The 4% Rule Is Too Low!

The 4% Rule Is Too Low!

The “4% Rule” is a common rule in personal finance. It’s a basic rule of thumb that suggests you can withdraw 4% from a well diversified portfolio and have a reasonably high chance of having money left over in 30-years.

Like any personal finance rule, it’s a bit of an oversimplification of a rule that contains many nuances. This rule is based on a famous study called “The Trinity Study”. That study was built on top of the work of Bill Bengen who used historical stock/bond/inflation rates to determine that a retiree can withdraw 4% of their initial portfolio value, adjusted for inflation each year, and have a reasonably high chance of success.

This is an amazing piece of work and has enabled many individuals to formulate their own retirement plans. But for Canadians it might be too low & too pessimistic.

When using the 4% rule it’s important to remember that “success” in the Trinity Study and in Bengen’s analysis means that there is at least $1 left after 30-years. It does not mean that investment principal will be left untouched. It’s very possible that a retiree could end up with just $1 in their account after 30-years and that would be considered success.

The nice thing about the 4% rule is that it’s pretty easy to find your target “retirement number”. All you have to do is estimate your annual retirement spending (including tax!) and multiplying by 25. If I wanted to retire with $50k/year before tax, according to the 4 percent rule, I would need $1,250,000 (25x $50,000/year)

The issue with the 4% withdrawal rule is that for Canadians it’s too low, it’s too pessimistic, and it leads people to forget about other types of retirement income and perhaps save too much. If you’re retiring in your 50’s to early 60’s then you could start withdrawing at a higher rate and still be successful.

(Disclaimer: Everyone’s situation is different. What works for one retiree may not work for another. Make sure to review your retirement plans with an advice-only financial planner to ensure your plan is successful)

Retirees in their 50’s or early 60’s will be eligible for two large government benefits just a few years after retirement. CPP and OAS can easily provide 25%+ of a retirees annual spending. Ignoring these benefits will mean you might save too much! Aiming for a portfolio that is 25x your annual spending is overkill because it doesn’t take into account these large government benefits.

For many retirees in their 50’s and early 60’s they can withdrawal MORE than 4% from their portfolio at the beginning of retirement. This is because a few years down the road they’ll be eligible for CPP and OAS. Once these benefits kick in their withdrawal rate will be much, much lower.

But, the earlier you retire the closer to the 4 percent withdrawal rate you need to be. Retiring early means you need to have closer to 25x your annual spending to bridge the gap between early retirement and government benefits. Bridging a 5-year gap between age 55, when retirement starts, and age 60, the earliest CPP can begin, is much different than retiring at 45 and waiting 15+ years for CPP.

Not only does retiring early create a larger gap between your retirement date and CPP/OAS but there are other risks too. One of the biggest risks is a change to OAS.

OAS is funded through government revenue. This means it’s not guaranteed the same way CPP is guaranteed. In fact, we’ve already seen OAS change twice in the last decade. OAS briefly went from age 65 to age 67 and then back again. This didn’t affect people who were already 55 but for those 55 and under they saw their earliest OAS date pushed later and later.

Still, for anyone in their early 50’s to early 60’s it’s reasonable to assume CPP and OAS will be available in its current form (but nothing is 100% guaranteed!)

Let’s look at two scenarios, one where retirement starts at age 55 and the initial withdrawal rate is above the “4% safe withdrawal rate”, and a second scenario where retirement starts at age 45 with the same withdrawal rate. For each scenario we’ll look at the success rate (how likely it is that we won’t run out of money before age 100).

Retirement Planning: Tax Strategies For Retirement

Retirement Planning: Tax Strategies For Retirement

Taxes and benefit claw backs are one of the largest expenses that a retiree will face. But with some careful planning we can minimize the impact of these expenses in retirement. Minimizing taxes and benefit claw backs will mean that a retiree can retire on less, spend more in retirement, and have a more secure retirement.

The median income for a retiree is around $36,050 for an individual and $64,800 for a couple but each source of income is taxed very differently. Even with the same income, one retiree could pay way more tax than another retiree even with the exact same income.

When it comes to retirement planning there are a couple of important strategies that we always want to follow. We always want to aim for 50/50 income splitting in retirement and we always want to be very careful about the types/amounts of retirement income when a retiree is eligible for GIS.

When planning tax strategies for retirement we always want to look at the marginal effective tax rate, not just income tax rates. Marginal effective tax rate (METR) is the combination of income tax rates and government benefit claw back rates. METR is the combined impact of tax & benefits on the next $1 of income.

METR is the most important factor to consider when creating tax strategies for retirement. At the end of this post we’ll look at marginal effective tax rate for a couple of specific retirement scenarios.

The Biggest Risk In Retirement Is… Sequence Of Returns Risk

The Biggest Risk In Retirement Is… Sequence Of Returns Risk

There are a lot of risks that we face in retirement (including early retirement). When you enter retirement, there are lots of changes happening all at once. Along with big personal changes, and lifestyle changes, there are also big changes happening to your finances. After you enter retirement one of the biggest financial changes you’ll face is a shift from a regular income source (eg. employment) to an income source based entirely on your own savings and pension. Making this switch can create a few risks, one of those risks is the risk of running out of money.

One of the biggest risks facing retirees is something called sequence of returns risk. When a good portion of your retirement income comes from your own savings this is the biggest risk a retiree can face. But what does “sequence of returns risk” mean exactly?

