This article was reviewed by Jay Brecknell, CFP®.
Early retirement and the promise of more time to do the things you love—travel, hobbies and connecting with friends and family— is becoming an increasingly popular dream. In fact, there is a whole movement called FIRE–Financial Independence, Retire Early–dedicated to helping individuals achieve early retirement. With a clear vision and a solid financial plan to guide you, it is possible.
When looking at early retirement, there are two main challenges to overcome:
- You are shortening the window of time you have to save for retirement
- You are lengthening the time during which you will spend money in retirement
In order to overcome these challenges, you have three options:
- Spend less in order to save more
- Earn more money and put the additional income into savings
- Do both
Most importantly, you need a strategic plan.
Your vision for early retirement
Everyone has a different vision for their retirement—world travel, owning a vacation property, starting a passion project, or something uniquely you. Each of these retirement visions has its own financial needs. There are also lifestyle factors to consider–the kind of home you want to live in, how frequently you want to go out for dinner or see a show, membership fees for various clubs–these all need to be factored into your expenses. By taking the time to let your imagination run wild and think of what your ideal retirement looks like, you can create a practical plan to get you there.
How much money do you need?
With the average life expectancy being 79.9 years for men and 84 for women, even managing “Freedom 55” means you will need to save enough money to ensure your quality of life for around 24.9 – 29 years respectively. Let’s paint a picture: You began working at 18 and now want to retire at 55 (or earlier if you can swing it). That gives you a maximum of 37 years to save for your retirement. The standard for financial plans in Canada, however, is based on a life expectancy of 95 years of age, which means you are in retirement for longer than your working career. You’re going to need a solid retirement savings plan! Here’s how you do it:
Step 1: Get clear about your retirement vision
To determine how much money you will need in retirement, you have to know how much your retirement lifestyle is going to cost.
- Review your anticipated monthly expenditures for necessities: groceries, mortgage payments, vehicle expenses, etc.
- Now, factor in your anticipated monthly budget for discretionary expenses: membership dues, spa visits, travel expenses, etc.
Step 2: Expect the unexpected
When planning for retirement, it is crucial to factor the unexpected into your plan. Some unexpected costs could include:
- Healthcare expenses
- Needing to financially support or assist one of your children
- Inflation
Adding at least 2.5% to your anticipated retirement savings goal, will help keep your dream retirement from being affected by unexpected expenses or inflation.
Step 3: Calculate your financial needs
We advise discussing your unique financial needs and situation with a certified financial planner. However, for the purpose of providing basic insight into what your needs could be, we are going to share two approaches to calculating your financial needs for retirement:
- Multiply your anticipated annual expenditures by 25 to 30. If you anticipate spending $96, 000 per year for example, you would need $2.4 million – $2.88 million in order to retire comfortably.
- Use the “4% rule” to divide your anticipated annual expenses by, you guessed it, 4%. Using our example of $96,000, divided by 0.04, you would need $2.4 million to retire comfortably. To create a larger safety net, divide your annual expense by 3% instead.
Generally speaking, it is anticipated that you will need 70-80% of your current annual income to thrive during retirement.
One last factor that will influence your retirement plan: Your income streams. Does your retirement plan include:
- Starting an income-earning passion project?
- Freelancing (between holidays perhaps)?
- Having a part-time job to stay active?
These additional income streams will impact how much you need to save as well as when you decide to take CPP and OAS (more on that later).
Preparing for early retirement
Preparing for retirement isn’t just about maximizing your savings. Another major financial element is paying off your debt. Entering retirement free of debts–such as car payments, credit cards, loans, and importantly, your mortgage—will help your savings go further.
Another factor to consider is healthcare costs. While we are fortunate in Canada to have Universal Healthcare, we all know that things like dental, eye care and paramedical services like physiotherapy, chiropractic and massage therapy are not covered. There are two options here:
- Purchasing your own extended health coverage, which would need to be factored into your expenses, same as if you decide to pay out of pocket.
- Working part-time for a company that offers health benefits.
Having a plan for how you will ensure your own healthcare needs are met is an important aspect of your retirement planning.
When you want to retire early, the best time to start saving is yesterday, but the second-best time is today. Because you are shortening the length of time you have to save, and thus less time to appreciate the benefits of compound interest, the sooner you can start, the better. Let’s talk about that next.
Investing for retirement
Get your money working for you! The best plan for early retirement is going to be unique to everyone, which is why we strongly advise working with a financial planner. We have decades of experience guiding thousands of people through retirement preparation and decisions. That said, there are a couple recommendations we feel would be applicable to just about everyone.
Maximizing your TFSA and RRSP contributions every year is going to be important for anyone’s retirement, but more so if you are trying to retire early. We have previously written about demystifying stocks and dividends, as well as using your TFSA to invest in stocks, bonds and other options that will increase your return.
Beyond the traditional investing options, we encourage our clients to consider alternative investments, such as real estate, art, commodities, private investments, and collectibles. While these alternatives are less liquid and more long-term investment options, they do offer less volatility (since they are not tied to the stock market) and offer opportunities for greater diversification of your portfolio. Real estate investments may also offer monthly income streams in the form of rent payments, which can offset your cost of living during retirement.
CPP, OAS, and early retirement
When planning to retire early, you have to consider the gap years between when you stop working and when you are eligible to begin receiving CPP and OAS payments. The earliest you can begin collecting CPP is 60 years old, OAS is 65. A good financial plan will account for when is the best time for you to start collecting these government funded pension plans.
During those interim years between when you retire, but are still too young for these government plans, your retirement income will come from these sources:
- Your private pension through your employer (which may be in the form of an RRSP or RPP)
- A registered plan (TFSA or RRSP account)
- Personal savings and investments
The income generated from these sources has to carry you through until you are eligible for CPP and OAS.
Key takeaways
Achieving early retirement is a dream that can be made into reality however it does require ample planning, dedication to the plan, discipline with your finances and savvy investments to get your money working for you. If Freedom 55—or even Freedom 40! —is something you want to make happen, we are up to the challenge of helping you create a solid financial plan, including an investment strategy and debt repayment plan, that can help you make that dream come true.
Additional Reading
- Are Online Retirement Calculators Accurate?
https://cedarrockfinancial.com/articles/are-online-retirement-calculators-accurate/ - Investing in Stocks and Dividends: Demystifying the Market
https://cedarrockfinancial.com/articles/investing-in-stocks-and-dividends-demystifying-the-market/ - Your Guide to TFSAs and Retirement
https://cedarrockfinancial.com/articles/your-guide-to-tfsas-and-retirement/ - Understanding CPP – A Complete Guide to the Canada Pension Plan
https://cedarrockfinancial.com/articles/cpp-guide/ - Navigating Old Age Security (OAS) in Canada
https://cedarrockfinancial.com/articles/navigating-old-age-security-oas-in-canada/ - When to Collect Canada Pension Plan (CPP) and Old Age Security (OAS). Navigating Canadian Retirement, Explained.
https://cedarrockfinancial.com/articles/when-to-start-collecting-canada-pension-plan-cpp-old-age-security-benefits-oas/ - A Guide to Retirement Income Sources
https://cedarrockfinancial.com/articles/a-guide-to-retirement-income-sources/