Perhaps the question we get the most from folks who are trying to plan their retirements is “how much money am I going to need every month in retirement to live on?”. The answer to that question depends on how much money they’re spending today. The challenge is that a lot of people don’t know what their spend rate is and so they don’t know where to start.
The good news is that you don’t necessarily need to track all your spending over a period of 6 months to figure out the monthly income you’ll need in retirement. For most retirement planning cases, there are two main expenses that people have when they’re working that they won’t have when they’re retired. First, there’s the mortgage; being mortgage free at retirement is a goal many people who are still working share, which we feel is very wise. The second expense people have now that they won’t have when their retired is saving for retirement; you won’t be saving into your various accounts when your retired, you’ll be spending from them!
The next figure we need is the after tax monthly income that the household is bringing in. Think of this as the cash-flow that is coming in from which all the expenses need to be paid. In most cases, a household is comprised of 2 individuals. If everyone is making $100,000/yr, their pay cheque would be roughly $2,800/every 2 weeks or $6000/m. So, for this example we’ll work with a total household after tax income of $12,000/m. If their mortgage payments are $2500/m and their saving $2500/m to their RRSPs, then we know that they’re spending $7,000/m on their lifestyle. The formula is very basic:
Household after tax income, less mortgage payments, less retirement savings equals the cost to run the household’s lifestyle today.
The next question is how much of the $7000/m will need to be financed from the investment portfolio. Once again, the answer depends on how much retirement income they can expect from sources that they’re not receiving today. The 2 main pensions available to most Canadians are the Canada Pension Plan (CPP) and the Old Age Security (OAS). For this example, we’ll assume that each person will receive the maximum amount available at age 65: $1,114/m for the CPP and $578/m for the OAS. Therefore, this household would be receiving a total of $3,384/m from Government Pensions from which we need to account for income tax of roughly $120/m for each individual. Based on these figures, this household will be receiving roughly $3,144/m of after tax pension income. We now know that of that $7,000/m required in retirement, they’ll need to finance $3,856/m, which is $7000/m less the $3,144/m, from their investment portfolio.
There are other variables that could throw this analysis a curve ball which need to be accounted for. Maybe there’s a work pension or real estate rental income. Maybe their kids are in the middle of University and they’re paying for their entire education. Perhaps there’s real estate rental income that needs to be dealt with or maybe they won’t be mortgage free at retirement. Maybe there’s debt building every month or maybe there’s cash accumulating. Every case is different and needs special attention, but in the end the most complex retirement planning cases can be worked on using this simple yet effective framework.
Once we know how much money a household will need to draw from their portfolio monthly, we can determine how large their portfolio needs to be to safely finance the required draw. We’ll touch on that in a future post.
Mike Preto and Jason Del Vicario are Investment Advisors at HollisWealth, a division of Scotia Capital Inc. Based in Vancouver, BC, Canada, they work together in bringing a unique approach to managing money to ensure their clients are financially prepared for their retirement. They can be reached at 604-895-3349.
This article was prepared solely by Michael Preto & Jason Del Vicario who are registered representatives of HollisWealth® (a division of Scotia Capital Inc., a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada). The views and opinions, including any recommendations, expressed in this article are those of Mike & Jason’s alone and not those of HollisWealth. ® Registered trademark of The Bank of Nova Scotia, used under license.