This article was reviewed by Jay Brecknell, CFP®.
Will your retirement savings last? This seems to be the question on everyone’s mind. Nearly half of all Canadians worry they don’t or won’t have enough money saved to last the full length of their retirement. With rising costs of living and inflation, many Canadians are concerned about retirement. It’s not just a concern about having enough in your savings account to survive on but having enough to live out your retirement dreams.
Many Canadians are concerned about spending money on vacations, or even a membership at the local golf club, out of concern their retirement savings won’t be enough in today’s economic climate. Being able to enjoy your retirement is important—and so is ensuring your savings last.
So how much do you need to save, and once retired, how much can you safely withdraw?
While it’s impossible to predict the future, there are tools that give us pretty reliable indications of how much money you will need to retire comfortably and how much can safely be withdrawn. Today, we are going to share some insights and information to help you plan based on the average 30-year retirement.
The 4% Rule
The 4% rule was originally established in 1994 by Bengen, who reviewed data from the past 80 years, and retroactively applied his rule to retirees for every single year between 1926 and 1994 to ensure its accuracy. Assuming a stock-to-bond ratio of 60/40 – 50/50, retirees were able to withdraw 4% of their savings each year, over the course of their 30-year retirement, and not run out of money.
While the 4% rule isn’t perfect, it is widely accepted and used as a good rule of thumb.
As an example of how the 4% rule could be applied: let’s say you want to withdraw $80,000 in your first year of retirement. Based on your calculations, this amount would not only cover your necessary expenses, but also leave room for leisure, travel, and other extraneous expenses. To follow the 4% rule, you would need a total retirement savings of $2 million ($80,000 ÷ 0.04).
In your second year of retirement, you’d adjust your withdrawal amount to account for inflation. For example, if inflation rises by 2%, your withdrawal amount would increase to $81,600 ($80,000 × 1.02). This pattern would continue each year, allowing your income to keep up with the cost of living while adhering to the 4% rule.
Restrictions to the 4% Rule
When Bengen put the 4% rule to the test, it was effective for a 30-year retirement nearly 100% of the time (under the assumptions of stock to bond ratio of 60/40 – 50/50). Still, there are some restrictions and considerations to acknowledge before using the method for your own retirement planning; the biggest of which are taxation and inflation. These two factors often have the biggest impact on retirement plans. The 4% rule is helpful in determining a ballpark figure, but the best financial plan for your retirement is one that is tailored to you and more importantly, one that is reviewed and adjusted annually to account for changes.
Pension Considerations
Since this rule was calculated to determine how much income you can safely withdraw from an investment portfolio, it does not consider other sources of income such as private and public pensions. For instance, the 4% rule does not consider OAS or CPP, which of course, provides an income for retired Canadians.
Another factor for Canadians to consider is which investment vehicle they are withdrawing from, as RRSPs, TFSAs, RRIFS and private investments all have different taxation laws. For instance, the money you withdraw from your TFSA is tax-free, whereas the money you withdraw from your RRSP is subject to tax. While the 4% rule is generally applicable, it is still important to keep this in mind when creating a strategic withdrawal plan with your financial advisor.
Market Fluctuations
Market volatility and fluctuations in inflation and cost of living are difficult to predict. While the 4% rule was calculated taking worst-case scenarios into consideration, safety is a major factor for retirees, and some may feel more comfortable with a reduced withdrawal rate during economic downturns. It is always important to monitor your finances and adjust accordingly. During times of volatility and inflation, you may feel more comfortable with a withdrawal rate of 3-3.5% to air on the side of caution.
Additionally, should your retirement investments take a hit within the first couple of years of your retirement, you may need to speak with your financial advisor to determine a plan to readjust. This may require a change to the withdrawal rate or finding solutions to increase your savings once more.
Be Prepared for Emergencies
Lastly, though the 4% rule was calculated to consider worst-case scenarios regarding the market, it doesn’t account for personal emergencies. Perhaps your adult children need assistance, or your elderly parents require care at your expense, or you or your spouse experience a health situation, or perhaps disaster strikes your home and insurance doesn’t cover you. It is generally our advice to ensure that not only are you prepared with adequate insurance policies, a living will and a will, but that you also have an additional emergency fund saved up and set aside for these unexpected expenses.
Early Retirement
Having been calculated for a 30-year mortgage, the 4% rule is not an accurate predictor of safe withdrawal rates for those managing early retirement. If you have achieved—or are likely to achieve—the dream of early retirement, you will want to speak to your financial advisor about a withdrawal rate that best suits your particular situation.
Will you have enough money?
As financial advisors, we aim to ensure our clients are well-prepared for their retirement. We want you to have the retirement experience you have always imagined—filled with travel, quality time with family and friends, adventure, and relaxation. The last thing we want is for financial instability to put a damper on your retirement, or to be a source of stress.
While the 4% rule provides a good guide, the key to financial planning success is custom, detailed financial plans that are reviewed and updated annually—which is exactly what we do for our clients here at Cedar Rock. As we say, the one constant in life is change, which means finances (at any stage of life), cannot be managed with a “set it and forget it” approach.
Starting your retirement with a healthy savings and investment portfolio is a way to set yourself up for success in your golden years. Some online calculators can give you a general idea of how much money you would need to retire and maintain your desired lifestyle. A good rule of thumb is to multiply your anticipated annual expenses by 25 to 30, to get a rough estimate as to what you would need to save in order to retire. Or use the 4% rule in reverse, dividing your anticipated annual expenses by 4% (or by 3% if you want a larger safety net).
Retirement always brings about a mix of emotions—there’s the excitement of having more free time to spend with family, friends, and on hobbies (new and old). But there’s also a sense of trepidation—change is hard. Add to that growing economic concerns and unrest, and it’s understandable to feel a little hesitant about your retirement and feel uncertain you have saved enough for you and yours to not only survive on but to thrive.
To ensure the money you have worked hard to save lasts your 30-year retirement, we highly recommend meeting with your financial advisor at least once a year to review your finances and ensure you are on a good course.