Preparing to retire
Retirement is one of the major events in many people's lives, involving not only a change in lifestyle but in many cases a reduction in income or change in sources of income. These changes generally require consideration in the pre-retirement period.
How much will you need
Estimating your needs
The most common question asked by those who invest for retirement is, “How much money do I need to retire?” That cannot be answered until you answer the question, “How much money do you need to spend each year?”
The answer to that question – and the answer is entirely up to you – is the critical ingredient when it comes to knowing how much is needed to retire. No one can tell you what sort of lifestyle you want to lead. That is your personal decision. Some people are happy with a paid for house and $2,000 a month to spend. Others insist that $100,000 a year is what they really want. You must decide what's right for you. Once you have done that, a ballpark estimate for how big your portfolio needs to be isn't too hard.
Trying to answer the question can bog you down in a paralyzing long list of questions:
- When do you want to retire?
- Do you plan on downsizing your home?
- Will you sell your expensive city home and move to the country?
- Will you be moving to a retirement community?
- Will you rent or own a vacation home?
- Will you spend time in warmer climates? How long?
- Do you plan on any major purchases or renovations to your home?
- Will you travel? How often? How far?
- Will you stay in costly hotels or will a B&B do?
- Will you work part-time while retired?
- Will you become more active in your community?
- Will you get involved in volunteer work?
- Will you be supporting or helping to support any family members?
- What hobbies will you pursue? What will they cost?
- Will you join a golf club? Or buy a boat?
- Will there be much dining out? Theatre? Movies?
- Do you want to spend your capital over your lifetime or do you want to leave an estate
- And so on. And so on. And so on.
You can start to try to answer these questions and get bogged down or you can try a more simplified approach.
- Start with your take-home pay and add back expenses that will not occur or will be reduced when you retire. When you retire you will not be making Canada Pension Plan (CPP) or EI payments any longer. You will not have a work related clothes budget nor a work related transportation budget.
- Add in the costs of what you might do in retirement, eg. "I want to take a Caribbean cruise every January which will cost me a total of $2000." If you don't know what you want to do, don't worry about it at this point.
- First, if you estimated how much you want to spend net of taxes, you need to bump it up a little to get back to pre-tax figures. Adding 25% is roughly right; you can refine your estimate by using a more precise tax estimator.
- Now deduct what pensions you will receive in retirement, because your portfolio won't have to produce that income.
A simple rule of thumb is that you can take roughly 4% from the starting value of an investment portfolio, raising it each year by the inflation rate, without courting disaster. (These concepts are discussed further in the article on sustainable withdrawal.) If your portfolio will need to support you for a period longer than 30 years, e.g. because you are an early retiree, then shave a little from the 4%, say 3.3% instead. History is not a perfect guide to the future, but barring nuclear war, natural disasters, or complete economic collapse, 3.3-4% should be your guide. That gives a convenient way of estimating the total funds required as 25-30 times what the portfolio needs to produce each year.
A simple example: The 63 year old Mr. Magoo wants $40,000 per year after taxes to spend in retirement. Before tax, it's about $50,000. CPP will pay $6,000, Old Age Security (OAS) $5,000, and his company pension $11,000 per year, so his investment portfolio needs to generate an extra $28,000 per year in retirement. At a 4% withdrawal rate, his portfolio should be worth at least $700,000.
You may also wish to consider purchasing an annuity if you wish to make sure you have a secure income stream.
Since their purchase is irreversible, always seek professional advice before you purchase an annuity.
Probability of ruin
Milevsky has introduced the concept of the probability of ruin - that is, that a retiree may run out of money during retirement. The calculation can be performed with tools available from The QWeMA Group, including their free calculators. Alternatively, a simple Excel spreadsheet based directly on the IFID paper is available here.
When do you want to retire?
Some people plan to never retire. Others would like to retire early. As with the How Much Will You Need question, the answer is entirely up to you. However, taking early retirement does affect the amount of CPP that you will receive as does taking CPP early..
What kind of lifestyle do you want in retirement?
Many people focus on the money aspect of retirement without thinking about what they will do with the 40+ hours a week that will be theirs alone. You can now do what you want, when you want, and how you want. Maybe you'll do the things that you've always dreamed of doing. It's not easy to gaze into the future but there is a at least one reality that is certain: you will not have the ready made social network of the work place. You may still keep work place friends but not the social network. You will have to replace that social contact.
