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?
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 questions, "When do I want to retire?" and "how much money do I need to spend each year?".

When do you want to retire?
Some people plan to never retire. Others would like to retire early.

Your retirement date controls the estimated duration of your retirement. A longer retirement (an earlier retirement date) will cost more.

On the other hand, if you work part time during retirement, you will need to replace less income.

Taking early retirement does affect the amount of CPP and other pensions that you will receive as does taking CPP early. .

How much money do you need to spend each year?
No one can tell you what sort of lifestyle you want to lead during retirement. To the extent that you can afford it, 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. To estimate your retirement income target, there are two general approaches:
 * 1) The quick and dirty income replacement rate approach
 * 2) A range of retirement budget models

The second approach is based on actual personalized retirement budget estimations, rather than a rule of thumb, and is strongly recommended.

When thinking about your retirement budget, consider some of the following questions:
 * 1) Will you be supporting or helping to support any family members?
 * 2) Do you plan on downsizing your home?
 * 3) Will you sell your expensive city home and move to the country?
 * 4) Will you be moving to a retirement community?
 * 5) Will you rent or own a vacation home?
 * 6) Will you spend time in warmer climates? How long?
 * 7) Do you plan on any major purchases or renovations to your home?
 * 8) Will you travel? How often? How far?
 * 9) Will you stay in costly hotels or will a B&B do?
 * 10) What hobbies will you pursue? What will they cost?
 * 11) Will you join a golf club? Or buy a boat?
 * 12) Will there be much dining out? Theatre? Movies?

Portfolio withdrawal target
Only part of your retirement income has to come from portfolio withdrawals or from annuities. To calculate a portfolio withdrawal target, take your retirement income target and subtract government retirement benefits, workplace pension plans. Portfolio withdrawals must cover the shortfall between planned expenses and income from other sources.

Portfolio size
Finally you can convert the portfolio withdrawal target into a portfolio size target. Rules of thumb for portfolio size include 25-30 times what the portfolio needs to produce each year. This is based on "safe" withdrawal rules, often used in conventional retirement planning approaches.

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 on the first day of retirement.

Other planning approaches
There are multiple issues with "safe" withdrawal rules. Other withdrawal approaches to consider are:
 * Variable percentage withdrawal
 * Using annuities

More broadly, safety-first retirement planning is an alternative to the conventional planning approach. Its goal is to guarantee that minimum income needs will be met during retirement. So the dual budget model, which distinguishes essential spending from discretionary spending, is used for planning. Essential spending is covered by matching strategies that rely on fixed income or annuity products. Discretionary spending is met with a "aspirational" or "growth" portfolio, which is invested in risky assets, or a mix of safe and risky assets.

Which planning approach you prefer, conventional or safety-first, partly depends on the question "do you want to spend your capital over your lifetime or do you want to leave an estate"? Said otherwise, are you willing to give up on potential wealth maximization in exchange for more safety and less probability of ruin.

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.

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.
 * Will you become more active in your community?
 * Will you get involved in volunteer work?

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:
 * 1) Family
 * 2) Relationships/friends
 * 3) Philosophy or Religion
 * 4) Leisure/hobbies/sports
 * 5) Work/profession

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.

Adjustment
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.