Outliving Your Retirement Portfolio

The average life expectancy for Canadians these days is over 81 years. While certainly not a bad thing, increasing life expectancies do complicate many traditional ways of calculating retirement plans. With retirement phases now being measured in decades rather than years, many Canadians are rightly concerned that their retirement portfolios will not last as long as they do. Additionally, further concern is being caused by the current investment environment and the fact that much of the burden is shifting from defined benefit pensions to the individual’s shoulders.

So how much do you really need to retire comfortably and how can you make sure your portfolio lasts? The answers to these important questions cannot be fully explained in a short article but here are a few ways to do some initial calculations and help get the conversation started:

4% Rule – This is a very basic method of calculating how much you can withdraw from your portfolio each year without running out. The rule states that you can withdraw 4% of your portfolio in the first year, adjust for inflation each year after that and not run out of money for 25-30 years. So if you have saved up $500,000 in your retirement investments, you can withdraw $20,000 per year and make the money last.

Rule of 20 – Similar to the 4% rule in some ways, this strategy was developed by Russell Investments a couple of years ago. This rule looks at the problem from the other direction and states that for every $1 in retirement income you desire, you will need to have $20 in your investment accounts. So if you think you’ll require $40,000 per year in retirement and you expect to receive $20,000 per year from CPP and OAS, you would require $400,000 saved away to make up the other $20,000 per year. When you compare the above two calculations, you’ll quickly notice that they show very different results ($400K vs $500K required) and this is due to one accounting for inflation and the other one not.

10% Rule – This is a very basic way of trying to decide how much you should be saving now to reach your retirements goals down the road. It simply states that you should be saving 10% of your gross income throughout your entire working life. The 10% figure really only works for those starting out in their early 20’s. If you don’t start saving until a later age, you will need to increase this amount accordingly. If you start at age 25 and earn $1,500 every two weeks (and therefore save $150) and assume a 7% rate of return and a retirement age of 65, you would have just over $800,000 in your nest egg. If you start at age 35 and put away the same amount, you would only have $380,000 after 30 years of saving. In order to reach the same $800,000 amount, you would have to up your bi-weekly contributions to $317, or 21%. This simple rule does not properly take into account age, income levels and future retirement needs so it should be used as a starting point only.

In order to run a proper retirement projection, it’s important to include variables such as market volatility, inflation and the type of taxation that different investment assets can be subject to. No matter how thorough your projections are, the only thing that is guaranteed is that it will be wrong. These projections should be a guideline and should be reviewed on a regular basis with updated figures to see if you’re ahead, behind or close to on track. Your withdrawal rates and other plans may need to be adjusted as required to ensure you stay with your plan.

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