Outliving your retirement portfolio

The average life expectancy for a Canadian is just over 82 years. For those that make it to age 65, your updated life expectancy is around age 85.

While it’s nice to see lifespans continually increasing, longer 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 forward investment growth projections and the fact that much of the burden is shifting from defined benefit pensions to the individual’s shoulders. The latest projection assumption guidelines recently released by FP Canada call for a balanced portfolio to earn 3.74 per cent per year on average.

These assumption guidelines are intended to be used for long term retirement planning being done today and 3.74 per cent is likely a fair bit lower than the rates of returns being used in many retirement plans.

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 four per cent of your portfolio in the first year, adjust for inflation each year after that and not run out of money.

So, if you have saved up $500,000 in your retirement investments, you can withdraw $20,000 per year and make the money last as long as you do. However, many people lately have been saying that the four per cent amount is likely too high and should be lowered further due to people living longer and interest rates being lower.

Rule of 20 – Similar to the “4% rule” in some ways, this strategy was developed 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 per cent of your gross income throughout your entire working life.

The 10 per cent 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. This simple rule does not properly consider 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 at least to some degree.

These projections should be a guideline only and 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 on track to meet your goals.