The late Toronto Star business columnist, George Brett and I co-produced an article in 1984. It said the government benefits of Old Age Security and Canada Pension need not be indexed to the CPI because people over 65 do not find inflation to be the same as the population as a whole.
According to George, he got more hate mail from his readers on this than any other article he had ever published.
Thirty years later another brave writer wades into the swamp of fairness. Fred Vettesse, chief actuary at Morneau, Shapell has a book to be released later this year. Its title is instructive. The Essential Retirement Guide: A Contrarian’s Perspective.
I don’t know Fred, but other actuaries I know tend to be very evidence driven in their thinking. From what I have seen of this book’s contents, little, he seems to share my belief from thirty years ago. In dollars, despite inflation cost of living after the first five years of retirement tends to flat line. Inflating costs and deflating ability to spend the money act together.
This flies in the face of what many advisors tell you.
Advisors tend to be concept driven rather than evidence driven so that may explain some of it. The conventional wisdom is you need 70% of your pre-retirement income. A nice rule of thumb but not easy to prove the need.
Let’s start with what matters. Spending. When it comes to planning, pretax income holds a great many tricks and traps. You cannot spend it. You always spend cash. The question you must answer is how much spendable cash will I need after I retire? HINT: It is nowhere close to 70% of your earlier income.
You don’t spend 70% of pretax income now. More likely 40% or less. Taxes, debt, education, savings and pension contributions in total are easily bigger than what you consume. Consumption is what you must replace.
Some of your income will be taxable, but likely at low rates. That income will offset some or all of your spending needs. With income sharing, taxes are not intrusive for many people. A couple over 65 will receive about $13,000 of OAS and possibly about that much more in CPP. If they have employer pensions for another $30,000 they will have income of $56,000, will pay tax of about $5,000 and have the rest to spend. The next $16,000 each that they receive costs less than $4,000 each in tax. Keep around $24,000. To have $75,000 per year to spend, neither will be forced above the 20% tax bracket. If you want more, figure on $2 for you, $1 for the government. Up to about another $50,000 of spending. After that, think more like $1 for you, $0.75 for them.
Clearly having education finished and debts paid matter. Other factors arise too. How much more to spend on recreation and travel? Long term care is insurable and for people who are pension rich and asset poor it is a near requirement. As one client has said, “If I need home care for any long time, I won’t have a home to have it in.”
To solve the “How Much?” problem you need rudimentary arithmetic skills and the answer to several questions.
- How much will I want to spend?
- How will inflation affect me?
- How much pretax income will supply the spending money?
- How much of that income is spontaneous and indexed?
- How much is the shortfall that I will need to cover from my personal resources?
- How much should I set aside this month at some conservative rate of return to reach that?
This is fairly straightforward once you get the rule of thumb out of the way. It certainly is not rocket science or music theory.
Don Shaughnessy is a retired partner in an international public accounting firm and is now with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.