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Your retirement should have a never ending stream of money

12 Month Plan to Improve Your Finances: Month 2 - How much do you need to retire?


In a Nutshell: If you follow the SmarterSquirrel 12 Month Plan to Improve Your Finances, in Month 2 "How much do you need to retire?", you should be on your way to improving your retirement. In this second month, you'll get a better understanding of your after tax income required from passive income in retirement. Using the spreadsheet included, you should get a sense of how much you need to save and how long you need to keep saving before you can retire with a sense of financial security.

“ I'm a big fan of creating a passive dividend income stream that never runs out...”

I hope you have already completed the Month 1 task... Where Are You Now? If you haven't yet, head there now and then come back to the Month 2 task. The Month 2 task "How much do you need to retire?", is going to rely heavily on the two numbers from the Month 1 task. We are going to look at your Cash In, which is the income you are getting annually that you calculated last month, and the Cash Out, which is the amount you are spending every year that we also calculated last month. 

We will use those numbers to assess what your money needs will be in retirement and as a result what that means for how much you need to save every month to have that amount in retirement without it running out before you die. (Yes, morbid I know but hey it happens to all of us eventually... the key is to not have your money run out before that happens that would be even more off putting.)

Some of you may have already done all this work, as I am repurposing an earlier article that I published before coming up with the 12 Month Plan idea. If so you can take a month off and wait for the Month 3 task. Or you can always revisit and make sure you got your numbers right, now that you've gone through the Month 1 task and have accurately figured out your income and expenses. 

So at the end of the Month 1 and this Month 2 task, you'll have a good grasp on your assets, liabilities, total income, total expenses, credit score, amount needed for retirement and the amount needed to be saved every month between now and when you retire. After that, we will start figuring out how to get you there. The first two months are really about knowing where you are and where you're going. Just like going on a road trip, those are the first things to figure out. Then you can decide the best route to get there. So Month 2 is about the destination. Follow along and you should be able to improve your financial situation.

BUT REMEMBER... I have no professional training, skills or accreditation in personal finance, I am not a certified financial advisor or planner at all... so if you need professional personal financial advice, seek advice from a professional. I'm not a professional, I'm just a guy with a blog who figured some stuff out for himself and am just sharing what I know and what I've learned over many years. Some of my friends ask me how to get on the same financial road I'm on, and so I thought I'd tell them and you how to do what I did through this SmarterSquirrel 12 Month Plan to Improve Your Finances, now in Month 2...


MONTH 2 - HOW MUCH DO YOU NEED TO RETIRE?

There are a couple of ways to figure out how much you'll need to retire. Since none of us really know how long we are going to live for, I'm a big fan of creating a passive dividend income stream that never runs out. As opposed to trying to time when you spend your last dollar and then going with that plan, spending your last dollar, and surprise, you're still alive and penniless! Now how do you pay for your next bag of groceries??

So I'll cover two methods of making sure you always have money in retirement. The first is to determine how much after tax passive income you need to replace your after tax employment income. If you've been living fine up to now on that employment income, then replacing that employment income with passive income should set you up fine for retirement. And if you don't spend all of your annual passive income in retirement each year, your portfolio should keep growing every year and never run out of money. 

The second method is to track your monthly expenses dollar for dollar for a year (doing it just for a month and multiplying by 12 doesn't cut it, you'll blow a lot of money on special occassions like Christmas, birthdays, anniversaries, etc ... so a full year will give you the most accurate idea of what you're spending... hey we're making a financial plan for the rest of your life here, what's a year of tracking relative to that?) and then determine how much you need in an investment portfolio to provide you with enough to cover those expenses. And again if you have enough passive income to cover your expenses and have a little left over every year, you should never run out of money.

METHOD 1: AFTER TAX EMPLOYMENT INCOME REPLACEMENT WITH AFTER TAX PASSIVE INCOME

Let's say you've been living your life fine on your current income, then that's what you'll need to have as income in retirement (inflated of course and figuring for the after tax amount, but we'll get there.) In Month 1, you figured out what that annual income is, so use that number for this exercise. For the sake of having an example for everyone to see how this works, let's say that income is $100,000. According to the chart below from StatsCan , $100,000 employment income seems to be more than what the majority of individuals in Canada make, so that's a good high number to use as an example, as it should cover off most people. You may need more, you may need less. But use the income number you figured out for yourself in Month 1 and then you can use the method I use to figure it out for your own situation. I'll use $100,000 as the example.
StatsCan chart on income percentiles
So if you make $100,000 from employment, what's your after tax income? Well that depends on many factors including which deductions you're able to take at tax time. Are you maximizing your RRSP to get that deduction? (I hope you are!) But let's look at a basic calculation of your after tax income if you make $100,000 from working. There's a great resource that makes this easy at Taxtips.ca. It's their basic tax calculator . Here's what your taxes look like across the provinces and territories of Canada if you make $100,000. 
Taxtips.ca basic tax calculation for $100,000 
As you can see from the table above, if you make $100,000 from employment and live in Ontario, in 2018 your tax payable would be $24,626. (Remember it would vary depending on your personal deductions, but this is a good ball park estimate.) So after tax, your take home pay from your employment income would be $75,374. 

