Parts 1-5 of this series highlighted the challenge in determining a definitive retirement number. Nevertheless, against my better judgment, today you will receive some simplistic retirement nest egg calculations; since we all like to know what everyone else thinks their number should be. Who the heck knows, if any of these numbers will be in the ballpark or not.
Before I get to the numbers, you will read about some Canadian income tax idiosyncrasies and the impact income taxes and inflation have on your anticipated retirement withdrawal amount.
One significant issue for retired Canadians is that your annual minimum Registered Retirement Income Fund (“RRIF”) withdrawal starts at 7.38% and averages approximately 8% of your actual RRIF balance over the first ten years. If your spouse is younger, you can elect to use their age to calculate your minimum RRIF withdrawal amount, which will lower your yearly required withdrawal. In either case, where the majority of your retirement funds are in your RRIF, the required withdrawal may be substantially higher than the 3-4% you plan to withdraw annually from your retirement nest egg (However, as per my example for Mr. and Mrs. Bean below, if you can split pension income with your spouse, the income tax cost of the excess withdrawal may be mitigated).
A discussion of how to manage the drawdown of your RRSP and take into account the minimum RRIF withdrawals is too fact specific and beyond the scope of this series. I may however, post a future blog on this topic.
For higher income Canadians, their Old Age Security may be clawed back as their retirement income increases. For 2014, the clawback starts at $71,592 and your OAS is fully clawed-back at $115,715.
As discussed way back in Part 1 of this series, the 4% withdrawal rule ignores income tax. Thus, I will provide you with some examples of how income taxes may impact your selected retirement withdrawal rate. These examples illustrate the tax centric framework I use for one of my own retirement nest egg estimates, which I then compare with other retirement calculators, formulas, etc. proposed by other expert retirement planners.
You will note my model is just a variation on the 4% rule and still ignores investment fees. However, I am going to assume you use low cost ETF’s so that your costs are minimal or if you use an investment advisor, your returns are at least market after accounting for your management fees ( ha ha). I am also going to assume the yearly inflation adjustment under the 4% rule will cover off inflation if not overcompensate for it. Just accept these assumptions for the time being. I know Michael James is flipping with the investment fee assumption.
Let’s say Mr. and Mrs. Bean each expect to receive full Old Age Security (approx. $6,500) upon retirement and that Mr. Bean and Mrs. Bean anticipate they will receive $12,000 and $6,000 respectively a year in CPP retirement benefits. Finally, assume Mr. and Mrs. Bean will have equal RRIF’s or make the election to split pension income such that they will each receive $50,000 in RRIF payments in Scenario 1, $40,000 in Scenario 2, $30,000 in Scenario 3, $25,000 in Scenario 4 and $20,000 in Scenario 5.
Using the sample data above, here is the Bean’s income tax situation upon their retirement.
In Scenario 1, Mr. and Mrs. Bean will pay almost as much in personal income tax ($27,000) as they receive in OAS and CPP ($31,000). Consequently, their true cash available for spending is essentially the gross withdrawal from their RRIF’s, likely a huge cash flow surprise for Mr. and Mrs. Bean. In Scenario 2, taxes eat up approximately 2/3 of Mr. and Mrs. Bean’s pension income. For Scenario’s 3-5, the impact of taxes though still significant, starts to decrease as a percentage of pension income and overall income under each of those scenarios.
At this point, let’s play with some of these numbers and see if we can come up with a crude ballpark number for the Bean’s retirement nest egg. As I stated on day 1, this framework is clearly limited, is
based on the 4% withdrawal rule and has no academic basis and should not be relied upon as the sole determinant for your own retirement planning.
One of the most important inputs into any retirement calculation is your anticipated spending. Mr. Bean, who is an anal accountant, has used Quicken for years to track his spending and can project which of these expenses he will still have in retirement. The amount he needs to add to his projected spending amount for travel is his “retirement wildcard”, but Mr. Bean is comfortable he can estimate this amount and not be materially wrong. Your spending requirement should really be a yearly calculation and should typically account for higher spending in the early years of your retirement and lower spending in the later years, plus account for one-time expenses like a car purchase, helping pay for a child’s wedding or assisting your child buy a house; however, for this crude calculation, I just use a set spending rate.
Once Mr. Bean determines his spending requirements, I can work backwards to help him determine his retirement number under my tax-centric formula. For example, if I assume the Bean’s spending requirement is going to be $71,000 a year in retirement and they have $31,000 in pension benefits, the Bean’s will need to make up a $40,000 retirement shortfall before I factor in income taxes. By co-incidence Scenario 5 reflects that exact situation. The Bean’s will each draw $20,000 from their RRIFs and have a combined income before tax of $71,000 ($38,500 + $32,500).
