This article is a part of a month-long Morningstar Money Challenge. You can find the details here.
We’re fortunate in Canada. We all have Old Age Security and the Canada Pension Plan/Quebec Pension Plan to help finance our retirement. Some additional sources of funding could be employer-sponsored pensions. Many retirees, out of necessity or choice, continue working at least part-time in retirement. In addition to all of this, retirees draw on their savings and investments, whether in RRSPs, TFSAs or non-registered accounts. To make sense of all of this, it is essential to have a road map, a plan on both how to amass enough to make sure you have the retirement lifestyle of your choosing, and once in retirement, a plan on how to navigate.
Let’s start with a couple of important questions: How much do we need to save? And how do we get there?
In attempting to help investors address the "how much is enough?" question, Fidelity Investments created retirement-savings targets by age. Their research suggests that investors could reasonably target a retirement nest egg amounting to 10 times their ending salaries at age 67. By age 35, investors should aim to have set aside a retirement kitty equal to 2 times their current salaries, with retirement assets escalating to 4 times current salary by age 45 and 7 times salary by 55.
“For people who are in retirement savings mode, there's no shortage of rules of thumb available to gauge savings rates and, by extension, the soundness of an investment plan. Investors may have heard that they should be saving 10%, 15%, or 20% of their salaries. Those guideposts are useful starting points, but they're blunt instruments: Asset allocation, income-replacement rate assumptions, and the expected length of retirement all have an impact on whether a pre-retiree's savings rate is adequate. For that reason, it's valuable to assess your retirement preparedness using your own data,” Morningstar’s director of personal finance Christine Benz says.
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She offers some steps to help you get there.
Step 1: Gather your inputs
The first step is to pull together data about your current plan, including current investments earmarked for retirement; annual retirement savings; expected retirement date; and other expected income sources in retirement.
Step 2: Find your current asset allocation
Because the asset allocation of your portfolio will be a key determinant of what sort of return you earn over your time horizon, it's helpful to start with a clear view of your current stock/bond/cash mix. (Don't include any assets you have earmarked for non-retirement goals, such as college savings.)
Step 3: Plug it all into a holistic calculator
Because savings targets will be so sensitive to individual-specific inputs, online calculators that allow investors to adjust these inputs are the best way for investors to determine the adequacy of their savings rates. Most of the major financial-services providers offer some type of tool to gauge retirement preparedness.
Step 4: Customize and course-correct
As you work with these calculators, it's also valuable to tinker with the inputs--rather than relying on any preset inputs--so that the calculator is factoring in your own situation. If it looks like you'll fall short based on your starting assumptions, you can make adjustments to help improve your probability of success.
Among the variables you will be able to customize--and that have a big effect on the success or failure of your retirement plan—Benz notes:
-Income-Replacement Rates: Generally speaking, higher-income workers and heavy savers will need to replace a lower percentage of their working incomes when they eventually retire than will lower-income workers with lower savings rates.
-Anticipated Retirement Age: As discussed here, being willing to work longer, assuming you can do so, delivers a helpful three-fer: accumulate savings, while also increasing benefits and decreasing portfolio withdrawals. All three steps can have a powerful effect on a portfolio's staying power.
-Life Expectancy: Predicting your own life expectancy is the trickiest business of all.
-Expected Rate of Return: Be conservative here!
-Savings Rate: This will be a bigger swing factor if you're earlier in your savings career and have more time to benefit from compounding.
“Because encountering a bear market early in your retirement years can have a devastating impact on portfolios that are too aggressively positioned, it's important to have a sizable dose of bonds and cash by the time you retire. Because no one can predict the future, there's no right answer about how much any of us should have in stocks, bonds, and cash,” points out Benz.
Morningstar's Lifetime Allocation Indexes, developed in conjunction with asset-allocation specialist Ibbotson Associates, provides asset allocations for investors of various expected retirement dates and risk tolerances.
Another key task for retirees and pre-retirees is to determine a realistic portfolio withdrawal rate. Benz’s book 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances has a section devoted to this. This article--an excerpt from the book--includes step-by-step guidance on sequencing your withdrawals. Now you have a plan!
Additional Reading
How to Set Up Retirement Income Sources
Will You Have Enough to Retire
On Retirement Day How Do Investment Needs Change?
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