Given that it is the time of year that is coined as RRSP season, I though I would evaluate the concept that most people are inundated with. You know the issues that come to mind when deciding in a rush on how to throw some dollars in an RRSP account just in time. As we are trying to figure out where and how much to put into our RRSP, the same old questions rattle around in people’s heads: How much do I need to save for retirement? Can I save too much for retirement? What if I save to little for retirement? How much can I spend when I am retired?
While this is definitely a more in-depth and detailed subject, I thought I would elaborate on the basic retirement saving and spending principles. Let’s tackle the least obvious one first.
Saving too much for retirement
It seems like every time you turn on the news, they are talking about how Canadians aren’t saving enough for retirement. You hear it so much that, if you’re like many of us, you start to panic. After all, no one wants to end up destitute in their old age.
While it is true that there is a large group of folks who have no savings, there are also some savers who have saved too much money for retirement. While this might not seem like a bad thing, it can be, being one of them can lower your quality of life in your earlier years and hinder when you can actually retire. Here are the main reasons why you may be saving too much and how to figure out what the right amount is to save.
Planning today is too general – One big reason you may be saving too much is that retirement planning has become too generalized. With the advent of online calculators and personal finance software, we’ve found ourselves in a situation where, in an effort to make planning easier, tech providers have built too many assumptions into their technology. Not all assumptions work for all people. Everyone has a different life situation that cannot be easily be packaged into a smartphone app or represented by a few numbers that you input to a calculator.
For example, it’s unlikely that any automated program will be able to accurately predict how much you need of your pre-retirement income – otherwise known as replacement rate – and what the return rates, inflation and consumption will be throughout your retirement years.
Your replacement rate alone can cause you to save much more than you need for retirement. The general rule is to estimate that you will need 80% of your income in retirement. However, it does depend on your income as well as a few other factors. The real range for your replacement rate is between 55% and 90%. If you are planning for 80% and only need 55%, that’s a big amount of money you end up saving that you probably won’t need.
The housing factor – Where you live during retirement is one of the biggest costs you will face. How you plan for and manage this aspect of your life will have a big impact on how much you need to save for retirement. Spending on housing in retirement is extremely difficult to estimate. Most retirees will spend most of their retirement in their own home. If you plan on staying in your home as long as possible, your costs will be lower than if you move to an assisted living facility. This is especially true if your home is paid for and you don’t have rent costs.
The cost of housing usually ranges from 30% to 37%. If you spend $50,000 a year at 30%, you would reduce your costs by about $15,000. When you spread that out across 30 years in retirement, you’ll need to save a lot less money than you had planned.
Saving the right amount – So how do you know if you are saving too much or not enough? The first step is to determine how far from retirement you are. If you are more than 10 years out, it’s likely best to save a generic percentage – preferably 15%. That’s because the further away from retirement you are, the harder it is to get the numbers exactly right.
If you are within 10 years of quitting work for good, you can do some more detailed planning that will shape how much you need to save in the years just before you retire. The easiest starting point is to assume the same standard of living in retirement as in one’s working years. Chances are, most will not spend that much money since they will no longer have to save for retirement, probably pay less in taxes and have certain costs like transportation go down significantly. Don’t just use the 80% of income as a replacement rate. Calculate out how much you spend now, remove expenses that you will no longer have and add in new expenses that will occur in retirement.
Once you have a real estimate on expenses, you can use that to figure out how much you need to save to be able to pay for those expenses.
Then create plans for medical and living expenses. Since this is the biggest unknown in your budget, knowing your options will help you save the right amount. Research Trillium, OHIP (or provincial equivalent), CPP, OAS and long term care insurance, assisted living costs and in-home care costs. Lastly, tally up what you expect to receive from pensions, CPP and possible OAS. The more you have from these resources, the less you will need to save in retirement accounts.
The bottom line – Planning how much you need for retirement is not an easy task. There are many variables, and we typically plan based on generics of these variables. With a little extra time, you can figure out the amount to save that’s right for you. And remember that if it ends up that you’re saving too much, you can retire sooner – or use some of that money right now.
Spending too little in retirement
Financial planners constantly sound the alarm that people are saving too little for retirement. What they rarely talk about are the effects of spending too little. How do you know if you’re underspending in your retirement years?
One likely sign: You’re spending so little that you have a near 100% chance of never running out of money. Nobody is advocating going on an irresponsible spending spree but – unless you truly have millions or are determined to leave a huge estate behind – if you’re that heavily resourced you probably can spend more than you are.
Underspending isn’t necessarily a problem, but if it results in excessive thrift, it can produce some unpleasant and unnecessary side effects. Each of the situations below is a sign that you not only can afford to be more generous with yourself; you probably need to be.
You’re settling for substandard medical care – You can buy generic green beans and maybe a used bicycle, but skimping on medical care isn’t an option. You saved all those years for situations like these so get the best and most appropriate care regardless of cost. Nothing is more valuable than your health and your life.
You have insufficient insurance – Studies show that federal and provincial government usually cover only an average of half your medical expenses. As you age, spending on healthcare will likely become a significant portion of your budget. Paying an extra premium to receive personal health coverage or other supplemental insurance is money well spent. Long term care insurance is another product to investigate, though it would have been better to have bought it when you were in your 50s. Don’t be cheap when it comes to appropriate insurance.
