Imagine you knew exactly how much money you needed to enjoy the type of retirement you want. Instead of worrying whether you were saving the right amount, you’d have confidence your annual contributions were enough to fund a long and prosperous retirement. Saving would no longer be a guessing game, but a calculated strategy in which you’d be closer to reaching your goal every year.

If you don’t know how much you need to retire—or you’d like a second opinion— MoneySense is here to help. We’ll show you how to come up with good numbers to aim for—and you won’t even have to reach for your calculator. We’ll also show you how much you’ll need to save each year to reach your goal, and what you need to do if you want to retire early.

No one knows exactly what life is going to throw at you, so you’ll have to adjust your plans as you go. But knowing what to aim for will empower you to work towards your goal and give you peace of mind as you follow your path to a comfortable retirement.

Retirement is on sale

The good news about retirement is that you’ll probably need a lot less income than you did at the peak of your working years in order to maintain a middle-class lifestyle. That’s because many of the expenses you have in your middle years usually don’t continue into retirement. Typically these include the cost of raising children, paying down your mortgage and work-related costs for transportation, clothing and payroll deductions. You won’t need to save for retirement, and with less income, you pay much less income tax.

As a result, we’ve found the cost of a retirement lifestyle that’s middle class or a little better is about $40,000 to $70,000 per couple (before tax). That’s borne out by data: The Statistics Canada Survey of Household Spending for 2010 found senior couples on average spent a combined $53,100 a year (including tax payments). Singles aren’t able to live as cheaply per person as couples, so in that case we estimate the cost of an active lifestyle that’s middle class or a bit better at roughly $28,000 to $50,000. (Statistics Canada found the 2010 average spending for single seniors was only $31,100, but that includes many older widows and widowers.) Another way to figure out the cost of maintaining your lifestyle in retirement is—very roughly—to look at the income in your peak earning years and apply a factor of between 50% and 60% for couples, or 60% to 70% if you’re a single. In each case, these rules-of-thumb work best if you have a paid-for home and no other debt when you retire.

While that’s a big range, you still get an active, comfortable retirement with a “basic middle class” lifestyle. “If you’re at the lower end, you can still have a really nice life,” says Sheila Walkington, co-founder of Money Coaches Canada, a national network of 21 fee-only planners and coaches. At that income, you can still afford things like a car, hobbies, entertainment, eating out and vacations, only at a more modest level than better-off counterparts. Of course, you may not be able to afford to do everything you want. “It’s often about being more careful about how you spend and prioritizing,” says Walkington, a financial planner and co-author of Unstuck.

Once you have a handle on retirement spending, you can figure out roughly the nest egg you’ll need in just a few steps. A key factor is how much you can safely draw down each year. A rough consensus of historical research has found that if you retire at age 65, you can withdraw about 4% a year based on the initial value of your portfolio (plus subsequent inflation adjustments) and run little risk of outliving your money. This means that if you retire at 65, your initial nest egg should be roughly 25 times the amount you plan to withdraw each year in today’s dollars. The research typically assumes you invest in a balanced portfolio of stocks and bonds, and lasts for at least 30 years. These conservative assumptions provide a substantial margin of safety in case you encounter an exceptionally poor investment climate while living to a ripe old age. But as retirement researcher Jim Otar of retirementoptimizer.com cautions, “it’s not foolproof.” If you’re very unlucky and your investments aren’t enough, you can use the equity from your paid-off home as a backup plan, or simply reduce discretionary spending.

To figure out how big a nest egg you’ll need, start with the annual retirement income you’re looking for. Then subtract government benefits like CPP and OAS (and any defined-benefit pension income from employers). That gives you the income you’ll need to draw from your nest egg. Then, if you’re expecting to retire at 65, multiply that figure by 25 (which provides for a 4% sustainable withdrawal rate, described above) to come up with the bottom line number.

We used this approach to calculate the nest egg you’ll need for different levels of income in the table, “How much money will you need to retire?” We’ve also shown the adjustments you should make in case you’re looking to retire earlier or later than 65.

If you have a defined benefit (DB) pension, you can subtract the income you’ll get from the amount you’ll need to live off each year. If your annual DB pension statement doesn’t show you how much pension income you can expect when you retire, ask your pension administrator for a projection. Make sure the figure is in terms of today’s dollars, in order to make it comparable with other figures presented here.