Where will you live
For most people, this decision is not ever made. They just stay where they were in their last job location. That is normal because people don't enthusiastically embrace change. For many, it is a desire to remain close to family and friends. This is totally logical.
However it does present a retirement challenge. Most working people live in high cost cities. Therefore this choice imposes a higher hurdle in terms of retirement income. This can also delay retirement.
Another frequent choice is to sell the city home and retire to "the lake". Here they have already established a social community, often with deeper and longer ties than their city location. The equity from the home can underwrite the relatively low cost of living year round in a seasonal location. There are two issues with this choice. First, the close availability of emergency care can become a life or death situation during retirement. Second, the "lake" can sometimes be desolate and isolated during the late fall and winter. Satellite TV, long distance phone plans and the internet can all work to alleviate this.
Some who have the financial means will retain a modest place in the city for the winter. Those with more flexibility will become snowbirds for the harshest winter months.
Finally there is the choice to relocate permanently to a snowbird location. This is covered in another section. It is the most radical of the choices and comparable in costs to "the lake" choice with some of the same tradeoffs.
Sometimes people just want to move to a smaller city within easy commuting distance of their original location. This has the challenge of establishing a new social life and often trying to establish appropriate medical care.
The key element to all these choices is to find the one that most likely would work for you and to make the appropriate financial plan to enable it to work. In most cases, it is a good idea to try it out before making a big financial commitment, even if this raises some higher short term expenses.
What will you do
There are five broad parts of anyone's life:
- Philosophy or Religion
and most psychologists recommend maintaining a good balance between the time spent on each on. Those that establish a good balance usually have no problem with retirement. The 40 or so hours devoted to gainful employment are easily absorbed by the other four parts. And even some continuing professional activities might contribute to the retirement lifestyle.
The important thing is to develop a new pattern to replace the pattern necessary for work. Those without such a pattern tend to drift in retirement. The biggest problem they have is the feeling of no longer contributing or being involved.
So the best way to prepare for retirement is too have a job jar overflowing with things that your are dying to get at if only you had the time. Sometimes people become active in charitable work, others in social settings (e.g. playing bridge or playing golf), while still others find intellectual pursuits such as reading or engaging others on the internet on "meaty" subjects, or even developing wikis!
It is fair to say that if you have no burning desires that are unfulfilled while you are working, you should probably keep on working.
There is no doubt that the day you walk out the door of your place of employment with your box, you will feel melancholy. Behind you is a way of life that sustained you in many ways for many decades. You will miss the camaraderie for your workmates. You will miss the habitual nature of the job. You will miss the coffee and lunch breaks. You will miss the company picnic and the golf tournament.
This is a transition that must be managed. Rather than focusing on all these things that you will miss, you must focus on your bright future and all the new things that your freedom will enable you to do. No matter how smart and adaptable you are, you will find the first six months to be the hardest. This is true in any change of job, and the one you are going through is the biggest.
So when you find a particular routine to have left a big hole in your life, you need to replace it. Maybe that coffee first thing with the workmates is it. So you need to head out to Tim Hortons (this is a Canadian investment site: TSX: THI) for a coffee. Eventually you will get to know the regulars. Through networking, you will develop a whole new set of relationships. Then try Starbucks and see how different it is.
If it is the work routine, maybe you need to volunteer to do the kind of work for a local charity. It does not have to be 40 hours. As little as 10 hours might help with the transition. And you will develop a new set of relationships. You can also keep in touch with other retirees. They will be fighting the same demons.
Within a year or so, you will be saying: "I cannot understand how I ever found the time for forty hours of work every week!" This too shall pass.
- M.A. Milevsky, Sustainability and Ruin, IFID Center Research Magazine, April 2007.
- "The QWeMA Group". http://www.qwema.ca/. Retrieved February 10, 2017.
- "CALCULATORS BASED ON QWEMA ALGORITHMS". QWeMA Group. http://www.qwema.ca/calc_QWEMA.html. Retrieved February 10, 2017.
- Jim Maroney, Early retirement available at age 60 for Canadians who meet the criteria under the Canada Pension Plan (CPP) Act,IncomeTaxCanada.net, Viewed October 20, 2009