How much do you need to retire well?

You probably don’t need a million dollars. Here’s a simple way to find your own magic number.

(Photo: Carl Pendle/Getty)

Chances are you’re more concerned than ever about whether you’ll have enough to retire. Given the uncertainty about the economy, stock markets, housing costs, pensions and interest rates, many of us are questioning our original retirement targets. Even the traditional age of retirement is changing. Mandatory retirement at 65 is becoming a thing of the past, and the government recently delayed the onset of Old Age Security payments to age 67.

We’re living longer and longer, and our money has to go further. Perhaps you have been advised that the new magic number for retiring comfortably is an astonishing seven figures. So, how much is enough now?

Coming up with a figure can be frustrating. We all have different financial circumstances, so a one-size retirement doesn’t fit all. Many retirees achieve comfortable middle-class retirements with only a few hundred thousand dollars. Others set much higher targets. The good news is, it’s not too hard to get a rough idea of what is right for you. There are two steps: First, you figure out how much you will be drawing from your nest egg each year when you retire. Then, you can figure out how big your nest egg needs to be. You can do this calculation quickly, using guidelines based on research. We’ve even summarized the results in a handy table below.

In the calculations that follow, we assume you’ll be retiring at age 65. Why did we choose 65, rather than 67? Because, until recently, age 65 has been a kind of standard retirement date for many jobs and the age at which most Canadians start receiving all of their government benefits. It’s true that younger Canadians can now expect to retire later, however the average retirement is currently about 62. People who are now in their 40s or early 50s are lowering their expectations of when they can afford to retire, but the reality is that will likely mean retiring at 65 rather than 62.

(1) Typical annual amounts in today’s dollars, assuming no traditional defined benefit employer pension.
(2) Spending before taxes, assuming the seniors own their own home mortgage-free.
(3) Assumes long careers at average wages, although these amounts are less than maximum benefits. Current maximum benefits per senior per year: OAS is $6,481 and CPP is $11,840 for a total of $18,321. You’ll get maximum CPP if you start CPP at age 65 and had worked for almost 40 years at average pay or better
(4) Provides for an annual withdrawal from the nest egg of 4% at retirement plus inflation adjustments. (The factor 25 equals 1 divided by 0.04.)
(5) Don’t count the value of your home equity or cottage. Canadians born after March 1958 will have the start of OAS payouts delayed and will need to compensate proportionately. If your start to OAS is delayed by two years to age 67, then you will need an extra $13,000 to offset that.

Sustain your lifestyle

To start with, you need a rough idea of how much you’ll spend each year in retirement. You’ll probably want to sustain a lifestyle that’s equivalent to what you enjoyed in your working years—“the standard to which you have become accustomed.” Fortunately, you’ll find that lifestyle costs a lot less in retirement. That’s because a lot of mid-life expenditures will disappear: hefty mortgage payments, the cost of raising kids (and helping with university tuition), transportation and clothing expenses for work, EI and CPP deductions from your paycheque, and, of course, the burden of saving for retirement. Once you’re retired with your home paid for and your kids financially self-sufficient, you can strip out those mid-life costs from your budget without impacting your lifestyle. And, with a lot less income, you pay a lot less income tax, and you get seniors’ tax breaks to boot. Things are a little trickier for seniors who don’t own a paid-for home and never had kids. Folks in that situation didn’t have the cost of raising kids or making mortgage payments, so less spending can be stripped out without making a big impact.

To get a rough idea of how much you’ll be spending each year in retirement, you can start by calculating what percentage of your working income you’ll need to replace. While many financial advisers say you need a replacement amount of 70% or more of your working income, research shows most couples get by comfortably on 50% to 60%. Some live well on much less. One B.C. couple, for instance, retired when both members were in their 50s, and lived on just 16% of their working income. In their case, both earned high salaries in the technology industry. They now live on about $40,000 a year, and enjoy middle-class comforts such as a paid-for three-bedroom home in a good neighbourhood, a car and vacations.

Look at actual dollars

For a more precise estimate, you can look at your actual dollar spending. If you’re many years from retirement and don’t have a clear idea of your retirement lifestyle, this might be hard to do. Statistics Canada helps here with data on what seniors actually spend. According to the Survey of Household Spending, 2009, the average senior couple spends $54,100, while median spending for senior couples is only $39,400. From these statistics, and from talking to retirees and their advisers, it’s fair to estimate that a typical middle-class retirement costs roughly $40,000 to $60,000 per couple per year, while an “upper middle-class” retirement costs in the range of $60,000 to $70,000 per couple per year. These numbers assume you own a paid-for home.