Of course, Scenario 5 reflects that after tax, they will only have $63,500 to spend, which is $7,500 short of their needs. Thus I need to gross-up the $40,000 withdrawal so the Beans can achieve their required retirement objective of $71,000 a year. Luckily I have a tax program that makes this easy to determine (you can do this with your personal tax program if you do your own taxes or use an online calculator) and when I run the numbers, I determine the Bean’s will need to take $50,000 or $25,000 each from their RRIFs (instead of the $40,000 or $20,000 each I required before tax in Scenario 5) to net out to their required $71,000 a year spending requirement. Again by a strange co-incidence, this is essentially Scenario 4 above.
Since the Bean’s will need approximately $50,000 before inflation for each year of retirement (in addition to their CPP and OAS), I can now utilize the 4% withdrawal rule to estimate the amount of money they will need to retire. The magic number is $1,250,000 ($50,000/.04), which if you believe the 4% rule, will allow the Bean’s to withdraw $50,000 plus inflation for approximately 30 years or $71,000 after-tax including their pension income. If the Bean’s want to provide a measure of safety and use a 3% withdrawal rate, they would require a nest egg of $1,666,666 ($50,000/.03). Mr. Bean however told me to stick with the 4%, since as an accountant; he has led a stressed life and does not anticipate making it past 85 anyways.
The above calculation results in an inflated magic number as it assumes 100% in registered funds. In reality, the number would be based on a draw-down between your registered and non-registered accounts.
When I told Mr. Bean these results, he was thoroughly depressed. However, with my warped sense of humour, I went on to tell him if he was to retire in ten years and he required $50,000 in non-indexed RRIF withdrawals (CPP and OAS are indexed for inflation) he would actually require approximately $61,000 in yearly withdrawals if inflation averaged 2%. That would push him closer to Scenario 2 above. That would mean he would require almost $80,000 in RRIF payments and using a 4% withdrawal rate he would need to have $2,000,000 at retirement, a staggering number. Personally, I think you cannot look at a 2% inflation rate and just inflate your spending expectation. I would suggest wage increases may partially offset these increases and presumably the extra 10 years of investment returns and new deposits would make it possible to get to $2M in 10 years even if they don’t have $1.25M now. In any event, it is a sobering calculation.
When I started this series, I was foolish enough to think that I could utilize the Bean's income and spending parameters to provide you with comparable nest egg numbers using various retirement expert's formulas. However, as I discussed in Part 5, there are multiple variables and assumptions that affect each calculation which makes an apples to apples comparison impossible. This will be vividly demonstrated as I walk through the various comparisons below.
Yet, I thought it would still be interesting to see how various retirement experts and their formulas, equations etc. compare when given the same retirement spending level and the same pension numbers. It is enlightening, if not slightly amusing, to see how the retirement variables are applied and the significant variances in the final nest egg determination.
William Bengen, the man behind the 4% rule, says that “Where the client has any degree of complexity to their retirement situation at all, I find I must have financial planning software to incorporate all these factors….The financial planning software is essential to blending all these elements and coming up with a withdrawal rate and the use of Monte Carlo, and so forth—I just find that essential”.
So I took Mr. Bengen’s advice and had a financial planner run some numbers on his software for me, based on the above $50,000 RRIF requirement and $31,000 of pension income. In the end our comparison was not apples to apples. His software forced him to make various assumptions I could not include in my crude calculation and he wanted to use a 3.5% real rate of return. He also decided he wanted to allocate the non-registered and registered accounts equally amongst other assumptions I could not make with my limited tax centric model. So what did his software reflect as the required nest egg? His number was $1,335,000.
In this Globe and Mail article from last week, the financial planner comes up with a retirement nest egg of $1,240,000 with a couple retiring at 65 and planning to spend $75,000 a year, with a life expectancy of 95 who receive two-thirds the maximum CPP/OAS payments ($25,000 a year) and who achieve an annual return of 5 per cent, in an environment of 2-per-cent inflation.
I next turned to Jim Otar, a financial planner and mechanical engineer (what is with engineers and retirement?). Jim is the author of Unveiling the Retirement Myth. Jim considers there to be three basic risks for retirement financing:
1. Longevity risk
2. Market risk
3 Inflation risk.
He uses an asset multiplier to factor in these risks. Jim does an awesome job of using “plain English” in this article “Do we have enough to retire?”.
You may not believe this, but I had done all my calculations above before I found Jim’s article. Honestly, it is just a fluke he used $70,000 as his required retirement spending (versus my $71k) and $32,000 for his pension income (versus my $31k). When I use Jim’s multiplier of 28 x my $40,000 pre-tax shortfall, I come to required retirement assets of $1,120,000. I am not sure how, or if Jim even factors in income taxes, into his multiplier.