You’re sleeping on a subpar mattress – If you or your spouse have a bad back, shell out a couple of thousand for a better mattress. And that’s only one example. How about a personal trainer to keep you mobile and healthy longer or treating yourself to something you’ve always fantasized about? Continue scrutinizing your expenses, but just because an item is expensive doesn’t necessarily mean buying it will make you run out of money in a few years. If an object or experience can improve your quality of life, write the check if you can afford it. Even if it’s not a necessity.
You live like a recluse – Retirement is supposed to be about visiting friends and grandchildren, traveling, going out to eat – all those activities you couldn’t do when you were working all the time. If you’re not doing the things you love because you’re afraid of spending the money, you might be saving too much. Remember, the earlier you are in retirement, the more likely you’re healthy and able to travel – and still enjoy spicy food and wave-surfing. That may not always be true.
Your savings withdrawal rate is below 4% – Most financial planners agree that the standard withdrawal rate, assuming you’ve adequately saved, is between 4% and 6%. If you’re taking out less than that amount, it’s time to reap the benefits of making disciplined financial decisions for so many years. Spend more. Your planner can assist you with strategies for withdrawing your retirement income.
You never give yourself a raise – Inflation is the great enemy of almost everything, but for a retiree, it’s a friend. Why? Because inflation allows you to give yourself a raise each year. Let’s say you withdrew 4% of your $500,000 the first year and inflation was 3% going into your second year. You can give yourself another $600 in year two. If you’re not, you are able to spend more.
You’re still operating in saving mode – There’s no doubt that our post-retirement world encourages living frugally; you need to ensure you’ve saved enough to retire comfortably. But when you reach retirement, your attitude should move from saving and frugality to reward. Much like finishing a giant project that took a lot of hard work and sacrifice, you’ve reached the time to splurge a little. If you’re still in accumulation mode, it’s time to start living the life you deserve.
The bottom line – Nobody would advise you to spend without good financial sense, and no wise person would tell you how to spend your money. What they will tell you is that one day you will pass away and you can’t take your money with you. You deserve to enjoy the fruits of your labor.
If you want to give money to others, do it now and enjoy their pleasure. If you want to take a trip around the world, get on the plane – and if you want to purchase the car you’ve always dreamed of driving, now is the time. Especially that car; you can’t drive forever. Being too cheap is no wiser financially than spending too much.
Spending too much In retirement
Now that we’ve explored the signs you’re spending too little in retirement, we need to focus on the more prevailing problem: spending too much. For the most part, when the money is gone, you can’t get it back. Of course, that is not the issue when spending too little. How can you tell that you’re spending more than your savings will support? If any of these five signs describe you, it’s time to make some changes.
Don’t know how much your spending – If you don’t have a budget, you’re probably spending too much. A recent study found that 53% of households risk falling more than 10% short of their retirement goal and more than 40% of retirees may run out of money for basic needs. Other statistics show that more than two-thirds of Canadians don’t use a budget.
A budget acts as a roadmap for overall spending during a given week, month, or year. A lot of times we are unaware of how much money we spend in any given month, so a budget really is an accountability tool to make sure we are living within our means. If you don’t follow a disciplined spending plan, start today.
Spending more than 6% of your savings annually – How much you should spend post-retirement depends on many factors, but retirement experts say that depleting more than 4% to 6% of your savings annually is ill-advised. If you have $750,000 saved, a 5% withdrawal rate would give you $37,500 per year plus CPP and OAS benefits. If you want to be safer, go with the traditional guideline of 4%.
Spending too much to service debts – Recent data found that the average retiree is spending about 30% of his or her income on a house payment. That works out to about $13,500 per year, assuming an average income of $45,000. The sad part, that usually is just the house payment.
Financial planners will advise no more than a 36% debt-to-income ratio. Debt hurts you in two ways. First, the interest drives up the cost of the item, and second, you’re using money that could remain invested to service the debt. The more money that remains invested, the more your accounts will continue to grow. This is even more important now that you’re no longer bringing home a salary.
A “cut loose” mindset towards spending – You spent decades working more than full time, supporting a family, paying into your RRSP and CPP and delaying the fun things that come with making a comfortable salary. Now you’ve reached retirement and it’s time to do all those things you’ve always dreamed of doing.
That’s true, but not all at once. Rewarding yourself in the first year by purchasing a Corvette, going on an around-the-world vacation, and purchasing a summer home will give you very few years of comfortable living. Spread those purchases over time if they fit into the budget.
Financial planning in general is focused on the long game. Retirees should not only view the investment process as long term, but they should also make the most of their savings in retirement. Spending down all of your savings in the first few years of retirement is a recipe for complete disaster.
Supporting excess spending with a part-time job – If you didn’t save enough for retirement – or you discover that your desire for adventure is costing more than your budget can support – working to support your spending can fill in the gap. Even a part time job that brings in $15,000 per year allows you to spend a lot more than the confines of your retirement budget may allow. Don’t fall into the trap of spending without a plan to augment your retirement income if you find yourself falling short.
The bottom line – It’s true that your thinking should change from amassing money to using it once you retire. But you need to create a transition plan. Your money may have to last 30 years or more – you probably hope you need it that long. Just keep in mind that over time, as your healthcare requirements rise, you may naturally spend more. Be sure you leave yourself enough of a cushion.
This whole subject matter can send people for quite a tizzy. Planning, saving and spending too little or too much, especially when you are talking about a life event that may not occur for another 20-30 years is difficult to grasp and contain. The essential point is that this is the key core in financial life planning where we attempt to optimize your goals, life’s eventualities, and your financial resources to the best we can. The adage is that the only constant in life is change. I guess the other constant could be to work with a financial life planner. So, it’s not an absolute science. But it is part of Keeping Life Current.
