Many Canadians aren’t sure how much it would cost them to sustain their livelihoods when they eventually retire. Understandably, deciding how much you need to save for retirement may not be so straightforward and depends largely on your retirement goals. To arrive at a savings goal estimate, you need to consider factors such as living expenses, lifestyle, dependents, financial liabilities, medical needs, amongst others.
Your retirement days are an important time in your life, and planning becomes an essential step to ensure that you have the funds to cater to your needs when you are no longer working. An excellent place to start is by identifying the possible sources of retirement income.
Government pension plans in Canada include the Canada Pension Plan (CPP), the Quebec Pension Plan (QPP), and the Old Age Security (OAS). To qualify for a monthly CPP retirement income, you have to be at least 60 years old have made at least one CPP contribution as an employee. Usually, the CPP contributions are made directly from your salary before you receive your paycheck. This retirement income is determined by your earnings, contributions to the CPP, and the age you retire –– usually between 60 and 70 years of age. Additionally, the more you delay applying for a CPP until 70, the more amount you receive. For example, as of 2021, you could receive the maximum monthly amount of $1,203.75.
On the other hand, the Old Age Security (OAS) is a government benefit for Canadians who are 65 years and above. You do not need to make any contributions into the OAS, and you do not need to have worked to become entitled to this retirement income. Generally, to receive this monthly benefit in retirement, you should have lived in Canada as a citizen or permanent resident for a minimum of 10 years. If you delay your OAS benefit till 70, you would be able to receive the maximum amount which is $615.37 as at 2021. You qualify for this if you have lived in Canada for 40 years after your age of 18, and a fraction of it if you have lived in Canada less (i.e., 30 years would qualify for 75% or 30/40). Of course, OAS is subject to a clawback provision if you make too much income. There is an additional Guaranteed Income Supplement (GIS) benefit for low-income pensioners in Canada.
As an active employee with most organizations, you may be offered a means to save towards your retirement through a defined contribution pension, a defined benefit pension, or other group retirement savings plans.
Why would you need personal retirement savings when you have government pension plans? Well, mostly because the retirement income from CPP and OAS may not be enough to cater fully to your financial needs and expenses in retirement. This would depend on your expenses and your general way of life. You can put personal savings in a registered retirement savings plan (RRSP) or even a tax-free savings account (TFSA). If you are investment savvy, you could use a self-directed trading account and invest directly in stocks, bonds, mutual funds, etc., as this gives you an opportunity to grow your retirement savings.
Ideally, the combined income from these different sources in retirement should be sufficient for catering to your daily living expenses. It may be beneficial also to plan to accommodate emergency expenses such as medical bills or home repairs. There are insurance policies that may provide financial relief for events such as critical illnesses in old age.
Now that you know the different ways you can receive income when you retire, the next step is to determine the amount you need to save, what age you want to retire, how long you expect your retirement period to be, and your retirement expenses.
To estimate your retirement expenses, you can work off your current expenses for items such as feeding, rent, mortgage, loan repayments, and clothing. Expenses such as transportation costs may reduce significantly as you would not be commuting for work as you used to. However, other items like travel costs, medical expenses may increase depending on your retirement goals and medical history.
The age you retire and how long you intend to depend on retirement income would also impact how much money you need to save. For example, you may need to save more money if you retire earlier than if you decide to retire much later.
You also want to consider economic factors such as taxes on your retirement income and how inflation may affect your purchasing power in retirement. For example, withdrawals from your RRSP are subject to tax. Also, retirement savings using aggressive investment accounts may yield more income in retirement. However, they are also subject to higher risks of losses.
There are several approaches on how to calculate an approximate amount that would be sufficient for retirement. The more common methods are:
The 4 percent rule: This involves planning how much you would withdraw every year in retirement and dividing that amount by 4% to arrive at your savings goal. For example, if you consider $40,000 to be enough for your yearly expenses, you will need to save $1,000,000 ($40,000 / 4%).
The multiply by 25 method: This rule assumes that you would need 25 times your annual retirement expenses for you to retire comfortably. For example, if you determine that $30,000 would cover you annually in retirement, then you need to save up $750,000, which is $30,000 X 25.
The 70 percent of income rule: This method suggests that you would need at least 70 percent of your current income in retirement. So, if you currently live off $80,000 annually, you may need about $56,000 for every year in retirement.
How much you need to save for retirement may differ for every individual. It will depend on how early you retire, your retirement goals, how much money you contribute to and receive from pension plans, any financial liabilities, retirement expenses, and medical needs - amongst other factors. Saving early goes a long way in ensuring that you meet your retirement savings goals. The rules suggested for calculating the savings amount needed for retirement are not entirely applicable for every individual and thus should be used as guidance, and a financial plan from a qualified individual may be in your best interest.
