For most millennials, retirement seems like it’s ages away. A future you problem. Unfortunately, the cards might seem to be stacked against us: the number of Defined Benefit pension plans are falling, we’re living longer, student debt levels are rising, and house prices are massive compared to our incomes. It can all seem so overwhelming that we don’t know where to start! I’ll provide an outline of the basic concepts of retirement planning.
It may be simplistic, but let’s start with the purpose of saving for retirement. Retirement savings is simply deferred consumption. You don’t save for the sake of saving. You save for retirement, so that one day, when you no longer earn an income, whether by choice or circumstance, you can maintain your lifestyle. For most people, the ultimate goal is to keep your standard of living the same in retirement as it was while you are working. Some people are happy with reducing their lifestyle, while others want to improve their standard of living. But we’ll stick with the idea that you’ll aim to maintain a level standard of living throughout your life – you’re not forgoing current consumption in order to spend more in retirement, and you’re also not spending everything at the expense of your future lifestyle. The standard rule of thumb is a 70% replacement ratio. This means you want to aim to receive 70% of your pre-retirement income throughout retirement. If you’re earning $100,000 per year before retirement, you aim for $70,000 in retirement. The 70% ratio comes from the fact that you don’t have CPP & EI premiums to pay for, you are no longer saving while in retirement, and retirees’ taxes are typically lower compared to their working years. While a general rule of thumb can be helpful, depending on your income, this replacement ratio can be much less, and may vary wildly depending on your situation if the goal is to maintain your standard living.
While you’re still working, income typically comes from one main source: your regular job. Most receive a relatively steady paycheque every two weeks or once a month. When you retire, you must piece together an income from a variety of different sources, including:
The Canada Pension Plan provides partial retirement income beyond age 60 to contributors. Up until 2019, CPP was intended to replace a quarter of average work earnings, up to a cap. CPP is being enhanced to provide a third of capped earnings beyond 2019. I’ll outline CPP and how it works in more detail in a future post.
Old Age Security is the second government pension program providing a base income for Canadians beyond age 65. There are no contributions towards this plan, it is available through taxpayers dollars.
Defined Benefit Pension Plans are employer plans that pay out a set amount, typically based on average or best earnings and number of years within the plan. I’ve discussed these plans here.
These are employer plans where employees and/or their employers contribute a certain dollar amount towards the plan each year. Employees then select the investments within the plan from a list of options. The investments within the plan grow until retirement and can then be withdrawn and used for retirement. I discussed Defined Contribution Pension Plans in a previous post and will go into more detail about withdrawing from these plans in a future post.
These include savings held within RRSP’s, RDSP’s, TFSA’s, non-registered accounts, corporations, etc. It can also include proceeds from downsizing your house or selling a business.
On average, about 13% of income for individuals 65 and older comes from employment income. Some might still be working full-time beyond age 65, while others might work part-time to supplement their income and stay engaged and active in their later years.
Owning rental properties will provide an income through regular rental payments.
There are many sources of income that are available to retirees. The trick is to determine how much each source will provide, what your tax rate will be, and making sure that you can sustain an appropriate level of consumption. For millennials, especially those without access to pensions, determining how much to put towards savings will be a key driver to being able to maintain your standard of living before and after retirement. While this may be extremely murky right now, getting started by picking a reasonable target will help you significantly in the long-term. Better yet, start putting something away for retirement now, even if it’s a small amount, and reassess once you’ve decided on a target.
