Have you ever opened your RRSP account statement and thought “Great, I have more money than last month, but what does that mean for my retirement?” or “My account value has gone down, should I be worried that I can’t retire when I want to”? Like any ship, most of us know where our destination is: a comfortable retirement. The water might be choppy and momentarily steer you off course, but as long as you have a map that can show where you are compared to where you want to be, you should reach your destination.
At PWL, we want to simplify the client experience to what matters to them most. For many of our clients, this means having enough money to live a comfortable retirement. They have saved and/or are saving up in RRSP’s and other accounts so that when they decide to take the plunge into retirement, they can be financially independent and live the life they want. The age old question is “how much do I need to retire?” For a while, a million dollars was the target. A million dollars is an arbitrary number, and one that doesn’t provide much value to a wide variety of clients. Instead, we try to simplify it to things you can actually relate to, yearly income. How much yearly income in retirement do you want or need? From there, we can determine if your current savings can achieve that, and what might be needed if it can’t. With our performance reports, we give clients saving up for retirement a graph that shows how much income their portfolio can generate in retirement. This income is affected by a number of factors including retirement date, life expectancy, current portfolio values, expected returns, inflation, and savings rates. In our view, the two large things that clients can directly impact right now are expected retirement dates and savings rates, and this chart can help them navigate these decisions.
To get a better understanding, I have put together a simplified chart using hypothetical information. Jane and Joe are both 45 years old, and have a life expectancy of 90. They plan on retiring at age 65 (in year 2033). Their portfolio has a 5% yearly return, with inflation at 2%. They are not currently saving any money in their portfolio, but are considering saving up to $15,000/year. Their portfolio was $500,000 when they started out with PWL, and has fluctuated with the markets. We show the impact of changing portfolio values on the income they can generate (vertical axis) over time. This is a very simplified graph, assuming that the future returns and inflation are the same each year. It also assumes that you will be receiving the same pre-tax payment each year from retirement until death, depleting the portfolio to zero (i.e. no inheritance is left over). Note that the income is in today’s dollars, therefore every year the payment would increase by inflation.
The bottom grey line assumes that the portfolio value will continue to be invested, earning 5% per year until death, but no additional savings will be added. Starting in year 2034 (at retirement), Jane and Joe can withdraw $110,233 every year until expected death at 90. The dark blue line shows that if they start saving $10,000/year until 2033, they can get an additional $17,708 in retirement income. The light blue line shows that Jane and Joe can withdraw $136,795 per year throughout retirement if they start saving $15,000/year until they retire.
Compare this income chart to the chart below which shows your portfolio value over time. Which chart is more helpful? If you were to only view the portfolio value chart, you may think that savings of $1.9 million at retirement is more than enough. But if you look to the income chart, that $110K a year might not quite be enough to sustain your expected consumption.
Compare this income chart to the chart below which shows your portfolio value over time. Which chart is more helpful? If you were to only view the portfolio value chart, you may think that savings of $1.9 million at retirement is more than enough. But if you look to the income chart, that $110K a year might not quite be enough to sustain your expected consumption.
As clients near retirement, the gap between the grey line and blue lines become much smaller, as increased savings don’t get the same compounding benefits. This is why it is so important for clients to have an understanding of what their portfolios and savings can do for them early on and make course corrections so they don’t end up in the Antarctic instead of Australia.
For clients within 10 years of retirement, we have or are working towards, putting together a more detailed financial plan that incorporates their income from all sources, taxes, the volatility of their portfolio returns etc. This provides a more accurate picture of how much consumption they can sustain each year.
So the next time you open your account statement statements or performance report, don’t ask yourself “Do I have enough money to retire?” Instead ask “what paycheque will I be getting in retirement?”