The bottom line? If you aspire to a middle-class retirement and stop work completely at 65, with no employer defined-benefit pension, you will probably need somewhere between $250,000 and $1 million per couple or $325,000 to $850,000 if you’re single, depending on how frugal or luxe you’d like to go.

We recognize that some people have even more luxurious tastes that require much larger amounts, so we’ve also defined a “deluxe” retirement. But that’s only an example since we recognize that when it comes to truly luxurious lifestyles, the sky’s the limit. At the other end of the spectrum, if you don’t have any savings of your own, you won’t starve—you can expect government benefits including CPP, OAS and the low-income Guaranteed Income Supplement will cover your basic necessities.

Now that you have a sense of the size of nest egg you’ll need, we can discuss the best way to get there.

Saving the right amount

While a comfortable retirement should be well within reach of most middle-class Canadians, you still need to save diligently to get there. But how much to save? It depends on whether you plan to save steadily throughout your working life or whether you instead focus on paying off the mortgage before you start seriously saving for retirement.

The steady-eddy approach was made famous by David Chilton in The Wealthy Barber. Chilton advocates salting away a steady 10% throughout a long working career. While results will vary with salary and investment returns, we think that approach works well for Canadians with fairly average incomes or better if you can manage it over a lengthy career of 35 or 40 years. Of course—as Chilton points out—if you don’t start early and save consistently, you’ll need to save more than 10%.

While that approach is effective, few people these days can afford to buy their first home, cover humongous mortgage payments, and also save 10% for retirement. “I think most people in that situation want to do the level 10% savings but can’t for the life of them figure out where the money is supposed to come from,” says Malcolm Hamilton, retirement expert and senior fellow at the C.D. Howe Institute.

So as a practical alternative, Hamilton has devised an alternative approach—the 20% “mortgage-first, save later” strategy. The idea is you first apply 20% of your gross income to paying off your mortgage as quickly as possible, then when it is fully paid off, redirect the 20% to savings in a concentrated period.

Hamilton says you should plan to have the mortgage paid off in your 40s, then focus on the savings phase for at least 15—and ideally—20 years. It helps in the savings phase if you also save some of your RRSP refunds on top of the 20%, but Hamilton doesn’t expect you to necessarily save all of it. “Life is going to look a lot better when you’re debt-free in your 40s,” says Hamilton. “When you turn your focus to saving, you’d be surprised how effectively you’ll be able to make up for lost time.”

Both strategies should provide Canadians with average incomes who retire at age 65 with an ample retirement nest egg, putting them squarely in the middle-class range we described earlier. The table “How much money will you need to save?” shows roughly how much savings you can expect at retirement in today’s dollars, using both strategies at different salary levels. (However if your income is below average, it may be harder to reach the middle class range. In our tables, we show how a single person earning an income of $40,000 can expect to end up just a little short of the middle class range as we’ve defined it.) Under each strategy, we’ve assumed that RRSP refunds are reinvested into savings and that those amounts are in addition to the 10% and the 20%. Of course, no one can predict the unknown financial future with precision, so take these numbers as middle-of-the-road ballpark figures only. You’ll need to monitor your situation and adjust your plans as you go.

What if you’d like to follow the “mortgage-first, save-later” approach but find you don’t have the full 15 to 20 years for saving? No need to panic. Most middle-income people can still accumulate quite adequate nest eggs in 10 to 15 years of concentrated saving or sometimes even less. It helps if your income is better than average and you manage to save more than 20%. But don’t shorten up on the savings period unless you have to because it leaves less safety margin. “You have to be careful about leaving things late, then finding you’re one of the unlucky ones whose skills aren’t in demand or are in poor health,” cautions Hamilton.

If you’re trying to catch up on savings, you can boost your chances by increasing your savings rate to 25% or more (plus saving full RRSP refunds on top of that). My sense is that most middle-income people can save 20% fairly comfortably once they have their mortgage paid off, but most can save 25% or more with a bit of stretching. If you have a family, you’re in a better position to save larger amounts once your kids become financially self-sufficient. (For a fuller discussion, see “How Much Can You Save?”) Also, while it may not be your first choice, you can always try to work longer.

