Retirement: A number you’ll love

When Kyle and Angela Martin started planning their retirement more than 20 years ago, they wondered how much they would need to live on once they stopped working. Their financial planner told them that the answer was well-documented. All the experts agreed that they would have to replace 70% of their pre-retirement income to live comfortably in retirement.

So Kyle, who worked as a market researcher, and his wife Angela, who worked in real estate, took a big gulp and started saving. They knew that replacing 70% of their combined $100,000 income wasn’t going to be easy. They would need a $1.5-million nest egg when they retired at 60 to generate the inflation-adjusted equivalent of $70,000 a year for the rest of their lives.

The Martins (whose names we’ve changed) gave everything they had to the job of building up their retirement stockpile, but in the end they managed to accumulate only $1 million – mere two-thirds of what their planner had told them they needed. As Kyle and his wife approached retirement in 2001, they readied themselves for some lean years.

Only it hasn’t turned out that way. So far they haven’t even touched their $1 million in retirement savings.

“Not a dollar has come out of our RRSP,” says Kyle, who just got back from a month of golfing in sunny Florida. “But we’re living well. I’ve got a nice house, a nice car, and my wife has two beautiful fur coats and lots of jewelry. We have plenty to live on, and in a few years when the law says we’ll have to start tapping our retirement savings, our income will double. In fact, it will be so high, I don’t know what we’re going to do with it all.”

As the Martins will tell you, retirement isn’t nearly as scary as many people would have you believe. Most retired Canadians live comfortably on half their working incomes and a big chunk of that money comes to them from government pension plans. If you’ve been tossing and fretting because you don’t have enough saved for retirement, it’s time to relax. In all probability, you’re doing a lot better than you think you are.

Few topics in financial planning generate as much heat as the debate over how much you need to retire well. The financial services industry – which, after all, has a vested interest in encouraging you to save as much as possible – has preached for years that you need to generate 60% to 70% of your pre-retirement income to live comfortably in retirement. One mutual fund company recently bumped the recommended replacement ratio up to 80% by assuming that you will spend just as much when you retire as you do while you are working.

What the company doesn’t explain is how a couple is supposed to achieve that 80% figure. To achieve that goal, a middle-class couple in their mid-30s would need to hunker down and put away a couple of million bucks to retire comfortably. That would require them to save a third of their incomes every year.

Fortunately, the evidence doesn’t agree with the scary numbers. We asked Statistics Canada to crunch the numbers for us and find out how much retired Canadians are living on as a percentage of their pre-retirement incomes. StatsCan discovered that the average Canadian couple comes nowhere close to replacing 80% of their working income in retirement. As you can see in Wealthy? Here’s some good news (page 9), the average couple replaces more like 45% to 55% of their working income.

Yet those retired couples are far from destitute, says Malcolm Hamilton, a Toronto-based actuary and worldwide partner at Mercer, the benefits consulting firm. Numerous surveys show that most retired Canadians are living just as well as they were when they were working. “When you tell people that senior couples have about half the income of a working family, they say, Oh, those poor dears! Theirs must be a life of misery and destitution,'” says Hamilton. “But it’s not at all. And the seniors know it.”

Seniors are able to live on less than they did while they were working because their expenses are less. They’ve paid off their mortgages and put their kids through school. They no longer have to save for retirement because they are already retired. Even their tax bill is less because they no longer have big salaries.

Hamilton says most people don’t understand the reality of retirement because they get misled by the apparent size of younger people’s paycheques. But how much you earn has little to do with how well you live. What determines your standard of living is how much you have left over after expenses.

The first stage of life, says Hamilton, occurs when you’re in your 30s and early 40s. Your paycheques are stretched to the limit and you never seem to have enough. At this stage, you’re probably paying 30% of your income to taxes and other deductions. Another 20% goes to your mortgage and another 10% to looking after the kids. That means that you and your spouse are living on only 40% of what you make.

The next stage occurs in your late 40s and 50s. You wave goodbye to your kids and burn your mortgage. Suddenly, you feel a lot richer – and that’s because you are. Your available cash flow has just leaped from 40% of your gross pay to 70%.

Unfortunately, you have to pour most of that increase into saving for retirement. If you put away 10% to 20% of your gross income, you wind up living on 50% to 60% of your pay.

The final stage is retirement. You could aim to replace 70% or 80% of your working income, just like the mutual fund companies say. But if you did you would have far more money than you ever had during your working life. That’s the amazing truth that many people fail to grasp: you can live on 50% to 60% of your working income when you retire, because that’s exactly what you were living on when you were working.

The news gets better. You don’t have to replace all of that 50% to 60% of your working income from your own savings. Government chips in far more pension money than most people realize.

The average combined monthly benefit from Old Age Security and the Canada Pension Plan is $11,300 per person, so a typical working couple can expect to get about $22,000 a year from the government. If you both worked and contributed to CPP your whole lives, you could get as much as $32,000 a year. As Kyle Martin puts it: “When I read about saving for retirement, I never, ever see anyone mention that the first $25,000 a year is in the bag.”

