How do you envision your retirement? Are you anxious and excited to enter that stage of your life; confident you will have the time to do what you want, and enough money to feel confident about your income security for life? Or are concerned you will not have enough savings, and are worried you will face poverty and dependency on others in your later years as you run out of money?
Unfortunately, with so few people retiring with a full, defined benefit pension plan and with the decline in interest rates over the past decade, the reality is more people could face a very difficult and stressful retirement than those that can approach their golden years with confidence and control.
However, with your discipline and commitment, combined with professional advice and a well thought out and crafted retirement plan, there may still be time to enter retirement with the incredible confidence financial security can provide.
Life can be very challenging when you are living pay cheque to pay cheque and there never seems to be anything left over at the end of the month. However, as long as you have the ability to work and earn an income, you can still create success for yourself and manage your cash flow and expenses. Now picture yourself in the future. Imagine being 75, 80 or 85 years old and broke. You could still have Canada Pension Plan and Old Age Security, however, these alone would not likely be enough to pay even the most basic expenses. Do you want to start looking for a job at that stage in life? Do you want to be dependent on someone else?
No matter what age you are today, a retirement plan can illustrate for you how much money you will need at retirement, and how much you should be saving each year to ensure you will be okay. A properly drafted plan will also set annual goals and benchmarks you should meet to ensure you are on track to meet your goals. As you approach retirement, it enables you to understand if you can retire when you want, or, if you need to work longer or adjust your lifestyle as you prepare to transition to a lower income.
If you are retired, a retirement income plan can ensure you are able to stretch your savings out for the rest of your life and follow a reasonable draw down rate to ensure you don’t run out of money. These plans also illustrate benchmarks that need to be monitored annually to ensure your income, and therefore your lifestyle, are sustainable.
Approximately 75% of people will live to retirement age, and when about half of all people age 65 will live another twenty years, retiring without a plan, or being retired without a plan, creates a real risk to your income security. Furthermore, the sooner you start, the better off you will be. As Albert Einstein once said, ““Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
As the rule of 72 indicates, when you divide 72 by the amount of interest you earn each year, you quickly learn how quickly your money will double in value. For example, if your portfolio earns 8% interest, it will double in value every nine years with no further contributions. However, if your portfolio only earns 4%, it will take 18 years for your values to double.
So, a 30-year-old with $25,000 saved in RRSPs, wanting to retire at age 66, would see that value double four times in the next 36 years creating a nestegg of $400,000 with no further contributions, at an annualized growth rate of 8%. That future value at retirement would swell to over $1.3M if he or she continued to save $5,000 annually.
If the same investor was more conservative with his or her investment philosophy and was only able to earn 4% annually, the future values with no additional contributions would be just under $103,000, or $490,000 with the $5,000 annual contributions.
Assuming the same people waited another nine years before starting to save, but then started investing $5,000 annually. The future value for the investor earning 8% would total $400,000 (compared to a value of $1.3M starting nine years earlier) and the one earning 4% would have a nestegg of $221,000 (compared to $400,000). Wait another nine years to age 48, and those future values drop to $187,000 and $128,000 respectively.
If you retire in your mid 60s and want to ensure you will never run out of money and can adjust your future income to inflation, your drawdown rate at the start of retirement should be no greater than 5% of your initial portfolio value. In other words, do not take out more than $5,000 for every $100,000 you have saved. A drawdown rate of 4% would be that much more sustainable.
Withdrawing more than that amount each year creates a risk that you will outlive your savings. A risk you do not want to face later in retirement. Most financial planners or advisors will create a comprehensive retirement or income sustainability plan for free. Take advantage of this opportunity and give yourself the peace of mind you need to retire with confidence and the knowledge that your income is secure for life.
Shawn Pankow is a Certified Financial Planning professional with Pankow Financial Solutions Ltd.