In Chapter 1 of Mr. Milevsky’s book , “The 7 Most Important equations”, he has a chart showing how much money you need for a 30 year retirement based on a real (after inflation) spending amount. Now to be fair to Mr. Milevsky, he says his first equation does not address taxes and you should use his final all-encompassing equation in Chapter 7. However, that chapter is about sustainable spending and I can easily grab a number from his Chapter 1 chart, so I will use the numbers in this chart and take some liberties with my calculations. If I gross my required spending up to $50,000 to account for taxes as I did in my tax centric model and use a 3% real return rate that Mr. Milevsky says in his book is reasonable in today's economic environment, his equation would reflect a retirement nest egg of approximately $990,000.
However, I have read where Mr. Milevsky has stated that in general you need 20-30 times your anticipated spending in retirement, so I think $990,000 would be at the low end of what he would suggest, so I will take the liberty of saying he would probably be more comfortable using a number closer to $1,100,000 for comparison purposes.
I asked Michael to use his calculator that I discussed in Part 3, to determine the Bean’s required nest egg. He assumed an allocation of 15% in bonds, 15% fully safe and 70% in stocks. He also assumed a 4% real return for stocks and a 2% real return for the bonds. He also assumed a very efficient ETF portfolio with fees of only 0.2%:
Michael determined if the Bean’s want to live indefinitely, they will need a nest egg of approximately $1,680,000. If they plan to live to the age of 95, they will need approximately $1,070,000. If they plan to live to 90 they will need around $960,000 or so.
If Michael used a 2% Management Expense Ratio (“MER) instead of his ultra low cost MER of 0.2%, his figures jump to $3,250,000 if you plan to live indefinitely, $1,270,000 for age 95 and $1,090,000 for age 90.
If the Bean’s require $71,000 to spend in retirement after-tax (including $31,000 in pension income), the various calculations would suggest that they should be shooting for a nest egg at the low end of $1,100,000 to $1,350,000 at the high end.
As noted above, I have taken liberties with some of the calculations and the variables would change for your specific assumptions and facts. Like I say in my title, who the heck really knows what you need to retire; all these numbers may be consistently wrong, but the above at least provides a starting point of some sort, even if simplistic.
Since my chart for the Bean's includes a scenario (#1) where they have a requirement for a $104,000 in after-tax spending ($131,000 in pre-tax income), let's see what the various formulas would reflect as their nest egg requirement for that level of spending.
Blunt Bean Counter – $2,500,000 ($100,000 RRIF/.04%=$2,500,000 for a 100% registered account).
Jim Otar –$2,044,000 (as the $104,000 is an after-tax spending amount and Jim uses a pre-tax spending shortfall, I have estimated that spending shortfall to be approximately $73,000)
Financial Planner –$2,250,000 using the same variables as noted in the prior example.
Moshe Milevsky –$1,978,000 at 3% real return, $2,100,000 at 2.5% return (as per his chart in Chapter 1 for a $100,000 after-tax shortfall).
Michael James – if you want to live indefinitely you will need approximately $3,370,000, if you live to age 95 the magic number drops to around $2,150,000 and at 90, it's $1,920,000 and finally, at 85 it's approximately $1,650,000.
If Michael used a 2% MER instead of his ultra low cost MER of 0.2%, his figures jump to $6,510,0000 if you plan to live indefinitely, $2,530,000 for age 95 and $2,190,000 for age 90.)
Before I get to the numbers, you will read about some Canadian income tax idiosyncrasies and the impact income taxes and inflation have on your anticipated retirement withdrawal amount.
Made In Canada Idiosyncrasies
One significant issue for retired Canadians is that your annual minimum Registered Retirement Income Fund (“RRIF”) withdrawal starts at 7.38% and averages approximately 8% of your actual RRIF balance over the first ten years. If your spouse is younger, you can elect to use their age to calculate your minimum RRIF withdrawal amount, which will lower your yearly required withdrawal. In either case, where the majority of your retirement funds are in your RRIF, the required withdrawal may be substantially higher than the 3-4% you plan to withdraw annually from your retirement nest egg (However, as per my example for Mr. and Mrs. Bean below, if you can split pension income with your spouse, the income tax cost of the excess withdrawal may be mitigated).
A discussion of how to manage the drawdown of your RRSP and take into account the minimum RRIF withdrawals is too fact specific and beyond the scope of this series. I may however, post a future blog on this topic.
For higher income Canadians, their Old Age Security may be clawed back as their retirement income increases. For 2014, the clawback starts at $71,592 and your OAS is fully clawed-back at $115,715.
I am The Blunt Bean Counter –So let’s get Tax Centric
As discussed way back in Part 1 of this series, the 4% withdrawal rule ignores income tax. Thus, I will provide you with some examples of how income taxes may impact your selected retirement withdrawal rate. These examples illustrate the tax centric framework I use for one of my own retirement nest egg estimates, which I then compare with other retirement calculators, formulas, etc. proposed by other expert retirement planners.