The government money makes a huge difference, Kyle says. Right now, he and Angela get about $25,000 a year from the government, plus several thousand in interest from savings outside their RRSPs, and a few thousand from two small company pensions. Their total annual income adds up to $36,000 and that’s plenty, because their expenses have plummeted since retiring. “A $100,000-a-year couple is really making more like $60,000 a year after expenses and taxes when they’re working,” he says. “So after the government money, a $500,000 RR SP is easily enough to provide you with what you’re used to.”

Hamilton agrees. “For married couples with children who buy a home, the replacement income that you need typically comes out to around 50%,” he says. “You get a 20% break from low taxes when you retire, and you’ll get a 30% break from not having a mortgage or kids to look after. So that means you can live on 50% of what you were living on before.”

Most middle-class couples can save what they need for retirement without enduring hardships along the way. For instance, if you and your spouse are making $100,000 a year while you’re both working, you will probably need a total income of $50,000 a year after retirement. Assuming that both of you stay on the job until 65, the government will provide the two of you with about $30,000 a year in CPP and OAS. That means you only have to save up enough in your pensions or RRSPs to provide the two of you with an income of $20,000 a year. If you have a corporate pension, it will provide you with a good chunk of that $20,000. But even if you don’t have a company pension, you don’t have to starve yourself while you’re working to afford a decent retirement. A typical couple, Hamilton says, should do just fine in retirement if they pay off their house and each accumulate a nest egg of $200,000.

Of course many of us want to do a bit better in retirement than just get by. Hamilton notes that wealthy couples often work very hard for their money, and see retirement as the reward years. Many want to spend those years traveling the world, or indulging pricey pursuits such as sailing. In other words, they want to live better in retirement than they did when they were working. If that’s you, you’ll probably need to replace more than 50% of your working income. But do you really need 80%?

To find out, you might want to talk to Dave Gower. He worked his whole life as an economist for Statistics Canada, and when he retired, he got one of those gold-plated government pensions you’ve heard about. He was able to retire just a few months after his 55th birthday – dream retirement age for many – and his pension still replaced a full 63% of his working income.

Gower is now 64 and says he has plenty to live on. He has a nice, fully renovated house in Ottawa, and he’s planning on buying a brand new car soon, which he’ll pay for in cash. He doesn’t travel much any more, he says, but that’s because he did more than enough travelling when he was younger, not because he doesn’t have the money. Gower prefers to spend time at home with his dog and cats, taking it easy in his new “cat-proof” La-Z-Boy.

Gower says the idea of the impoverished senior is largely a myth, and he can’t figure out why he gets seniors’ discounts when he’s never had more money. “I’ve gently chided them at Burger King when they’ve looked at me and said they’ll give me a discount,” he says. “I’ve told them, ‘Don’t you know that seniors are better able to pay full price than most people?'”

Gower says he’s got lots of money in his RRSP that’s just sitting there, unused. He’s not spending all of his income, even though it’s only 63% of what he made before. Yet next year, when he turns 65, that income will go up. “I had just assumed that I was making too much to get Old Age Security, so it would all be clawed back. But it turns out I’m eligible for the full amount,” he says. “I was surprised to find out that you have to be making more than $100,000 to have it all clawed back.” So what will he do with the extra money? “I really don’t know,” he says. “But that’s got to be one of life’s more pleasant problems.”

Hamilton says that Gower’s situation is actually quite typical. Many seniors find themselves with extra money. They wind up saving it, even though they really don’t have anything to save toward. “Of all the age groups, seniors have the second highest savings rate,” Hamilton says. “They save at a rate that is just behind couples in their 50s who are at their earning peak.”

Much of this excess savings happens because we slow down in our late 60s and 70s, whether we want to or not. That means that even if you want to live it up in retirement, you probably only have to budget for about 10 years of the high life.

“If you want to live large in retirement, split your savings in two,” says Hamilton. “For the first chunk, just think about what you’ll need to maintain your regular standard of living, which is what you’re used to. For the second chunk, think about how much you’ll need for those once-in-a-lifetime things you want to do in your 60s, because once you reach your 70s, you’ll just want to relax.”

Planning for retirement is all about balance. Sure, you don’t want to live like a pauper when you’re retired – but living like a pauper while you’re working so you can live it up in retirement is even worse. If you follow the industry advice to try to save up enough money so that you can live on 80% of your working income when you retire, you become a slave to your own retirement. You scrimp and save for your whole life to finance 10 luxurious years when you retire.

Hamilton says a better solution is to aim to live on a steady 50% to 60% of your working income – not including mortgage payments, savings and supporting the kids – no matter what stage of your life you’re in. “It’s good to prepare for retirement,” he says. “But you shouldn’t become overexcited by your ability to foresee what the future will bring. Life is filled with mysteries, and it’s hard to predict when you’re going to want to retire, what your career will be like, what your health will be like, and all these other factors that have a big impact on what you’ll need.”

So put away the complicated worksheets and stop lying awake at night trying to predict what the markets will be like decades from now. Your retirement solution is simple. “Live frugally, spend your money sensibly, don’t cheat yourself out of things you need while you’re raising a family, and get out of debt fast,” Hamilton says. “If you do all that, you’ll be just fine.”