How Much Do I Need to Save for Retirement?
17 Aug 2022.
Planning and saving for retirement can be a stressful time. We’re often told we should be saving as much as possible over the three or four decades of our careers to help finance our lives in retirement. But as we begin to reach retirement age, how do we know if how much we’ve saved is enough?
There are many rules of thumb when it comes to retirement savings, but they can make anyone anxious and feel like they’re behind your retirement goal. Am I saving enough? Did I have 3x my salary saved by 40? 8x by 65? Is that in addition to my emergency savings? You may ask just how relevant are these retirement saving rules of thumb in today’s world? Let’s take a look at a few rules of thumb and see how they measure up.
The 4% Rule
The 4% rule is a popular principle that states in order to have income for life, you should withdraw no more than 4% of your retirement savings per year. If your investments grow by 4% a year and you don’t withdraw more than that, you will have income for life as you are just withdrawing gains and leaving the principal investment untouched. Therefore, 4% is a safe withdrawal rate.
For illustrative purposes only
Financial planner, William Bengen, first articulated the idea in a 1994 study titled, Determining Withdrawal Rates Using Historical Data.1 The 4% figure is based off average market returns over a 68-year period from 1926 to 1994 – a time frame that included three major recessions that is assumed to reflect the ups and downs of an economic lifecycle. Many have followed this rule of thumb for decades, so what’s the issue? Like many rules of thumb, it doesn’t consider that a person’s life changes in retirement, much like it does during their working lives. A person’s life and expenses in their twenties is much different than their thirties, which is again much different than their forties or fifties.
This rule assumes a standard 50/50 or 60/40 stock/bond portfolio allocation but doesn’t consider investment-related fees or the tax implications of withdrawing money from different investment vehicles, both of which would decrease the safe withdrawal rate.
It also doesn’t factor in extra sources of income generated in retirement from rental properties, workplace pensions, the Canada Pension Plan (CPP) or Old Age Security (OAS) in Canada, which would increase the safe withdrawal rate.
Moshe Milevsky, a finance professor at York University’s Schulich School of Business, laid out his concerns about the 4% rule at a Financial Planning Association of Canada webinar in 2021. He asked what if things other than inflation change or the stock market declines substantially the following year? In Milevsky’s view, the 4% rule requires one to pre-commit to the plan for the next 30 years, never adjusting no matter what.
The “You’ll Need 80% Of Your Annual Income” Rule
This rule of thumb assumes you’ll need 80% of your pre-retirement income to live on when you retire. The 20% decrease accounts for expenses you no longer have, like commuting, business clothing, and perhaps going out for lunch – as well as no longer paying into CPP, OAS, or Registered Retirement Savings Plan (RRSP). But this rule came from a time when many retirees had defined benefit (DB) pension plans, and this isn’t really the case anymore. The number of private-sector DB pension plans shrank from 21.9% in 1997 to 9.2% in 2017, and the trend continues downwards. It also assumes things like home ownership with no mortgage – 25% of Canadians 65+ rent, while the percentage of homeowners with no mortgage almost doubled (from 8% to 14%) between 1999 and 2016 – not to mention it ignores the dynamic spending habits of retirees. You’re much more likely to want to travel or take that cruise when newly retired as opposed to mid-nineties.
So, rather than using an outdated rule of thumb, the better approach would be to discuss with your financial advisor what your individual costs will look like – which expenses will remain, and which won’t. This will give you a better idea of your personal savings and the retirement income you will need and a retirement savings goal.
The “100 Minus Age” Rule
This rule states that you should subtract your age from 100, and that’s the percentage of stocks you should have in your portfolio – i.e., 60% at age 40 and 35% at 65. The idea behind this rule is that the older you get, the less time you’ll have to wait for the market to bounce back.
Like many rules of thumb, it’s a good place to start, but there’s not much to it aside from a catchy name. In fact, an analysis by Wade Pfau and Michael Kitces shows that the 100 minus age approach has delivered the worst outcome in a poor stock market, depleting your retirement savings 30 years after retiring.
Simply assuming that age alone decides a person’s asset allocation doesn’t take into account factors like the investor’s risk tolerance (some people simply cannot stomach the ups and downs of the stock market), goal timelines, or unique circumstances.
And, most importantly, it also doesn’t consider the fact that we’re all living much longer lives than we were even a few decades ago – someone who’s 60 may or may not want more than 40% of their portfolio allocated to stocks.
The Bottom Line
Rules of thumb are great when speaking to large groups of people, but they don’t take into account the particular needs of an individual. By combining the lifetime income feature of a defined benefit pension plan with the flexibility of a mutual fund, Longevity is an open-ended product tailored to retirees that provides lifetime income streams.* With the freedom to continuously invest or redeem at any time,** you have the freedom to decide what’s best for you and your particular needs.
Speak with your financial advisor to see how Longevity can fit into your portfolio, or contact us if you’d like to chat with our retirement income specialist.
1. “Determining Withdrawal Rates Using Historical Data.” William P. Bengen, Journal of Financial Planning, October 1994. https://www.financialplanningassociation.org/article/journal/MAR04-determining-withdrawal-rates-using-historical-data
* Income in the form of Fund distributions is not guaranteed, and the frequency and amount of distributions may increase or decrease.
**The Fund has a unique mutual fund structure. Most mutual funds redeem at their associated Net Asset Value (NAV). In contrast, redemptions in the decumulation class of the Fund (whether voluntary or at death) will occur at the lesser of NAV or the initial investment amount less any distributions received. You can always access the lesser of unpaid capital (initial value of your investment less any income payments made) or your net asset value. Fees may apply.
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