How does someone who is approaching retirement know what assets they need to sustain their retirement income? Are there tools that provide the “magic numbers” based on their specific situation?
There are many easily accessible calculators, but they don’t provide the most accurate answers.
In this blog, we dive deeper into how these calculations are built around flawed simplistic assumptions.
To calculate the assets required to sustain your retirement, you need certain questions answered:
- How long will your income need to last?Most individuals will consider life expectancy when determining this timeframe. Of course, life expectancy is an average. When planning for retirement, it is prudent to assume one will need funds if they live longer than the average. In other words, planning to the average life expectancy will fall short for those who live beyond the average.
- What income will you need?Much has been written about needing 70% of your pre-retirement income. The assumption that goes with this percentage is that retirees will have lower taxable income and more opportunity to income-split in retirement. On top of expecting to pay less in taxes, their needs should theoretically be more moderate as they, for example, no longer need to commute to work or buy work clothes. In reality, determining income requirements is quite challenging and requires some work. See our blog How much money do you need when you retire? for a deeper dive.
- What investment growth should you expect in your portfolio when you retire?This can be approximated by using historical returns for portfolios with reduced equity (stock) exposure and increased fixed income exposure. Portfolios with less risk may be appropriate for retirees. An often-used rule of thumb is to subtract your current age from 100 to determine what percentage of your portfolio you should hold in stocks. The rest would be allocated to bonds. For example, according to this approach, a 70-year-old should have 30% in stocks and 70% in bonds. However, in this very low interest rate environment, and with individuals living longer, a 70-year-old may want to consider holding more stocks and less in bonds. They may also consider fixed-income alternatives to bonds to provide more income to the portfolio. The asset mix of a retirement portfolio matters in estimating investment growth.
- What about inflation?It is challenging to predict mid-term inflation let alone longer-term inflation trends. This is particularly true given that during the Great Recession (2007-2009) and the most-recent pandemic, central banks have been printing money and keeping interest rates low. The FP Canada’s Financial Guidelines published April 30th, 2020 proposes the use of a 2.0% inflation rate when creating financial plans. However, if you were to experience 3% inflation in retirement, when planning for 2%, your retirement experience could be dramatically different.
- What will be your tax rate in retirement?It is tempting to extrapolate current tax rates into the future for simplicity purposes. However, taxes are not static. There are times when governments will increase taxes, and there are times when governments will reduce taxes. Retirees should also consider that their personal situations may change. For example, a married couple today could take full advantage of income splitting, but if one of them should pass away early in retirement, this benefit would be lost, and the surviving spouse would be faced with a potentially higher tax rate.
If calculators account for the variables while answering these five questions, they could more accurately recommend the assets required to retire. However, many calculators and financial planning software over-simplify the answers. To calculate a result, they often use static numerical inputs, not variables and what-if scenarios. They do not plan for the unknowns of reality, and so take a grossly simplistic calculation to provide this so-called “magic number”.
To create a better understanding of whether you have sufficient assets for retirement, a calculator needs to take all of these factors into consideration and it needs to be adaptable. Our proprietary Retirement VIEW approach works in probabilities. When creating plans for clients, we run 10,000 different potential scenarios that encompass many unknowns such as investment returns. Our advisors then manage those scenarios, adapting them as the real-world environment changes. We project inflation expectations at different rates for basic expenses, discretionary expenses, and luxury expenses.
We help retirees understand the level of security in their plan based on the assets they have and the income they need. This exercise is done not only as one approaches retirement, but throughout retirement as well.
We can help retirees find their so-called “magic number” today – the assets required to sustain their income with a high probability of success – and more importantly, ensure that as life’s data points change: inflation, investment returns, needs, taxes, the plan is adaptive and continues to evolve along with retirement life.
At Tall Oak Private Wealth, we help many clients plan for, and enjoy, retirement. Using our proprietary Retirement VIEW, we work side-by-side with our clients throughout their unique retirement lives. We help retirees reduce their financial stress and answer the most important question they will face throughout that chapter: “Am I ok?”
If you would like to hear more about our Retirement VIEW, please click here to schedule a complimentary discovery call.
This material is provided for general information and is subject to change without notice. Although every effort has been made to compile this material from reliable sources; no warranty can be made as to its accuracy or completeness, and we assume no responsibility for any reliance upon it. Raymond James advisors are not tax advisors and we recommend that clients seek independent advice from a professional advisor on tax-related matters. Before acting on any of the above, please contact Tall Oak Private Wealth of Raymond James Ltd., for individual financial advice based on your personal circumstances. Raymond James Ltd. – Member – Canadian Investor Protection Fund.