One of the most important aspects of your retirement plan is knowing how much you plan to spend during your retirement years. Knowing exactly what spending looks like in retirement is one of the most important (and sometimes the hardest to determine) parts of a retirement plan. Even small changes in spending can have a big impact on the success of a retirement plan, so making a good retirement budget is critical.
Depending on your level of spending, that last $10,000 in spending could incur marginal tax rates of 30-40%+. For example, going from $70,000 to $80,000 per year in spending will incur a high marginal tax rate on that extra spending. If we’re using RRSPs to fund part of retirement then we’d need to make pre-tax withdrawals of $14,286 to $16,667 just to support that last $10,000 in spending.
If there was no tax we could support that last $10,000 in spending with financial assets of around $250,000 (this varies from situation to situation but for simplicity we’ll assume a 4% safe withdrawal rate). But to support the taxes on those withdrawals we need much more. To support that last $10,000 in spending we need between $357,142 and $416,667 in registered assets!
This is why getting your spending assumptions right is very important when building a retirement plan.
This is where guidelines like the 70% rule can be very dangerous. It might be ok to use these rules of thumb when you’re 20-30 years away from retirement but when you’re 5-15 years away from your retirement date they can be very misleading.
To create a solid retirement plan we want to build a detailed retirement budget. We want a budget that is built from the ground up, category by category, and is based on facts. It’s more accurate to say how much you’ll spend in each category and then add it up versus using a general guideline like the 70% rule. Plus, it provides a great opportunity to review your spending and ensure it aligns with your values and goals.
There are a few key considerations when building a retirement budget.
Splitting income is an interesting tax planning opportunity for couples. Because we’re taxed individually on our income it can be advantageous to split income and reduce the overall income tax bill for the household.
The goal of income splitting is to perfectly split the household income and the corresponding tax bill. Splitting income 50/50 is the ideal way to minimize the household’s income tax. However, the CRA doesn’t like this, and there are lots of rules in place to prevent income splitting in certain situations.
Income attribution is what happens when you split income that you shouldn’t have. Even if you didn’t earn that income it can still be attributed back to you and needs to be captured on your annual tax return.
For example, if the higher-income spouse gives the lower income spouse $10,000 to invest, any income earned on that investment is attributed back to the higher income spouse, even if it doesn’t get paid into their account and/or they don’t receive a T5/T3 tax slip.
Income attribution is a huge deal. It requires people to properly report their income. The onus is on the couple to split their income properly. If a household doesn’t properly split their income, and they fail to report income attribution, it can come back later in the form of an audit and/or fines & penalties.
The goal with income splitting is to avoid these attribution rules and legally split income to the extent it’s possible.
Income splitting isn’t for everyone but many people can benefit from at least some basic income splitting.
The Canada Pension Plan is expanding this year and that’s going to make retirement easier in the future. This expansion is part of a multi year effort to increase the size of CPP payouts in the future. The increased CPP benefits will make retirement easier for many people. It will mean less personal savings are needed for retirement and if you continue to save at the same rate as today you might actually be saving too much!
CPP is one of the best pension funds in the world. Actuaries have stated that CPP is solvent for 75+ years. That means anyone contributing to CPP now has very little to worry about when it comes to future CPP payments.
Despite Canada Pension Plan being one of the best pension in the world I still come across comments from people who are negative about CPP and OAS. They prefer not to count these retirement pensions in their financial plans. Instead they prefer to save more for retirement.
While I understand the desire to be prudent, this line of thinking makes things more difficult than they need to be. Retirement pensions like CPP and OAS provide an enormous amount of retirement income and ignoring them just means you have to save more.
Ignoring CPP and OAS is like running in a windstorm with a parachute tied to your back!
Why add that extra resistance when it’s already hard enough to save for retirement?!?
The good news for many people is that CPP enhancement will now fund even more of their retirement. Future CPP payments will make up an even higher % of retirement income. Before CPP reform the original goal for CPP was to cover 25% of earnings (up to the max) but with CPP enhancement the goal is to increase this to cover 33% of earnings (with a higher max too!). The result is that CPP payments will be up to 50% higher in the future!