That is the goal then of what you would need to replace with passive income in order to retire. Using this method, you would need to generate $75,374 after tax in retirement, adjusted for inflation. So if you are 40 today and need $75,374 in today's dollars, that means when you are 65, that amount will inflate at 2% annually to you needing $123,659. You will also need a portfolio that grows dividends as fast as inflation to keep up with it.  Also any Canada Pension Plan (CPP) payments we look at are meant to keep up with inflation, so looking at present day dollars should work fine for CPP assuming the government keeps increasing payouts at the rate of inflation.

So how much of that $75,374 will you get from CPP? According to Canada.ca there is a fairly wide range between the average payment and the maxium payment. 
Average and maxium CPP payment for 2018
The average CPP monthly payment in 2018 is $666.56 (the devil IS in the details!) and the maximum is $1,134.17. Thanks to the efforts of former Prime Minister Paul Martin and a host of other politicians in Canada, and the investment decisions being made by the Canada Pension Plan Investment Board , the CPP should be around for a very long time. The fascinating story of how the CPP was saved and how politicians in Canada actually did something beneficial across federal, provincial and party lines has been documented by Bruce Little in his book Fixing the Future.  You might be able to find it at your local library. 

I'm not so sure on OAS and other government payments still existing by the time you retire, so let's only consider the CPP which I'm fairly certain will still be around by the time you retire. 

To be conservative let's take the average CPP payment of $666.56 a month and multiply that by 12 months. That gives you $7,998.72 each year before tax. According to Taxtips.ca basic calculator, earning just that amount results in no taxes payable. So for now let's subtract that amount from the $75,374 we need after tax to retire. That means we now need to replace $67,375.28 after tax from other sources.

If you're going to get other pensions subtract that amount as well. For now I'll assume like many Canadians, you have no other pension other than the CPP.

I'm going to enter the CPP income of $7,998.72 in the Employment & Other income section of the basic tax calculator and I'll start entering different numbers in the eligible and non eligible dividend sections of the basic tax calculator to see what is needed to get to $75,374 after tax. 
Basic tax calculator for retirement income
Playing around with the numbers in the basic tax calcuator shows that with CPP of $7998.72, Canadian eligible dividends of $45,000 (dividends that allow you to get Canadian dividend tax credits, like dividends you receive from TD, BCE or FTS for example) and Canadian non-eligible dividends of $28,500 (dividends that don't give you Canadian dividend tax credits, like JNJ, KO, or TXF), you wind up with a total passive income of $81,499 which is less than your employment income of $100,000. But in Ontario, you wind up with an after tax passive income of $75,386 on that $81,499 passive income, which is just a few dollars more than your after tax employment income of $75,374 on employment income of $100,000. 

That means, taking into account your CPP income, your total income from dividends needs to be $73,500 when you retire in today's dollars to replace your current $100,000 employment income. (Remember you should be doing this exercise using your own income number that you figured out in Month 1.) Assuming your average dividend yield on your portfolio is 5%, that means you would need a dividend portfolio worth $1,470,000 to replace your employment income of $100,000 a year.  That's if you're retiring today! We also need to look at inflation from now to your retirement based on your age.

$1,470,000???? ARE YOU CRAZY? I CAN"T SAVE THAT MUCH BY RETIREMENT!

Before you completely wigout at me or the bank that keeps telling you you're richer than you think you are, when in reality you may now feel poorer than you think you are, let's look at what you would need to do to get to dividends of $73,500 inflation adjusted. 

For all the scenarios I'll assume you're investing in a dividend portfolio paying an average yield of 5%, that on average raises its dividends by 3%, and on average the stocks in your portfolio get average capital appreciation of 3% every year. I'll also assume all your investing is taking place in your RRSP and TFSA to get tax free compounding growth until you retire. And I'll assume inflation holds steady at 2%. 

If you're 30, that $73,500 you need, inflation adjusted by 2% annually, will be $146,992 needed by the time you're 65. If you start with $0 to invest and add $17,000 to your portfolio every year, by the time you are 65 you should have $2,929,385 in your portfolio. That portfolio should be providing you $146,469 in dividends every year, so you've pretty much hit your target. You need to save and invest $1,416.67 every month, you can do that!