Which approach works best? The “mortgage-first, save-later” approach works well for anyone whose finances are pinched early in their working careers but who enjoy much greater capacity to save later on. That’s particularly true for young homeowners with kids and rising incomes. Those rising incomes also generate bigger tax refunds if you’re in a higher tax bracket later on.

On the other hand, childless renters have no good reason to put off saving and generally should buckle down with the steady-eddy approach. In addition, renters will need to save more to cover accommodation in retirement compared to homeowners with paid-for homes. You also should save steadily to the extent that your employer matches those savings in a group RRSP or defined contribution pension plan. In that case, the benefit of free money usually trumps other considerations.

Most people with average incomes or better are best off focusing first on building their retirement savings inside an RRSP. This is particularly true if you save your refunds. On the other hand, you’re better off putting your money in a Tax-Free Savings Account if you expect to retire on a low income. That’s because TFSAs are more flexible when it comes to withdrawals. And unlike RRSPs they are not counted against the Guaranteed Income Supplement (GIS) for low-income seniors.

What if you want to retire early?

Many people dream of retiring early. To make it happen, you’ll need a bigger nest egg, for two reasons. Not only will you be drawing from your nest egg over a longer retirement, but you’ll need to bridge the period until you can collect full government pensions.

A rough way to adjust for the cost of early retirement is simply to add your annual spending requirement for each year you retire early on top of the nest egg you would need for retiring at age 65. Say you figure you need savings of $625,000 at age 65, expect to spend $55,000 a year, and plan to retire two years early at age 63. Then you would add the $110,000 to the target nest egg to come up with an adjusted figure of $735,000 in today’s dollars to retire two years earlier than the standard date. In practice, many people end up starting CPP earlier than age 65 at a reduced amount. If you’re just trying to get a very rough sense of your finances, you may find it simpler to do rough calculations assuming you’ll wait until 65 to draw CPP, instead of going to the greater effort of making two more precise but largely offsetting adjustments.

If you’re out to make a more precise estimate of the nest egg you’ll need for early retirement, you should estimate your CPP based on when you expect to start it. You should also adjust the sustainable withdrawal rate that applies to withdrawals from your portfolio. While there is no consensus among experts on how best to do this, we believe it makes sense to reduce it by about 1/10th of one per cent for every year earlier than 65 that you plan to retire, if you retire in your early 60s. Thus if you plan to retire at 63 instead of 65, you would be able to withdraw 3.8% per year plus inflation adjustments based on the initial value of the portfolio instead of the 4% that would apply at age 65. As a result, your initial nest egg in that example should be roughly 26.3 times the size of your annual withdrawals. If you retire earlier than that, you should be able to shave off a little less than 1/10th of one per cent for years from age 55 to age 60. So if you retire at 55, an initial withdrawal rate of about 3.2% should be reasonable. By similar reasoning, if you delay retirement past 65 for a couple of years, it would be reasonable to increase your initial withdrawals by about 1/10th of one per cent per year.

Also, if you were born after March 1958, you’re affected by government plans to transition the start date for OAS from age 65 to age 67. In that case, you’ll need additional savings to replace delayed OAS, currently $6,550 a year for long-time Canadian residents. If affected, you should add the amount of OAS you’ll have to replace—up to the equivalent of two years worth of OAS—to the size of the nest egg you’ll need at age 65. If you retire earlier than 65, you’ll have to add additional dollars to your nest egg to bridge the longer gap before OAS starts.

If the cost of early retirement seems prohibitive, another option may be to work part-time or on periodic contracts. Assuming you can find a part-time job that you enjoy or at least that you don’t dislike too much, that’s a good way to stay active and socially engaged. If you can cover half your spending needs with part-time pay then you can retire roughly twice as early as you could otherwise afford.

Ready, set, go

The numbers in this story should give you a rough idea of what your retirement will cost. If retirement is still decades away, it should be enough to give you a sense of how much you will need to save. However, if retirement is getting closer, consider hiring a qualified financial planner who can provide detailed projections that are tailored to your objectives and particular circumstances. It will give you peace of mind that you’re on the right track.

While it’s a good idea to use a plan as a guideline, lots of unexpected things can happen to throw you off track. You’ll have to make plenty of adjustments as you go. Do that and chances are you’ll be able to achieve a satisfying retirement. Says Walkington: “Most of us are able to live some version of our retirement dreams if we’re open to possibilities of how best to make the numbers work.”