Before we talk about sequence of returns risk it’s important to understand that most retirement plans are based on an assumed (and constant) investment return each year. This investment return is usually assumed to happen in a straight line with the same percentage return each year. An assumed return of return of 5% would be 5% per year starting on the day you retire, but in reality your investment return is going to fluctuate from year to year, and this is where the risk comes from.

Over the short-term you will probably see your investment return fluctuate greatly from year to year. Instead of seeing investment returns of +5%, +5%, +5%, +5%, +5%, you might see +20%, +2%, -10%, +15%, +1%. In this case the average return is still +5%, but there were some huge swings from year to year. “Sequence of returns risk” refers to this sequence, the actual investment returns you see year after year.

The big risk for retirees happens when the sequence is negative for a few years in a row. Even if average investment returns recover over the long-term, that short period of negative returns can have a devastating effect on a retiree’s portfolio.

10 Day Routine To Kick Start Your Finances This New Year

10 Day Routine To Kick Start Your Finances This New Year

It’s the new year! Time to kick start your finances!

This ten day routine will help you shift your finances into high gear. This routine is aggressive, ambitious, and a bit challenging. This routine will cover all the basics of a good financial routine. Having a routine for your money is one of the best ways to improve your finances this year.

If ten days seems like too much (and it probably is!) then consider spreading these steps over ten weeks or even ten months to make things a bit easier. The key is to find a pace that works for you. It’s better to take a bit more time if it means you’ll stick to your new routine.

If it seems daunting then consider pairing up with a friend, co-worker, or getting the help of a financial coach. At PlanEasy we offer custom financial coaching & advice for our clients. As a new client, we’ll create a 12-month program tailored specifically to you and your goals. If you struggle with your financial routine then a bit of coaching & advice might be exactly what you need to improve your finances this year.

Best Time To Plan For Retirement? Age 70? 65? 60? 55? 50? 45?

Best Time To Plan For Retirement? Age 70? 65? 60? 55? 50? 45?

There is never a bad time to start saving for retirement, but when is the BEST time to start planning? We’ve been told to start saving & investing for retirement from a very young age, the earlier the better, but when do you actually start planning for retirement itself? When do you start to think about income, expenses, taxes and government benefits during your retirement years?

Retirement can be very complex. When you reach retirement it’s pretty easy to have 6-10 different income sources, all with different tax treatments and claw back rules. One income source can be tax free while the other is fully taxed. Some retirement income is counted when calculating government benefit claw backs while others aren’t. These rules can make it difficult to estimate how much you can expect in retirement.

Retirees usually have their own source of retirement income from TFSAs, RRSPs, LIRAs, RRIFs, and non-registered accounts. Plus, they have government retirement programs like CPP, OAS and GIS. Then there are government benefits like the GST/HST credit and other senior’s benefits. And on top of that there are defined benefit pensions and annuities too.

With all these different income sources, it can get a little confusing. It can be difficult to know exactly how much can you expect in retirement income, how much will be lost to taxes, and how that matches up with retirement expenses.

As you get closer to retirement it can be extremely helpful to have a retirement plan in place. A plan that integrates all these different sources of income, calculates taxes and government benefits, and ensures you can reach your retirement spending goals. But can you reach a point where it’s too late to plan for retirement?

When is the best time to plan for retirement?

What Is Financial Independence Retire Early aka FIRE?

What Is Financial Independence Retire Early aka FIRE?

You may have noticed a new term starting to creep into the mainstream financial media, that term is FIRE, and you might be wondering, “What the heck is FIRE? And how is it related to personal finances?”.

FIRE is an acronym that stands for Financial Independence/Retire Early. The basic idea is that if you pursue FIRE you can eventually stop working for money. You can be financially independent. You can do anything, retire early, keep working, volunteer, basically you can have more freedom.

The idea is that with enough savings/investments you’ll eventually reach the point where you can live off your investment income indefinitely. Once you reach this point you’re considered financially independent, you no longer NEED to work for an income, and can retire to a life of leisure (although you may choose to continue to work, change roles/professions, start a business, or volunteer).

While the concept of early retirement sounds amazing, it does take quite a bit of focus and determination to get there. To reach FIRE it requires a high savings rate, very high. The typical financial advice given to the public is to save and investment approximately 20% of your net income (part of the simple 50/30/20 budget). But to reach financial independence retire early you need to save more, much more. To reach FIRE you need to have a savings rate somewhere in the 30%-70%+ range. The higher your savings rate the faster you can stop working for money.

FIRE is made easier with an above average income. With a high-income basic expenses are covered and it becomes more about managing lifestyle inflation. People who pursue FIRE limit their lifestyle inflation to maintain a high savings rate.

FIRE is also possible with a below average income, but requires a lot of creativity to reduce basic expenses. This may include house hacking, avoiding car ownership, and more extreme lifestyles. To reach financial independence retire early with a low-income you need to live an alternative lifestyle.

Reaching FIRE is one of those extreme personal finance goals, it’s a goal that isn’t for everyone.

Even though the end goal sounds appealing it requires a lot of hard work and dedication along the way. Reaching financial independence retire early means living way below your means for the rest of your life. It’s a lifestyle more than it is an end goal. It’s a lifestyle with a lot of freedom, but it’s also a lifestyle that requires a lot of control.

If you’re able to control your spending, and save a large % of your income, then reaching financial independence might only be a few years away.

To find out roughly how far away from FIRE you are you can download our FIRE calculator. It’ll help you estimate how many years from FIRE you are based on your net-income, current expenses, and existing savings.

We’ve used our FIRE calculator to create four examples of how to reach FIRE.

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