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By Jonathan Chevreau
National Post
FP Money Section
Saturday, April 10, 2004 |
Estimating nest egg needs is your first step.
Current
Ages |
Financial Worth (1) |
Income Requirements |
Nest egg Required (2) |
Return on Investment Required (3) |
| 35/33 |
$100,000 |
$50,000 @ 55 |
$1,575,000 |
10.20% |
|
|
$75,000 @ 55 |
$2,575,000 |
13.70% |
|
|
$100,000 @ 55 |
$3,600,000 |
15.90% |
| 50/48 |
$500,000 |
$50,000 @ 60 |
$975,000 |
4.70% |
|
|
$75,000 @ 60 |
$1,700,000 |
11.20% |
|
|
$100,000 @ 60 |
$2,425,000 |
15.50% |
| 65/63 |
Achieved |
$50,000 @ 65 |
$525,000 |
|
|
|
$75,000 @ 65 |
$975,000 |
|
|
|
$100,000 @ 65 |
$1,475,000 |
|
|
At the height of RRSP season, a bank study found that the earlier you begin saving for retirement, the less you must sock away each year.
Adrian Mastracci, investment counsel at Vancouver’s
‘fee-only’ KCM Wealth Management, says, “We talk life expectancies, inflation and the kind of incomes they want. Clients understand this. It's meant to get them thinking about their situation and decide what's really important to them.”
TD Bank economists showed that those starting RRSPs at age 30 can retire by age 60 by contributing $3,774 a year. But if they wait until 45 before starting, they must put aside more than $10,000 a year -- three times as much over a shorter time horizon.
It's hard to argue with the main conclusion of the report (entitled The Retirement Savings Challenge): "Save early, save often."
TD's projections were based on retirement incomes of just $20,000 and $40,000. If you can live on that, then RRSPs (or RRIFs) of $250,000 to $500,000 will be needed in retirement.
But what if you want an income more in line with what most Post readers likely enjoy while working: $50,000, $75,000 or $100,000?
Fee-only planner Adrian Mastracci, investment counsellor with Vancouver-based KCM Wealth Management, ran some scenarios through his proprietary forecasting model and found the necessary nest eggs merely begin where TD left off and can exceed $3-million.
One reason for the huge numbers shown in the accompanying table is inflation. We can count on politicians always inflating our currency, which means a continual erosion of purchasing power.
Even assuming 3% annual inflation, the nest egg needed to retire in the far-off future looks astonishingly large when expressed in future, rather than 2004, dollars.
Mastracci looked at three theoretical couples: one in their mid-60s embarking on retirement today; a second in their mid-30s starting to get serious about retirement savings; and a third pair -- prototypical Baby Boomers -- currently around 50. In each case, the husband is two years older than the wife.
Because of their head start and longer time horizon, the youngest couple expect to retire at 55. The Boomer couple is resigned to knocking off at 60; the oldest couple are now 65 and 63 respectively and have just left the workforce.
The table reveals the counterintuitive insight that the farther away retirement is, the bigger the nest egg required -- this is the inflation factor at work.
Thus, the youngest couple will need a whopping $3.6-million if they want the equivalent annual income of $100,000 in today's dollars when they retire at 55. If they can get by on $75,000 a year, they'll still need a hefty $2.6-million. Even if they think $50,000 a year will suffice in the year 2024, they'll still need to amass $1.6-million.
Compare that with the couple who are 65 and 63 today. If they've already saved $1.5-million, they can generate a $100,000 annual income now. If they seek only $50,000, then $525,000 will do the trick.
In between are 50-ish Baby Boomers like myself looking to retire in a decade or so. They will need $2.4-million for the high-income target, $1.7-million for the medium one and $975,000 for the lower.
Mastracci admits these figures are higher than what the financial industry usually presents to clients. The figures are rounded and may vary up or down by 10%. The projections may seem shocking, but they're no surprise to his clients when he unveils the numbers. "We talk life expectancies, inflation and the kind of incomes they want. They understand this. It's meant to get them thinking about their situation and decide what's really important to them."
There are several assumptions. The figures are all pre-tax. They exclude the value of the principal residence. The couples plan to "die broke," leaving only a paid-up home to their children, who are assumed grown and out of school. Therefore, the couples gradually cut into capital as the years roll by. Mastracci also tacks on five years to his mortality estimates to be on the safe side. When the first spouse dies, the survivor receives 75% of the desired income amount.
Another reason the projections look so high is they assume no employer-sponsored pension plan. Those who have one, particularly generous defined benefit plans, need far less. This is something Ottawa's mandarins, all of whom enjoy gold-plated DB plans, should get their heads around -- Canadians without such pensions need far more RRSP contribution room than is currently permitted.
For the two couples still in wealth accumulation mode, Mastracci assumes $15,000 of additional savings is injected each year.
He also assumes the two main government pensions kick in at 65: Old Age Security and 75% of the maximum Canada Pension Plan benefits (although the Boomer couple would likely take early reduced CPP benefits at 60).
He assumes 3% annual inflation and investment returns of 6% a year. That was the figure used by TD and roughly what a balanced portfolio of 60% stocks and 40% bonds can be expected to generate.
The young couple starts with $100,000 from earlier RRSP contributions or non-registered savings, inheritance or proceeds from the sale of a business. The middle couple is assumed to have $500,000 at the start date.
Another key variable is investment returns. Note the young couple hoping to live on $100,000 by age 55 will have to invest aggressively to amass the necessary $3.6-million. The necessary return on investment in the above case is an optimistic 15.9%, achievable only with aggressive growth strategies. Similarly, the Boomer couple will need a 15.5% ROI to generate the $2.4-million needed to fuel the $100,000 lifestyle.
The smaller nest eggs needed to furnish the more modest $50,000 way of life requires only a bond-like 4.7% return for the Boomers but an equity-like 10.2% return for the young couple.
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