Hello everyone, and welcome to the Retiring Canada Podcast!
In today’s episode, we’re diving into the crucial topic of estimating your expected retirement income.
We’ll cover:
1. The average income replacement rate for those entering retirement.
2. Three common reasons your income needs might increase or decrease in retirement.
3. Four key tenets to guide a 30+ year retirement income plan.
4. How to intertwine your retirement income plan with an investment and tax strategy.
5. Where to start when formulating a retirement income plan.
6. A few actionable steps to consider as you move forward.
Today, we’re chatting about how to estimate your retirement income needs. I’ll be referencing an academic study by Marlena Lee titled *“The Retirement Income Equation – Understanding How to Arrive at a Target Replacement Rate.”* If you’d like to delve deeper into the technical details, I’ve included a link to the study in the episode description.
For those of you within 5-10 years of retirement, understanding your expected spending in retirement is incredibly important. Developing this estimate will help you finalize a realistic retirement date, identify any additional investments needed to reach your goals, map out those first few years of retirement spending, and uncover potential gaps in your retirement plan.
As a Certified Financial Planner, knowing this number is essential for creating a baseline financial plan. We then stress-test that plan against various factors like savings rates, inflation, and the impact of a deep market correction on your retirement funding.
However, the most challenging part of this process is predicting what you’ll spend in a retirement that could last over 30 years. We can’t foresee the future, and attempting to predict what those decades might look like is difficult. That’s why we developed the Fundamental Retirement Plan process—to provide clarity and vision for what the future may hold.
So, the big question: How much income in retirement is enough?
For most people, the replacement rate ranges between 58% and 82% of pre-retirement income.
For example, if your household’s pre-tax income is $10,000 per month, your retirement income need could vary from $5,800 to $8,200. However, this wide range doesn’t necessarily narrow down what makes sense for your household.
Replacement rates vary because every household is unique. Higher-income households, in particular, tend to have lower replacement rates since they often reduce spending in retirement and benefit from lower tax rates.
When thinking about your future retirement income, start by considering your current pre-retirement income—the income you generate while working. If your current monthly household income is $15,000 and you aim to replace this fully in retirement, you’re looking at a 100% replacement rate.
Common sense tells us most people replace less than 100% of their pre-retirement income. While working, your income typically goes toward three things: taxes, savings, and spending. However, in retirement, taxes generally decrease, and you no longer need to save for retirement.
For example, if your savings rate is 10% and your tax rate is 30% while working but drops to 20% in retirement, you’d need an 80% replacement rate to maintain the same level of spending.
So, if your pre-retirement income is $15,000 per month, you’d need $12,000 in pre-tax retirement income to maintain your standard of living.
Every household is unique, so there’s no one-size-fits-all percentage. Let’s drill down on some other factors—beyond savings rates and taxes—that can impact your replacement percentage.
One significant factor is whether you’ve paid off your debts before retirement. Eliminating this liability is crucial for long-term retirement success. If you’ve paid off your mortgage, for instance, your replacement percentage could drop significantly.
For others, spending might remain level or even increase in the early years of retirement, especially if you want to enjoy your health and travel as much as possible.
On the other hand, you might find that you can maintain your standard of living on less, which would decrease your replacement rate.
Step two of our process helps refine this replacement percentage, as there’s never a black-and-white answer.
We believe this number should be guided by four key tenets to ensure it’s sustainable for 30+ years:
1. Live off multiple streams of income. This could include investment income, CPP and OAS, rental income, and proceeds from property or business sales. Understanding the full picture will help determine a sustainable withdrawal rate to maintain your standard of living. (Check out Episode 22 for more on this concept.)
2. Primarily live off the investment income produced by your principal investments. If you need to draw down on your principal, it’s crucial to create a retirement income plan that offers a clear view of the future. It’s better to adjust today than to be blindsided 10 years into retirement.
3. Ensure your income increases with inflation throughout retirement. Over a 30-year retirement, inflation’s impact can’t be understated. For example, if your pretax replacement rate is $12,000 per month, indexing that at 2.5% for inflation means you’d need $25,000 per month to maintain the same standard of living by the end of retirement.
4. Make your income as tax-efficient and tax-free as possible. Every pre-tax dollar used in retirement comes with a tax bill, and at some point, that bill must be paid. By using a strategic approach and targeting specific tax brackets and areas of the tax code, we can often save you substantial amounts in taxes—potentially hundreds of thousands of dollars, depending on the size and composition of your overall portfolio.
That’s essentially found money that can address many other retirement questions and issues, either now or later down the road.
Going back to our example, if your average household tax rate in retirement is 25% instead of 20%, you’d need to draw an additional $750 per month from your investments to maintain your replacement rate. More money withdrawn each month means less growth, less flexibility, and more risk to your ability to stay retired.
Proper income planning is deeply intertwined with your investment and tax strategies—two key steps in our Fundamental Retirement Plan process. These plans provide visibility into the future, helping you refine a sustainable retirement income.
This visibility allows you to understand how today’s decisions will impact your future.
When done correctly, income planning gives you the confidence that you’re making sound decisions.
To get started, I encourage you to map out a budget and review your current spending, taxes, and savings. Are there any large expenses, like a mortgage or helping the kids, that will disappear in retirement? What about travel or renovations? These could increase your spending and drive up your replacement rate in the early years of retirement.
For more on budgeting, listen to Episode 11, where I discuss some options to help you drill down on this number.
Remember, your spending is one of the few financial aspects you can control today and in retirement. Factors like inflation, markets, and interest rates are beyond your control, but your spending can be adjusted to help ensure you stay retired.
Alright, that’s it for today’s episode!
Two action items to take away:
1. Revisit Episodes 11 and 22 of the podcast for deeper dives into budgeting and creating a sustainable retirement.
2. If you need guidance in refining your replacement rate, visit our website, fundamentwealth.ca, to learn more about our Fundamental Retirement Plan process.
For the links and resources discussed today, check out the show notes or visit retiringcanada.ca.
If you enjoyed the show, please subscribe and leave us a 5-star review on your favorite podcast app. And don’t forget to sign up for my weekly Retiring Canada newsletter.
And hey, when it comes to your retirement, don’t leave things to chance.
Make a plan so YOU can retire with confidence.
“The Retirement Income Equation” Credit: Marlena Lee PhD
All comments are of a general nature and should not be relied upon as individual advice. The views and opinions expressed in this commentary may not necessarily reflect those of Harbourfront Wealth Management. While every attempt is made to ensure accuracy, facts and figures are not guaranteed, the content is not intended to be a substitute for professional investing or tax advice. Please seek advice from your accountant regarding anything raised in the content of the podcast regarding your Individual tax situation. Always seek the advice of your financial advisor or other qualified financial service provider with any questions you may have regarding your investment planning.
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