Contrary to the popular belief of many Canadians, collecting CPP and OAS isn’t quite enough to retire on. That’s because the maximum benefit for CPP is only slightly more than $1,100 and the OAS supplement is around $540. That means the maximum amount the government will give you when you’re wrinkly and retired is around $1640. In major cities like Calgary, Vancouver or Toronto, $1640 might only be enough to pay for property taxes, insurance and your cellphone bill. Forget about eating out.
The only way to retire comfortably is to have another form of income other than the government stipend. So just how do you do that if you’re retired? Are you forced to work at a Tim Horton’s drive thru for the rest of your life just to get by in your 70’s?
What’s Your Number?
Before we can actually determine how much you need to retire, the question that needs to be answered first is what are your needs and how much will it cost you? Simple questions need to be answered.
- Do you plan to rent?
- Do you plan to travel?
- Do you want your lifestyle to be better or worse than current?
The easiest way to determine how much you need, is to compare to your current lifestyle. Are you satisfied? Will you dial back the spending once the cash flow comes in? The number you come up with is really an individual choice, but once you determine what kind of lifestyle you want then we can proceed.
Imagine a budget like this:
- You will own your house. Property taxes take up $400/month. Maintenance is $150/month
- Utilities and insurance come up to roughly $600/month
- You plan to travel and will average out to $200/month
- You consider your current lifestyle and it will cost $1500/month to maintain
With everyone summed up, the total per month you will need is $2,850. This is considered in today’s dollars, so fast forward 30 years later with the assumption that inflation will run around 2% and the final number becomes roughly $5150 a month.
If we adjust CPP and OAS for inflation and make the assumption that 30 years later the government is still paying it, and you’re collecting the maximum amount, the shortfall will be $2,180.
Saving, Saving, Saving
Without a job, how do you make up a $2,180 shortfall? Well there’s a couple of ways.
1. The Old School Way
Figure out how long you’ll live for, multiply that out by the amount you’ll need. This is the conservative approach. To maintain that lifestyle will require $26,160 a year. With inflation and an expected 20 years left to live the requirement would be $635,620.
This method leaves little room for error. In the last few years, the fear will be outliving your savings and might require even more scaling back of spending. For many Canadians, who are conservative, this is by far the most popular approach.
2. What Financial Planners Say
Assume a 4% withdrawal rate on your capital while at the same time investing it to keep up with inflation. The ideology is that your principal will be maintained forever while the 4% supports your lifestyle indefinitely. The amount that needs to be saved to support the above lifestyle is $654,000.
This method requires slightly more money saved, but the idea is that it’s supposed to guarantee your income forever. If you live longer than your expected 20 years after retirement, at least you won’t be broke. This approach is the most sought after by people trying to reach financial independence. The greatest fear here is that the capital depreciates too fast or suffers losses during retirement. Those with anxiety rarely trust this methodology.
Where Do I Get It?
Now the million dollar question (or $600,000 question) for everyone is how do we get over $600,000 in savings? For most Canadians that are 30 years away from retirement, their savings is probably much less than a $10,000. That’s a problem.
The only way to really get there is to save money and that has become a problem for many Canadians in recent years. Recent surveys have shown that Canadians are among the worst savers across the ENTIRE world! With a paltry savings rate of only 0.8% on income earned, we’re making Americans look like Scrooge (they save 6.0%). The only country that saves less are the Chinese. They are too obsessed with real estate and Canada Goose jackets to care.
Once you really sit down and plan for the future, it really opens your eyes as to what you need to do now. People are to busy living with FOMO and subscribing to YOLO. The sad truth is practicing YOLO means when you’re old and saggy, your life is going to suck. If you think your life sucks now, it’s going to get worse. You can FOMO now, but pretty much you can miss out on everything in retirement and expect to live on Mac & Cheese for the rest of your life. Quite a pretty picture isn’t it? Or maybe you just don’t expect to live past 50, who knows?
How To Get There
Saving $650,000 over 30 years is pretty hard. Let’s just think about it. We plan to buy a home, we also want to maintain our standard of living and after all that it’s hard to come up with $20,000 a year that we can put away. That’s over $1600 a month that needs to get saved. For most of us that’s the cost of rent or a mortgage. There’s nothing left over after that.