You will note my model is just a variation on the 4% rule and still ignores investment fees. However, I am going to assume you use low cost ETF’s so that your costs are minimal or if you use an investment advisor, your returns are at least market after accounting for your management fees ( ha ha). I am also going to assume the yearly inflation adjustment under the 4% rule will cover off inflation if not overcompensate for it. Just accept these assumptions for the time being. I know Michael James is flipping with the investment fee assumption.
Sample Data – Mr. and Mrs. Bean
Let’s say Mr. and Mrs. Bean each expect to receive full Old Age Security (approx. $6,500) upon retirement and that Mr. Bean and Mrs. Bean anticipate they will receive $12,000 and $6,000 respectively a year in CPP retirement benefits. Finally, assume Mr. and Mrs. Bean will have equal RRIF’s or make the election to split pension income such that they will each receive $50,000 in RRIF payments in Scenario 1, $40,000 in Scenario 2, $30,000 in Scenario 3, $25,000 in Scenario 4 and $20,000 in Scenario 5.
Using the sample data above, here is the Bean’s income tax situation upon their retirement.
Mr. Bean
|
Scenario 1
|
Scenario 2
|
Scenario 3
|
Scenario 4
|
Scenario 5
|
Old age security
|
$6,500
|
$6,500
|
$6,500
|
$6,500
|
$6,500
|
CPP
|
$12,000
|
$12,000
|
$12,000
|
$12,000
|
$12,000
|
RRIF
|
$50,000
|
$40,000
|
$30,000
|
$25,000
|
$20,000
|
Total income
|
$68,500
|
$58,500
|
$48,500
|
$43,500
|
$38,500
|
Tax payable
|
$14,400
|
$11,100
|
$7,700
|
$5,800
|
$4,500
|
Net after-tax amount
|
$54,100
|
$47,400
|
$40,800
|
$37,700
|
$34,000
|
Mrs. Bean
|
Scenario 1
|
Scenario 2
|
Scenario 3
|
Scenario 4
|
Scenario 5
|
Old age security
|
$6,500
|
$6,500
|
$6,500
|
$6,500
|
$6,500
|
CPP
|
$6,000
|
$6,000
|
$6,000
|
$6,000
|
$6,000
|
RRIF
|
$50,000
|
$40,000
|
$30,000
|
$25,000
|
$20,000
|
Total income
|
$62,500
|
$52,500
|
$42,500
|
$37,500
|
$32,500
|
Tax payable
|
$12,600
|
$9,100
|
$5,600
|
$4,200
|
$3,000
|
Net after-tax amount
|
$49,900
|
$43,400
|
$36,900
|
$33,300
|
$29,500
|
Combined
after-tax
|
$104,000
|
$90,800
|
$77,700
|
$71,000
|
$63,500
|
The Tax Effect – Ouch
In Scenario 1, Mr. and Mrs. Bean will pay almost as much in personal income tax ($27,000) as they receive in OAS and CPP ($31,000). Consequently, their true cash available for spending is essentially the gross withdrawal from their RRIF’s, likely a huge cash flow surprise for Mr. and Mrs. Bean. In Scenario 2, taxes eat up approximately 2/3 of Mr. and Mrs. Bean’s pension income. For Scenario’s 3-5, the impact of taxes though still significant, starts to decrease as a percentage of pension income and overall income under each of those scenarios.
Playing with Numbers to get a Tax Centric Number
At this point, let’s play with some of these numbers and see if we can come up with a crude ballpark number for the Bean’s retirement nest egg. As I stated on day 1, this framework is clearly limited, is
Determine Your Spending Requirements
One of the most important inputs into any retirement calculation is your anticipated spending. Mr. Bean, who is an anal accountant, has used Quicken for years to track his spending and can project which of these expenses he will still have in retirement. The amount he needs to add to his projected spending amount for travel is his “retirement wildcard”, but Mr. Bean is comfortable he can estimate this amount and not be materially wrong. Your spending requirement should really be a yearly calculation and should typically account for higher spending in the early years of your retirement and lower spending in the later years, plus account for one-time expenses like a car purchase, helping pay for a child’s wedding or assisting your child buy a house; however, for this crude calculation, I just use a set spending rate.
Reverse Engineering Mr. Bean’s Retirement Needs
[Note: For purposes of this example I am assuming all the Bean's funds come from a RRIF to exaggerate the income tax effect; in reality, you will probably have anywhere from 20-40% of your retirement funds in a non-registered account(s). In addition, I do not try and account for the fact the required RRIF withdrawal may be in excess of 4%].
