I’m in a place where I’ve spent the last 10-12 years saving like a chipmunk before an ice age. I’ve been fortunate and have a decent chunk saved up. I’ve got another 15-20 years of work ahead of me but want to find a bit more balance between saving and living during that time.
How does one forecast retirement targets vs current value? In other words, how can you calculate when it’s ok to decrease retirement savings without compromising too much?
You’re looking for what’s typically termed financial independence. There are many blogs on the subject, Mr Money Moustache is one of the most popular, and I like Millennial Revolution for their Canadian flavour. You’ll find quite a lot of information there (MR’s investment series is quite informative).
For a broad forecasting assumption, a 4% safe withdrawal rate is common, which means you can withdraw 4% of your portfolio on any given year with a high probability that your portfolio will outlive you. That essentially means you need to save 25x your annual spending (in retirement).
There is so much nuance to it it’s easy to get overwhelmed. Early Retirement Extreme has a series diving into the math and probability of withdrawal rates, with a multitude of simulations. There’s FIREcalc, which can help with planning but can get complex.
To make it simple, I’ve not put hard limits or goals on savings. Disciplined spending will get me there. Invest in low-cost whole-market index funds, don’t put too much pressure on yourself, and enjoy the journey.
I think the 4% rate is generally only safe if you’re retiring much later (i.e. ~65). I think retiring at 50 will require a much safer withdrawal rate without exposing yourself to too much risk
I believe the original study (Trinity Study) that determined the 4% used a 30 year time horizon. One would have to adjust to their own risk profile and assumptions.
I mentioned ERN’s SWR series because of that. He simulates longer time horizons and I believe finds 3.5% is a more conservative number, but everything will vary by individual.
Ah this is great! Thank you!
Fully agree on the disciplined saving. I basically automated my paychecks to send x% to my various savings accounts. That’s got me this far, but I’m really keen to be more strategic with it. This should help!
Here’s an idea. I’d be interested to know if it makes sense. Let’s assume the 4% withdrawal rate from another comment. Let’s use some numbers for illustration. Let’s say you want to spend $50,000 each year without working. You’ll need to earn between $55 and $60,000 before taxes, depending if it’s coming from RRSPs or interest or dividends. Let’s assume $60,000 pretax. At 4% withdrawal, that requires $1,500,000.
If you’re not at your target ($1,500,000) yet, keep spending your usual amount ($50,000) and save as much as you can. Once you reach your goal, if you’re still working, increase your spending to match the sustainable amount (4%). Let’s say you earn $120,000 after tax. In the year after you reach your capital goal, you spend $50,000 and save $70,000. Let’s say your investments grow by 5%. The following year you’ll have $1,648,500. So you spend $52,224 net ($65,940 gross) and you save $54,060. Because from now on, you can spend $52,224 after tax every year.
If you work another year, your capital will grow to (assume 5%) $1,787,688 and you can spend $56,634 net ($71,507 gross) sustainably. This would be one way to view your goal, reassess each year and adjust for changes in cost of living and lifestyle creep. It’s something I’ve thought about, but I’m far from implementing. Does it make sense to you, OP? Do other readers have feedback?
Can you do this for someone who earns $34k a year and has to spend $33k
Okay, forget what I said about sustainable spending. I’ll make this into a separate post, but since you’ve asked here, I’ll explain how I (a stranger on the internet) think about this.
I understand from your question that $34,000 hits your bank account and that you’re only able to save $1,000 into a savings account of some kind. If this can be extrapolated to a trend, you can expect your investments to grow by $1,000 per year, but also with a compounding return. If you invest it in a savings account, a GIC, a bond fund, a stock fund or a high-flying stock, you’ll expect different returns. I’ll lay that out below. You need to build that up until there’s enough to last for your retirement. There are two ways to think about that: having enough for 20 years (or some fixed duration) or having enough forever, which means some will certainly be left over. I pick 20 years as an example, because that would be age 65 to 85 (median life expectancy) and for 50% of people that’s enough.
But before we figure out how much money you’ll need in retirement, let’s think about what the government will provide. (Disclaimer: government programs could change.) OAS pays you just for living in Canada for 40 years and turning 65. If you do that, you’ll get about $700 per month (in today’s dollars) for the rest of your life, and it’s indexed to inflation. CPP depends on how much you paid in. If you continue earning $34,000, that’s about 50% of the pensionable maximum, so you’d get about $600 per month, indexed, for life. You can increase both of these amounts by starting later, so if you’re not ready to retire at 65, you could receive a higher guaranteed income. $700 + $600 = $1300 x 12 = $15,600. You’re already almost halfway there (but we still need to account for taxation). If that’s all the income you receive, there will be almost no taxes, and the government will also offer GIS, the guaranteed income supplement. I’ll let you look that up.
So now we need to account for taxes. If you want to spend $33,000, you need to earn about $38,000 (depending on your province). You’ll pay $5000 in tax and be left with $33,000 to spend. You’ll need $22,400 of your own money in addition to the $15,600 from the government. Ignoring inflation and investment returns (if your money is in a GIC, they’re roughly the same), you would need $448,000 (22,400 x 20) to create that income. If you’re saving $1000 per year for 30 years, you would need a 15% interest rate / rate of return to make that work. That’s not realistic, so you’d either need to save more, work longer or spend less in retirement. For example, if you have 40 years instead, you “only” need a 10% return.
Here are a couple suggestions for a person in this situation.
- You could invest in an RRSP. This would give you a tax return, which you could also invest. That would boost your savings rate from $1000 per year to $1250 per year. But your tax rate is relatively low, so it’s not necessarily better.
- You could invest in a TFSA. This way, the growth is all tax-free, and so is the income in retirement. Instead of $38,000, you would only need $34,000.
- You could set up two savings accounts. For example, have a TFSA that holds long-term investments and have a savings account at the bank where you can move money back and forth from your checking account. Every month, move $75 to the TFSA. But also move $25 or $50 to the savings account. If you need it, you can still access it. But if it’s still there at the end of the month (or two or three months later), you can make an extra contribution to the TFSA.
- This is difficult, but you could keep looking for better work, or work casual part-time at a second job. Just an extra $100 per week of savings can make a huge difference over 30 years. But I know it’s not easy to find a good job or to work more than full time.
That was a difficult scenario. My suggestions may not be very helpful (and remember that I’m an internet stranger), but hopefully you can see how I think about it.
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I like using https://walletburst.com/tools/coast-fire-calc/ as a quick barometer from how far out I am. Keep in mind that your retirement goal shouldnt just be a dollar amount, but instead a ‘lifestyle’ you want to be able to keep and maintain.
Very nice, thank you. Makes sense to put a number on your lifestyle at that point. This made me rethink how well I’d done!
Also depends on your anticipated career growth.
Depends on what you plan to do with retirement.
I plan on working until I can’t walk no more, like Joe Biden.
So I’ll do all the experiences as I go. Save for the things I need as I go, and invest the rest asi go.
Ah this is great! Thank you!
Fully agree on the disciplined saving. I basically automated my paychecks to send x% to my various savings accounts. That’s got me this far, but I’m really keen to be more strategic with it. This should help!
