It’s the most important question when it comes to your investments and your lifestyle. After all, you work hard your whole life so that one day you can reach that proverbial light at the end of the tunnel and spend the rest of your days enjoying the freedom of spending your time however you’d like. It’s a nice goal, and it’s not out of reach, but you have to know what it’s going to take to get there and contribute accordingly along the way.
At Invisor, we’re launching a financial planning tool to help simplify the process so that your retirement goal is less of a black box and more of a clear target. The math can be a bit much, but if you’re comfortable with a calculator, you can follow the same steps we use to get a simple and clear picture of what you’ll need in retirement. Here are the steps we follow to build out your goal.
Step 1 – How much income in today’s dollars would you need in retirement?
We use a rough estimate of 60% of your income today, but that varies from person to person. An easy way to figure this out is to take your current income, and subtract: any mortgage payments (if you think your house will be paid off); any child related expenses (hopefully they move out by then!); and any amount you put towards savings. You'll also want to add in any additional travel and medical expenses. What you’re left with is the amount you currently put towards living expenses.
|Child Care Expenses||-$6,000|
|Travel & Medical||+$4,000|
|Require for Living Expenses||$36,000|
Now that you know what you need, you can subtract that number from the amount you expect to receive from other sources, like a pension or the CPP. The average Canadian CPP this year is $7,974, but the maximum amount is $13,110. You can use this calculator to find out how much you could receive, but let’s say for argument’s sake, you expect other sources to cover $11,000 per year. This means you’re left with $25,000 that you’ll need to withdraw from investments per year.
|Required for Living||$36,000|
|Pension or CPP||-$11,000|
|Require from Investments||$25,000|
Step 2 – How much do you need to save to receive your required income from investments?
The first thing you should think about is when you want to retire. Canadian’s typically retire at 65. If you want to work a bit longer, your goal will be lower, and if you’re planning on retiring earlier, your goal will be higher.
Next, how long will you need the income for? The average life expectancy in Canada is 80 years old, but we like to plan for a longer life to be safe, so we set our target to 90. Pick a number you feel most comfortable with.
Now the math. What does $25,000 today look like when you’re 65? If you’re 40 today, then you need to know what that looks like in 25 years. Assuming inflation of 2%, the calculation is 25,000 x 1.0225 = $41,015.
More math. This calculation is best done with a financial calculator, like this one. You need to enter the number of periods (25 = 90-65), the payment or PMT ($41,015) and the growth rate (rate of return – inflation: we’ll use 3% = 5% - 2%). With this calculation, we’ll need about $740,000 in retirement.
Step 3 – How much do you need to save to reach that target when you retire?
The final step is figuring out how much money you need to put aside each year. Start by estimating how much your money will grow annually. This depends on your risk preferences, but on average we use about 6%.
Do you have any investments to start with? We’ll use $50,000 for our example.
Use another financial calculator. The future value is $740,000, number of years is 25 (65-40), starting amount is $50,000, and growth rate is 6%. The resulting target per year is about $9,500.
If your target seems out of reach there are a few things you can do:
- Review your risk preferences – allowing for more risk usually means higher return. With a long term goal like retirement you can afford more day to day fluctuations if it increases your chances for higher return.
- Decrease your target income or increase your retirement age.
- Lower your investment costs. This is the simplest and most effective way to increase your rate of return.
We know the math can be overwhelming, and thinking about all the factors that affect how much you’ll need and have in retirement can get confusing, so we’ve designed these tools to be as intuitive and easy to use as possible. Not only that, the dashboard will act as your GPS to help you stay on track towards your goals. Check back soon for our release of the financial planning tools. Or, if you just can’t wait for our latest release, you can always schedule a call with one of our advisors and we will walk you through it.