Once Mr. Bean determines his spending requirements, I can work backwards to help him determine his retirement number under my tax-centric formula. For example, if I assume the Bean’s spending requirement is going to be $71,000 a year in retirement and they have $31,000 in pension benefits, the Bean’s will need to make up a $40,000 retirement shortfall before I factor in income taxes. By co-incidence Scenario 5 reflects that exact situation. The Bean’s will each draw $20,000 from their RRIFs and have a combined income before tax of $71,000 ($38,500 + $32,500).
Of course, Scenario 5 reflects that after tax, they will only have $63,500 to spend, which is $7,500 short of their needs. Thus I need to gross-up the $40,000 withdrawal so the Beans can achieve their required retirement objective of $71,000 a year. Luckily I have a tax program that makes this easy to determine (you can do this with your personal tax program if you do your own taxes or use an online calculator) and when I run the numbers, I determine the Bean’s will need to take $50,000 or $25,000 each from their RRIFs (instead of the $40,000 or $20,000 each I required before tax in Scenario 5) to net out to their required $71,000 a year spending requirement. Again by a strange co-incidence, this is essentially Scenario 4 above.
 |
| Mr. Bean is short a few beans. |
The above calculation results in an inflated magic number as it assumes 100% in registered funds. In reality, the number would be based on a draw-down between your registered and non-registered accounts.
When I told Mr. Bean these results, he was thoroughly depressed. However, with my warped sense of humour, I went on to tell him if he was to retire in ten years and he required $50,000 in non-indexed RRIF withdrawals (CPP and OAS are indexed for inflation) he would actually require approximately $61,000 in yearly withdrawals if inflation averaged 2%. That would push him closer to Scenario 2 above. That would mean he would require almost $80,000 in RRIF payments and using a 4% withdrawal rate he would need to have $2,000,000 at retirement, a staggering number. Personally, I think you cannot look at a 2% inflation rate and just inflate your spending expectation. I would suggest wage increases may partially offset these increases and presumably the extra 10 years of investment returns and new deposits would make it possible to get to $2M in 10 years even if they don’t have $1.25M now. In any event, it is a sobering calculation.
Comparing Apples to Oranges to Pineapples
When I started this series, I was foolish enough to think that I could utilize the Bean's income and spending parameters to provide you with comparable nest egg numbers using various retirement expert's formulas. However, as I discussed in Part 5, there are multiple variables and assumptions that affect each calculation which makes an apples to apples comparison impossible. This will be vividly demonstrated as I walk through the various comparisons below.
Yet, I thought it would still be interesting to see how various retirement experts and their formulas, equations etc. compare when given the same retirement spending level and the same pension numbers. It is enlightening, if not slightly amusing, to see how the retirement variables are applied and the significant variances in the final nest egg determination.
What a Financial Planner Says
William Bengen, the man behind the 4% rule, says that “Where the client has any degree of complexity to their retirement situation at all, I find I must have financial planning software to incorporate all these factors….The financial planning software is essential to blending all these elements and coming up with a withdrawal rate and the use of Monte Carlo, and so forth—I just find that essential”.
So I took Mr. Bengen’s advice and had a financial planner run some numbers on his software for me, based on the above $50,000 RRIF requirement and $31,000 of pension income. In the end our comparison was not apples to apples. His software forced him to make various assumptions I could not include in my crude calculation and he wanted to use a 3.5% real rate of return. He also decided he wanted to allocate the non-registered and registered accounts equally amongst other assumptions I could not make with my limited tax centric model. So what did his software reflect as the required nest egg? His number was $1,335,000.
In this Globe and Mail article from last week, the financial planner comes up with a retirement nest egg of $1,240,000 with a couple retiring at 65 and planning to spend $75,000 a year, with a life expectancy of 95 who receive two-thirds the maximum CPP/OAS payments ($25,000 a year) and who achieve an annual return of 5 per cent, in an environment of 2-per-cent inflation.
Jim Otar’s Retirement Asset Multiplier
I next turned to Jim Otar, a financial planner and mechanical engineer (what is with engineers and retirement?). Jim is the author of Unveiling the Retirement Myth. Jim considers there to be three basic risks for retirement financing:
1. Longevity risk
2. Market risk
3 Inflation risk.
He uses an asset multiplier to factor in these risks. Jim does an awesome job of using “plain English” in this article “Do we have enough to retire?”.
Moshe Milevsky’s Equation
In Chapter 1 of Mr. Milevsky’s book , “The 7 Most Important equations”, he has a chart showing how much money you need for a 30 year retirement based on a real (after inflation) spending amount. Now to be fair to Mr. Milevsky, he says his first equation does not address taxes and you should use his final all-encompassing equation in Chapter 7. However, that chapter is about sustainable spending and I can easily grab a number from his Chapter 1 chart, so I will use the numbers in this chart and take some liberties with my calculations. If I gross my required spending up to $50,000 to account for taxes as I did in my tax centric model and use a 3% real return rate that Mr. Milevsky says in his book is reasonable in today's economic environment, his equation would reflect a retirement nest egg of approximately $990,000.