This expansion will happen in two phases and the impact on your financial future will depend on how much you’re earning today and how long you’ll contribute under the new rules.
Unfortunately, if you’re retiring this year you won’t see much of an increase. But if you’re retiring in the next 5, 10, 20+ years you’ll likely see your CPP payments increase anywhere from $1.44/month up to $500+/month depending on timing and contributions! That’s an extra $6,000+ per year at age 65 or $8,500+ per year if delayed to age 70! And double that for couples!
The new Canada Pension Plan expansion won’t impact everyone equally, some people will gain more than others. Let’s look at the two phases of the expansion and how it will impact us.
What does it take to become a millionaire? Surprisingly, not much, as long as you follow certain principles…
There’s something alluring about being a millionaire. Becoming a millionaire is not a traditional financial planning goal. There’s absolutely no reason to aim for a round $1,000,000. In fact, $1,000,000 might be too much! But there’s something appealing about it, alluring even. It could be the simplicity. It could be the many references to millionaires in movies, tv, music and social media. I have to admit, there’s just something interesting about having a 7-figure net worth.
Becoming a millionaire isn’t too difficult, if you start early enough and follow some basic principles. It’s a formula that’s been proven to work time and again.
So, what does it take to become a millionaire household in Canada? About 11.1%.
By using the right accounts, you can invest your way to $1,000,000 pretty easily, all it takes is time and discipline. The average household income in Canada is around $94,833 per year based on research by Statistics Canada and adjusted for inflation. That means to become a millionaire household by the time you hit retirement at age 65 you need to save about 11.1% per year. That’s it.
If you can save 11.1% of your gross household income from age 25 to age 65 you have a good chance of becoming a millionaire. And this is a million in today’s dollars. With inflation, you’ll actually have over $1.6M in future dollars.
This might be a bit lower during the beginning of your career when your income is lower, and it might be a bit higher later on when your income is higher. But by saving 11.1% of your income per year you should have a reasonably good chance of becoming a millionaire!
The key is to start early, be consistent, avoid unnecessary fees, and avoid the many mistakes investors tend to make.
Everyone is talking about investment fees these days. There are ads on the radio, television, and online… there are podcasts, websites, blogs dedicated to low-fee investing… there are also books, magazines and research studies… all focused on one thing… how much the average investor pays in fees while saving for retirement.
But very few people are talking about the effect investment fees have on retirement itself. Mostly they talk about how fees impact you as you save for retirement, but very few mentions what happens if you continue to pay high fees as you enter retirement.
Fees definitely have an enormous impact on how much you can save for retirement. The average mutual fund fee is 2.35% in Canada, and that’s the average, there are lots of situations where the fee is even higher. The effect of this fee on a lifetime of savings and investments is enormous!
But what if you’re close to retirement? What is the impact then? Arguably the effect of investment fees on retirement planning is even greater than any other period.
Fees have an enormous effect on retirement planning because by the time we’ve reached retirement we’ve already saved up a huge nest egg. Unlike the accumulation phase, where you have limited assets in the beginning, when it comes to retirement, you’re starting with a huge amount of investment assets. This makes the impact of fees enormous, especially in early retirement.
The problem for retirees is that investment fees are hard to spot, hard to find, they’re almost hidden by investment providers, whether that is intentional or not. I’ve seen this on countless investment statements I receive from clients. Based on the statement alone you would NEVER know how much they’re paying in investment fees each year.
This isn’t an isolated issue, it’s a problem that many, many retirees face. Low-fee investing is a relatively new option in Canada. If you were investing 10-20+ years ago there just weren’t as many options to reduce your investment fees.
Many retirees who have high-priced investments are shocked (and somewhat saddened) to learn exactly how much they’re paying each year. It’s not their fault, this information is hard to find and not readily available to investors.
To figure out how much an investor is paying each year usually requires some digging. Mutual fund codes vary by fund and fund class. Sometimes fees can vary by 1% or more for the same mutual fund depending on the class.
But once you know how much you’re truly paying you can start to see the impact it will have on your retirement plans. There are two main effects that high fees can have on retirement, and the impact can be substantial.
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).