers:
$75,000 = $20,000 + $0 + $0 + $?
With a little quick math we can see that “$?” equals $55,000. We’ll need to be taking $55,000 per year from your retirement investments.
Now that we know how much we’ll need to be withdrawing from your retirement investments every year, we need to estimate how much your retirement nest egg should be to provide this income. To calculate this, we can use a “Present Value of an Annuity” calculator tool, like this one on Omni Calculator.
This calculator takes the annual income you’ll need, an average annual rate of return you are earning on your investments, and the number of years you’ll be receiving the income to calculate what your nest-egg should be at the start of your retirement.
Enter the income you’ll need in Payment Amount, set your Interest Rate at 4% which is a reasonable real rate of return for a retirement portfolio, and then enter the number of years you’ll live in retirement.
In this example, we used $55,000 as the income from investments requirement, and 30 years for the retirement timeline. This shows us that at the beginning of our retirement, our investment nest egg should be about $950,000.
What does this mean? It means that if you have approximately $950,000 at the start of your retirement, and you have that money in an investment that provides an average 4% return on your money after inflation, that you will be able to withdraw $55,000 per year for 30 years.
But $55,000 times 30 is $1,650,000 so how is this possible? It is because your money is also invested and growing over time. If you just had $950,000 is a savings account that didn’t have a return at all after inflation, you would run out of money before 18 years was up. That’s why money earmarked for long-term goals should be invested.
Step 3: How much should I be saving each year to invest for retirement?
So, how do we make sure we grow our nest egg to the required amount by the time we retire?
First, how much do you already have set aside for retirement?
Let’s use Omni Calculator again to figure out what that could reasonably be expected to be in the future, using the Future Value Calculator. A future value calculator will take a single amount and a rate of return and calculate it’s value in the future.
Let’s say you already have $100,000 saved and you have 25 years to retirement. Using 6% as a reasonable real rate of return on your portfolio, this grows to about $430,000.
So we have to invest enough over the next 20 years to create approximately $950,000 - $430,000 = $520,000 in wealth. So, what do we need to do?
For that, let’s go back to Omni Calculator, this time using the Future Value of an Annuity Calculator. This calculator takes a series of payments (the amount you are putting aside every year), a rate of return, the number of payment periods (in our case, years) to calculate the future value. But we can also use this calculator in reverse by entering the future value first, then entering the rate and period, to arrive at the annual amount we will need to be investing.
Enter $520,000 as your future value, 6% as your interest rate, and 25 years the number of years we have before we retire.
This calculation shows you’ll need to be putting about $9,500 per year into an investment portfolio for the next 25 years to hit your goals.
When you have done these calculations for yourself, you’ll need to align your goals and your capabilities. Can you realistically save the amount you’ll need to every year? What changes can you make to your retirement plan? Lowering expenses? Taking a part-time job? To find a solution that will work for you, you will just need to spend some time to figure out the details yourself or seek advice from an accredited advisor, but don’t let this delay putting money aside in your retirement investment accounts.
What accounts should I use for retirement investing?
Canadians have two primary account types that have been created to help us invest for retirement: The Tax-Free Savings Account (TFSA) and the Registered Retirement Savings Plan (RRSP). If you are unfamiliar with these types of accounts, we’ve extensively covered TFSAs and RRSPs in previous articles. At the end of the day, both types of accounts are excellent vehicles for your retirement nest-egg, so please take a few minutes to read through these articles and familiarize yourself with your options.
How Evermore Retirement ETFs can help you get started
So, how can Evermore help you get started on this journey?
When it comes to “saving”, that’s where you have to do the heavy lifting. Figure out your budget so you can put the right amount of money aside. Once you have saved, it’s time to invest. That’s where we can help.
With our Evermore Retirement ETFs - the first target date ETFs in Canada - Canadians can get started investing for retirement through direct investing accounts at any major Canadian financial institution.
Whether you’re brand new to investing or working with an advisor, our Retirement ETFs are built for RRSP and TFSA accounts. The Evermore Retirement ETFs are explicitly designed for retirement investing, adjusting risk as you approach your retirement and beyond. It’s an easy, low-fee, all-in-one solution for Canadians looking to jumpstart their retirement investing, no matter their prior investing experience, how much they have saved, or how many years they have until retirement. You can learn more about the Evermore Retirement ETFs here.
We understand that investing for retirement can be challenging, but we’re here to help you along the way! Be sure to subscribe to our newsletter to receive helpful and easy to understand information about retirement investing right to your inbox.
The information is intended for educational purposes and calculations used are for illustration only. Nothing herein should be construed as investment or tax advice. Investors should consult their own professional advisor for specific investment advice tailored to their needs and based on the latest available information. Commissions, management fees and expenses all may be associated with exchange traded funds (“ETFs”) investments. Please read the prospectus before investing. ETFs are not guaranteed, their values change frequently, and past performance may not be repeated.