Going solo

If you’re single, expect to spend more on a per-person basis for an equivalent lifestyle than a retired couple. That’s because couples realize economies of scale by doubling up on accommodation, transportation, food and travel costs. Malcolm Hamilton, a retirement expert and partner at Mercer Human Resource Consulting, estimates that it costs a single retiree roughly 70% of the cost of a retired couple to live an equivalent lifestyle. One way to estimate the cost of a single senior lifestyle is to take the figures provided for couples and apply Hamilton’s 70% factor. Doing this puts the annual cost of a middle-class single retirement at about $28,000 to $42,000, and the cost of an upper middle-class single retirement at $42,000 to $49,000.

Once you have a rough sense of what retirement will cost, the next thing to do is figure out the portion covered by government benefits. Expect payouts from Canada Pension Plan (CPP) and Old Age Security (OAS) to give you a leg up, but there will most likely be a gap to cover from your own savings. If you start drawing these benefits at 65, you can earn up to $6,481 a year from OAS and $11,840 from CPP, for a maximum combined total of $18,321. (The government’s plan to start transitioning to OAS payouts at age 67 instead of 65 affects those born after March 1958.) Benefits paid to you from CPP are based on how many years you and your employers contributed, size of contributions and when you start the payouts. Few Canadians earn the maximum CPP amount (basically, only those who work close to 40 years at an average wage or better and don’t start drawing before age 65). For a ballpark figure, use a combined government benefits number of about $15,000 if you don’t meet the conditions for full CPP. If you work a substantially shortened career or earn below-average wages, you should use a lower figure.

After deducting what you can expect from government, the rest has to come from your nest egg. This assumes you don’t have a generous defined-benefit pension plan. A couple who expects to live modestly on $40,000 a year might only have to cover $10,000 from their savings. But if you and your spouse want to spend $70,000 a year, you may have to cover upwards of $40,000. Singles may need to dig into their wallets for anywhere from $13,000 to $34,000 a year. But how big does your nest egg have to be to support that?

How much to withdraw?

There’s quite a bit of research, based on historical returns, that finds if you retire at age 65, you can withdraw 4% a year (plus inflation adjustments) from your nest egg with only a small risk of outliving your money. This assumes you invest in a balanced stock and bond portfolio and earn market returns. (Sorry, you don’t get to count the equity in your home.) Put another way, your nest egg should be 25 times the size of your annual withdrawals.

Many people are surprised at this low “sustainable” withdrawal rate. It is set conservatively to cover the possibility of you living an exceptionally long life while suffering poor returns on your portfolio. Odds are you’ll do much better and die with a hefty estate, but it’s better to allow for a near worst-case scenario. Apply that factor of 25 to your retirement spending needs and you get a rough estimate of the size of portfolio you’ll need for retiring at age 65.

While the 4% sustainable withdrawal rate has you covered in most circumstances, there’s a small risk it won’t. To be safe, you could go with a lower 3.5% withdrawal rate (requiring a nest egg 28 ½ times the size of your annual withdrawals) or reduce your withdrawals if your portfolio takes a beating. In case things go drastically wrong, it’s a good idea to have a backup plan, such as tapping the equity in your paid-for home. If you run short of funds late in life, but want to stay in your home, you could draw on a home-equity line of credit or a reverse mortgage. Many Canadians finance the costs of moving to a retirement home or nursing home from the proceeds of selling their home.

Can you retire earlier than 65?

What if you want to retire earlier than 65? Clearly, you’ll need a bigger nest egg. Not only will you be drawing from your nest egg over a longer retirement, you’ll need to bridge the period until you can collect full government benefits. As a rough way to adjust for early retirement, add your annual spending requirement for every year you retire early on top of the amount you would need for retiring at age 65. Say you need $500,000 to retire at age 65, you expect to spend $50,000 a year in retirement and you want to retire at age 62. Add $50,000 for each year of early retirement onto the $500,000 target, which would bring the early retirement nest egg to $650,000. You can draw early CPP at a reduced rate to help cover the cost of early retirement, but that’s offset by lower CPP payouts after age 65. For the purposes of rough calculations, it is simpler to assume the amount of waiting until 65 to draw CPP rather than making two offsetting adjustments.

The bottom line is, the size of your nest egg depends on how much you plan to spend. The cost of a middle-class retirement at age 65 can vary from $250,000 to $750,000 for a couple, and $325,000 to $675,000 for a single. An upper middle-class retirement will cost more. If you have expensive plans, you might conclude that you should target seven figures after all. As always in these matters, you might want that size of nest egg, but you don’t need a million dollars to retire.

David Aston, CFA, CMA, MA, is a retirement expert at MoneySense magazine