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Retirement savings

December 19, 2012

How much do you need to save to retire?

It’s the question everyone wants an answer to. But opinions differ. A new book says you may need less than you thought.

It is not uncommon for personal finance experts to say one requires 60% to 70% of his or her annual pre-retirement income in order to retire comfortably, but a new book suggests that’s an unnecessarily high goal. The Real Retirement: Why You Could Be Better Off Than You Think, and How to Make That Happen, coauthored by Bill Morneau and Fred Vettese of Morneau Shepell recommends Canadians aim to replace between 40% and 60% of their annual income.

“Fears of a retirement crisis are overblown in Canada,” said Vettese, Morneau Shepell’s chief actuary. He and I spoke on Monday. “I’m not telling people they shouldn’t be saving for retirement. I’m saying they shouldn’t be going overboard and depriving themselves too much of a decent lifestyle during their working life.”

This of course runs contrary to a lot of what we hear about how prepared Canadians are for retirement. In the country’s private sector, less than a quarter of workers have access to an employer-sponsored defined benefit pension plan. About 70% have no employer plan at all. And less than one-third of Canadians save money in a registered retirement savings plan each year.

But even if you’re not comfortable adopting Vettese’s numbers in your own plan, his argument is worth a listen.

Vettese lists four types of expenses that most Canadians face before they retire: mortgage payments, child-related expenses, employment-related expenses and retirement savings. Strip those out, and Vettese calculates we live on less than half of our actual take-home pay each year.

Post-retirement, those expenses disappear. Assuming you retire without mortgage or any other significant debt, your day-to-day needs fall somewhere in the 40% to 60% range of what you made before you retired. “Why is it suddenly, at the point of retirement, you need to have 70%?” Vettese asked me.

In fact, Vettese said his numbers are conservative. He has assumed, for example, that retirees don’t take out a reverse mortgage on their home. He has also assumed that retirees have no other sources of income such as an inheritance or additional personal savings.

I asked Vettese if this makes annuitizing a relatively large percentage of your retirement savings (along with a portfolio of suitable insurance products) worth considering. If you only need about half your pre-retirement income, should you just go ahead and lock that in? “One could make that kind of an argument,” he said. “Annuities are a surprisingly good deal by the time one hits 75 or so.”

I’ve known Vettese a long time, and I have a lot of respect for his work. One aspect of this makes me uneasy though: healthcare expenses. Can we count on access to government-funded healthcare at current levels? Won’t the capacity of governments across the country to pay our health costs be diminished by the sheer numbers of aging baby boomers who require access to care?

The affect this will have on retirement plans may be overstated, Vettese told me. While it’s prudent to expect an offloading of costs by governments, he believes that will result primarily in user fees targeted at working-age Canadians and well-off seniors. “I don’t believe we’re ever going to reach the stage in this country where healthcare is denied somebody because of a lack of income,” he said.

To the extent you agree with that call, a recalculation of your retirement income needs might be in order. Remember, though, that Vettese is talking about needs, not desires. Canadians who want a more comfortable standard of living in retirement may find a drop to 40% or so of their pre-retirement income unacceptable.

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