However, I have read where Mr. Milevsky has stated that in general you need 20-30 times your anticipated spending in retirement, so I think $990,000 would be at the low end of what he would suggest, so I will take the liberty of saying he would probably be more comfortable using a number closer to $1,100,000 for comparison purposes. Michael James
I asked Michael to use his calculator that I discussed in Part 3, to determine the Bean’s required nest egg. He assumed an allocation of 15% in bonds, 15% fully safe and 70% in stocks. He also assumed a 4% real return for stocks and a 2% real return for the bonds. He also assumed a very efficient ETF portfolio with fees of only 0.2%:
Michael determined if the Bean’s want to live indefinitely, they will need a nest egg of approximately $1,680,000. If they plan to live to the age of 95, they will need approximately $1,070,000. If they plan to live to 90 they will need around $960,000 or so.
If Michael used a 2% Management Expense Ratio (“MER) instead of his ultra low cost MER of 0.2%, his figures jump to $3,250,000 if you plan to live indefinitely, $1,270,000 for age 95 and $1,090,000 for age 90.
Summary of $71,000 Spending Requirement
If the Bean’s require $71,000 to spend in retirement after-tax (including $31,000 in pension income), the various calculations would suggest that they should be shooting for a nest egg at the low end of $1,100,000 to $1,350,000 at the high end.
As noted above, I have taken liberties with some of the calculations and the variables would change for your specific assumptions and facts. Like I say in my title, who the heck really knows what you need to retire; all these numbers may be consistently wrong, but the above at least provides a starting point of some sort, even if simplistic.
What if the Bean’s have a $104,000 after-tax Spending Requirement?
Since my chart for the Bean's includes a scenario (#1) where they have a requirement for a $104,000 in after-tax spending ($131,000 in pre-tax income), let's see what the various formulas would reflect as their nest egg requirement for that level of spending.
Blunt Bean Counter – $2,500,000 ($100,000 RRIF/.04%=$2,500,000 for a 100% registered account).
Jim Otar –$2,044,000 (as the $104,000 is an after-tax spending amount and Jim uses a pre-tax spending shortfall, I have estimated that spending shortfall to be approximately $73,000)
Financial Planner –$2,250,000 using the same variables as noted in the prior example.
Moshe Milevsky –$1,978,000 at 3% real return, $2,100,000 at 2.5% return (as per his chart in Chapter 1 for a $100,000 after-tax shortfall).
Michael James – if you want to live indefinitely you will need approximately $3,370,000, if you live to age 95 the magic number drops to around $2,150,000 and at 90, it's $1,920,000 and finally, at 85 it's approximately $1,650,000.
If Michael used a 2% MER instead of his ultra low cost MER of 0.2%, his figures jump to $6,510,0000 if you plan to live indefinitely, $2,530,000 for age 95 and $2,190,000 for age 90.)
Summary of $104,000 Spending Requirement
If the Bean’s require $104,000 to spend in retirement after-tax (including $31,000 in pension income), the various calculations would suggest that they should be shooting for a nest egg at the low end off $2,000,000 to $2,500,000 at the high end.
Canadians Know Best
Final Caveat
Throughout this series, I’ve shared with you my research and analysis and provided you with as much information as possible so that you can try and determine (or at least consider) the assets you need to accumulate for your own retirement nest egg. There is not one definitive number. Keep in mind, one size does not fit all. My retirement funding includes the sale of my partnership interest; yours may include the sale of a business or a severance payment for taking early retirement. The point being, we all have unique situations.
Conclusion – This Series is Finally Over!!
After going through the analysis I provided to you, I've determined that I am much further away from my retirement goal than I had anticipated and I will still be working for several more years. I now wish I had a company pension. The largest surprise of this exercise to me is that I may give consideration to purchasing an annuity with some portion of my retirement funds, to ensure I have a constant minimum cash flow. Depressing as this exercise was, it brought some clarity to my retirement planning. I also realized that I have no idea whose Monte Carlo simulator will hit the jackpot and that historical data can be interpreted in so many ways it leaves your head spinning.
I do know a multitude of factors beyond my control may impact my expected withdrawal rate (see Part 5 for the laundry list) and thus as a result, I will have to:
1. Be flexible in my spending requirements and may need to be open to working part-time in retirement
2. Review, revise and refine my retirement plan on a consistent basis to account for financial and life events and any changes in my behaviour
In conclusion, I
hope my quest or journey for freedom 55,65,75, helps guide your retirement
planning.
The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.
The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.
Those taxes do add up. I wonder what the impact would be if CPP payments were removed. I'm guessing the marginal tax rate is around 35% so the total tax on the CPP income is $6,300 and the net value is just under $12,000. Of course getting an RRSP large enough to support those withdrawals without contributing to the CPP would be quite a feat :)
ReplyDeleteHi Richard
DeleteThe marginal rate in scenario 1 is closer to 31%. Many people who own corps ignore CPP and RRSP and try and build up their retirement within their holding companies.