So what are the alternatives? Well without risk there comes no reward. That’s been the motto in life. If you’re the ultra conservative type, you’ll have to live a very frugal life and perhaps even lower your standard of living to achieve the $600,0000 in savings for retirement.
For most Canadians that do invest, we invest in a very conservative manner using fixed income like GICs (Guaranteed Investment Certificates). We use GICs because we fear losing money. Losing a hard earned dollar is more painful than a root canal for most Canadians.
Those that strive to FIRE or have a greater risk tolerance know that investing in a diversified balanced investment portfolio has been the way to go. Over the long run, stocks have always gone up. There has NEVER been a 20 year time span where stocks have actually gone down. That makes stocks a very good investment choice for those with a 20 year horizon.
Just what does investing in stocks actually do for growth in savings? Let’s take a look. Below is a chart showing someone that saves money in their bank account doing nothing. The second person invests using GICs yielding 2% a year. The third person uses a balanced diversified portfolio yielding 6% a year. Each person continues to invest the same amount every year over 30 years to get to $600,000.
So what does the chart tell us? It’s quite striking actually. Notice the amount of money each person needs to save each year to get to $600,000. The person that saves money and does nothing with it needs to save $20,000. The person that uses a GIC yielding 2% needs to save $14,800 only. That’s more than 25% less than the person doing nothing. The person who invests using a balanced portfolio only needs to save $7,600 a year. That’s 62% less than the saver who does nothing and roughly half of the saver investing with GICs.
Clearly saving $7,600 a year, or $633 a month is much more doable than finding $1,666 a month. But even $633 a month for many Canadians can be a stretch. In fact, most Canadians will be lucky to save $100 a month.
So what happens when we delay our savings until the kids are grown up and the house is paid off? That means we only have 10 years to save. First off I’m not even going to show you saving without investing or using GICs. The fact is you just won’t get there.
What makes this very scary for many Canadians who are planning retirement is that when savings are delayed, the amount needed to save doesn’t go up linearly but exponentially.
A couple trying to save for retirement with a 20 year horizon needs to save $15,100 a year investing at 6% over 20 years. That’s more than double the original $7,600 a year. If saving for retirement is delayed to the last 10 years when the kids are gone and the house is paid off, the amount necessary to save is staggering. $40,100 invested at 6% a year. That’s almost 6 times the amount you need to save if you started 20 years prior.
Putting It In Perspective
The reality for many Canadians is that we are already behind the ball. What many Canadians have done are rely on their homes to retire on. But as this analysis shows, owning the home and then saving later on in life just isn’t going to cut it. Canadians have to find a way to save while paying off their homes to achieve their retirement plans.
There are many things that need to be done by the current generation that is probably out of the normal. They have to think about their future first, rather than thinking about the present. What does this mean?
- Prioritize your own retirement savings before RESPs and the kid’s programs. Yes, this feels backwards, but the reality is that every dollar counts. The kids have much greater potential to correct for your own mistakes because let’s face it, they are much younger and have the time. Teach them personal finance rather than piano lessons and they’ll be more successful than you in life. Guaranteed.
- Dial back expenditures on the home. Yes, I love granite counter tops and hardwood floors just like everyone else, but we don’t need to go overboard. Like fashion we don’t need to change all our doors to barnyard sliders and certainly we don’t need chandeliers in our basements and bathrooms. Let’s keep the renovations to a minimum based on need rather than vanity. The house is going to cost a lot more than you imagined in the long run.
- Stop borrowing to spend. The opposite should be true. Stop spending so you can save. Canadians are being too optimistic if they think they can save just 0.8% of their income to retire. Be proactive now so that you are not left scrambling when it’s too late.
If you’re already ahead of the curve that I’ve shown then congratulations. You’re probably a 1% saver in Canada. If you’ve got a defined pension and it’s going to give you $5,000 a month you need to retire, then ignore everything that I’ve written. You’re the envy of every Canadian.
These are the harsh truths that Canadians face with their personal finances. It’s not a pretty picture. The fact that too many Canadians have less than $10,000 in their bank accounts should be alarming. We’re heading down a slippery slope. Something I hope the future generation doesn’t have to deal with. Let’s be responsible and give our children a chance.