Hi Mark,
ReplyDeleteGreat series. I suspect many people will realize that they are on a Freedom 75 path unless they save more or plan to spend less in retirement.
Michael, thx for your assistance and your insights.
DeleteGreat series!
ReplyDeleteI figure we could retire at 55 with $1.5 M in RRSP, TFSA and non-registered assets and my LIRA.
This excludes my pension, my wife's pension and any CPP and OAS payments. It excludes our home value. We would draw down most of the RRSP from 55-65 and keep some RRSP for a RRIF at >65. We would defer CPP until age 65 to maximize payments. OAS at 67 or later.
The biggest problem I have with the retirement number, is it's not static, it's dynamic, there are not only yearly tax implications but payment implications as well. No study can cover all the variables and likely never will.
Your series did a great job covering very, very well Mark. Well done, that was a ton of work.
Signed,
This Mark and Phil Mickelson fan
Hi Mark:
DeleteThx for your comments above and your comments throughout the series. As you note, no study can cover all the variables and your retirement number is not static. But you at a far younger age than I, already have a target and a goal and your eye on the retirement ball, which is great.
Phil and Tiger have their work cut out for them, with all the great younger players, hope to see some golf weather soon, very depressing winter.
Yes, this weather sucks. Just got my clubs regripped and I can't wait to hit some balls in the spring weather.
DeleteHappy to comment on your great blog Mark.
At Marks' request, I am posting my previous email to him:
ReplyDeleteI like to share my experience:
Ten years ago I figured that I could retire. I created a spreadsheet that calculated, year after year, investment return, expense adjusted for inflation, income tax, and remaining capital. The assumptions I used were:
- 2% inflation
- 4% investment return net of management and trading fees; the entire return fully taxed
- income tax rates remained the same, but brackets adjusted for inflation
My registered accounts were fairly large, so I was careful to calculate each year the minimum withdrawal and the resulting income tax. In fact, one main reason I created this spreadsheet was so that I could play around with registered account withdrawals before minimum withdrawals kick in, to see which strategy would work best.
I did not factor in OAS or CPP (there is always that sticky OAS clawback, and even the Service Canada website cannot give you an accurate CPP amount in a future year when you actually start drawing on it). And I did not factor in my house.
The expense number I used to start was simply my previous year’s actual expense. In the model, I just ran with this expense, adjusted for inflation.
Starting from age 50, it turned out that my withdrawal rate was 3% (excluding income tax), and the money ran out after 45 years. That was how I concluded I could retire.
(It turned out the best withdrawal strategy from registered accounts is to leave the money there as late as possible. The tax savings and resulting returns from these earlier years seem to offset higher income tax during the requisite withdrawal years.)
Here is my experience so far:
- My actual income tax has been lower than calculated, probably because of dividends and unrealized capital gains in my unregistered accounts.
- My actual return on capital yearly had been: 6.62, 6.82, 3.79, -7.27, 11.31, 8.32, 6.12, 6.20, 7.78%
- My actual expenses (excluding taxes) had fluctuated from year to year, but over 10 years, the actual total expenses are 4% less than the projected total.
As a result, I am ahead of the model I that ran 10 years ago. Every year I update the spreadsheet with actual numbers, so that I can compare where things differ, and also see how the projections change. (I don’t bother updating the tax brackets or the expense projections.) Currently, the projections show that there will be quite a bit of money left after year 47.
Just for curiosity, I plug in a hypothetical withdrawal rate of 4% at age 65 into the spreadsheet, and let it run. Money will run out at age 95. So a 4% withdrawal rate excluding income tax is probably OK but I would be cautious of it.
On the other hand, I did not include OAS and CPP. Also, my situation is a two-income family.
This spreadsheet has been one of my most important financial management tools in the past 10 years. It is not that hard to create a spreadsheet like this where one can fill in one’s numbers and assumptions and see the projections; there ought to be one in the public domain.
Thx Anon.
DeleteI appreciate you sharing your real life example. I was also struck at how well thought out and considered your plan is. Thx again for sharing.
where can I get that spread sheet. I am not that smart to create my own!!?
Deletehttp://www.thebluntbeancounter.com/2014/04/retirement-planning-spreadsheet.html
DeleteWe've never planned on retiring at 55 but we've always worried about being forced to semi-retire/financially-catastrophically-job-change at 55. (Both sets of parents got forced into early retirement so we know it can happen.) Based on all the numbers you've kindly provided I think we'll survive if it does happen to us, despite the fact that we don't have DB pensions. (Both our Dads have but they weren't indexed.)
ReplyDeleteI always shiver when I hear people counting on their higher earnings in their 50s to help them with their retirement. So much can go wrong with that kind of delaying tactic. We'll be encouraging our kids to start saving for their retirement in their 20s like we did. (We think they may be able to because we expect to help them with the lion's share of their education costs.) All those sales pitch graphics about the merits of investing early, even if you have to stop for a while during the young child years, really hold some truth. A large part of our retirement savings dates back to contributions made when we were under 30.
Thanks for such a detailed and interesting review of what it might take. It's been fascinating following along!
Hi Bet
DeleteThx for persevering through the 6 parts and for your personal experience and advice. It sounds like you have observed first hand some unexpected developments that threw retirement plans into disarray. If everything went as expected, planning would be oh so much easier.
Thank you, this series has been very informative and interesting. I am feeling much better about our finances now!
ReplyDeleteHi Barbara
DeleteI am glad you are feeling better about your finances, I am feeling worse :(
Multiple retirement scenarios presented, all of which require at least one million dollars in investable assets, yet only ~1% of individual Canadians will ever attain this level. During the peak of Boomer retirement this ratio may hit ~2%, the highest degree of millionaires throughout Canadian history!
ReplyDelete"Household" millionairedom is substantially higher at ~3%.
With that said, I am glad you acknowledge in your conclusion the dismal and daunting task set out before the populace (e.g. 'Freedom 75'). Unattainable goals are of no use, except possibly for destroying motivation.
If YOU are "feeling worse" about your finances now, imagine how the median Canadian feels, the ones who are not high-income earners or business owners or mortgage-free.
Setting realistic and achievable financial goals, coupled with learning the use of the proper monetary devices, would seem to be a much more productive path to a satisfactory retirement (at whatever dollar amount that may be).
Don't get me wrong, I think the value of expert tax advice far outweighs that of the investment "experts" (mainly because taxes deal with what is, not what could be), especially in a country as heavily taxed as Canada. Your website is a boon to all who care to be concerned about their financial well-being.
Save diligently, invest wisely, live prudently, retire happily.
Hi SST,
DeleteYour comment above is one of my all-time favourites and I really like your comment about setting realistic and achievable financial goals.
That being said, I explicitly state in my header that this site is "meant for taxpayers no matter their income bracket, but in particular for high net worth individuals and entrepreneurs who own private corporations." Thus, I guess I am writing for the lucky 1%, however, I always try to make the posts inclusive for anyone, not matter their financial situation. Believe it or not, my initial numbers used way higher spending limits, but I dialed them back because of exactly what you commented about. So, I walk a fine line as to what I am trying to accomplish with this blog and trying to promote tax and financial literacy for all.
Thanks for pointing out what I missed (your target audience).
DeleteThat being the case, I see no reason why a current HNWI would miss the published retirement targets if they remain focused on the controllable factors (adapting to the uncontrollable). Just as the median Canadian could take lessons from the HNWI and adapt them to their own situation.
In the meantime, thanks for all your effort!
An excellent series and a good start ... I think a couple of commenters are onto a key issue. Optimizing tax can do a lot to reduce the magic number - optimizing through timing in retirement years as Anonymous says and type of investment for non-reg. If I can reduce my net tax rate from 30% to 20%, that's like 0.4% more net return on 4% gross return.
ReplyDeleteThx CI
DeleteYes, I have attempted to try and write a blog on the tax optimization (may go with overview of issue), but the math is too intense and just too time consuming to follow through. I will leave it to a math wiz like Michael James to write such a blog.
This comment has been removed by the author.
DeleteHi Jo
DeleteNote sure where you get your basic survival rate number. Everyone is different based on their specific circumstances.
You should engage a fee for service financial planner who could review your exact details and confirm yeah or nay.
Reading your blog I feel less alone in my quest of financial self-suffiency - retirement freedom !
ReplyDeleteI find that results are always based on inaccurate information. First the majority of people do not live until 95 and only exacerbates the concerns of people feeling they have to reach unattainable numbers to retire. Second it appears fundamental thinking is that people should rely on RSP for their total planning. Logically thinking should it not be broken down in steps? Your first stage of retirement should be taken care of by your RSP and in my opinion used up before age 72. The time you are forced to place it in a RRIF. Next it seems, no one takes in account of peoples largest investment their home and the value you have built over the years. This income source once sold, is in some cases larger then their RSP. Third, once if you have lived this long, personal savings should be used to finalize your remaining costs and hopefully you have used your resources to secure you and your love ones with a healthy and enjoyable retirement.
ReplyDeleteHi Anon
DeleteI think in reality, many peoples retirement follows a somewhat similar staging as you suggest. However, tax efficiency needs to be factored in and that often changes or alters your plan. It is best to have your accountant or financial planner walk through your plan to ensure cash flow and tax efficiency.