If you're 40, that $73,500 needed will inflate to $120,584 needed at 65. If you start with $0 to invest, you would need to put away $33,000 a year to hit $2,412,496 and get dividends of $120,625. You need to save and invest $2,750 a month, you might not be able to do that on a $100,000 salary, so hopefully you have a lump sum you can start with to improve your situation. 

If you're 40 and you start with $200,000 to invest, you would need to put away $14,300 every year to get to $2,415,110 and get dividends of $120,755. You need to save and invest $1,191.67 a month, you can do that!

If you're 50, that $73,500 needed would be $98,921 inflated to 65, and you would need to start with about $500,000 and put away $14,500 a year to hit $1,979,790 and dividends of $98,989. You need to save and invest $1,208.33 a month, you can do that! (If you can start with $500,000 of course.)

Clearly, if you're starting with $0, it's much easier to retire well the earlier you start saving and investing. And saving the amount you need each year is much easier to do if you live frugally. Buy a second hand car , avoid too much gift giving , and avoid buying things you really don't need! You can do it!

And remember, this assessment was done to replace the after tax income of someone earning $100,000, with the goal of never running out of money.

It changes quite a bit if you assume you will only live to 100 years of age and want to time it so you have exactly $0 in your portfolio when you turn 100. 

For the 30 year old with $0 starting savings, instead of the monthly savings of $1,416.67, they would only need to save $958.33 a month to wind up penniless at 101 years of age (other than any income from CPP and other government grants). 

For the 40 year old with $0 starting savings, instead of the monthly savings of $2,750 a month, they would only need to save $1,833.33 a month to wind up penniless at 101 years of age (other than any income from CPP and other government grants). 

For the 40 year old starting with $200,000, instead of monthly savings of $1,191.67 they would only need to save $300 a month to wind up penniless at 101 years of age (other than any income from CPP and other government grants).

For the 50 year old starting with $500,000, instead of monthly savings of 1,208.33, they wouldn't need to save anymore, and instead could take out a $76,000 lump sum for a spending spree if they wanted to live close to the edge. (But please don't do that, having more than you need is a much better problem than hoping all goes well and trying to get precisely to the exact amount... reduce the risk by saving more.)

As I said at the outset, I am not comfortable at all with the idea of planning to run out of money at some future age, I prefer planning to have an ever growing portfolio where I never have financial stress in the future, where as I spend money liberally in retirement, my portfolio continues to grow every year. That provides security, no financial stress, freedom to enjoy retirement to the fullest, instead of always worrying about whether the money will last and always denying yourself those grand travel plans or those nice things in life that money can buy. It's all personal preference, I'd rather be a little bit frugal while working to enjoy retirement and to have financial security and independence. Think about it, if travelling in retirement, wouldn't you rather have so much extra passive income coming in that you can easily afford to pay to fly to Asia while sleeping in a first class lay flat bed than being an uncomfortable 65 year old squished into a tight upright coach seat for 16 hours? In other words I'd rather hit 100 years of age with a big financial safety net rather than seeing a $0 sum in my bank account. 

And if I'm too old to enjoy all the money I have by that point, well maybe I can do some good in the world by funding an orphanage or a school, paying for guide dogs for the blind, donating to an elephant sanctuary... or any number of worthy causes that money can help.

It's a balance. I've struck a balance for myself. I suggest you do the same. YOLO (You only live once... unless you believe in reincarnation...), so you need to enjoy the present and not scrimp and save so much that you don't enjoy the present, but YOLO, so you need to save and invest enough to make sure the latter part of your life is enjoyable as well and that you don't get familiar with poverty in your senior years. Don't get so old and so poor that you regret buying multiple $20 cocktails at fancy lounges in your 20s. Find the balance that allows you to enjoy the present and allows you to be financially secure enough to enjoy your future.

The bigger the financial cushion, the less important market downturns will be to you in the future, the easier you will sleep, the more you will enjoy. I think it's worth saving the extra few hundred dollars a month to have an ever growing portfolio vs. an ever disappearing one. 

Remember this exercise has been done assuming someone makes an income of $100,000. If you're enjoying your life and able to pay all your expenses without adding debt, earning less than $100,000, then you don't need as much passive income to replace your employment income because you have a lower employment income that works for you. Do the calculations for yourself based on the income you figured out in Month 1 to see what you'll need. If you're earning more than $100,000 and spend most of it, you'll need more than what's shown above to retire. 


​​METHOD #2: INCOME TO PAY YOUR EXPENSES

This method uses the total expenses you calculated in Month 1. But in Month 1 as an expense we also included savings. Since you'll be in retirement you can remove the savings amount from your expenses as the assumption is, in retirement you no longer have to save as you will be living off of your savings. If you haven't already done this exercise in Month 1, it will take a little longer because you will have to track every single dollar you spend for a year to get the most accurate picture. I am a firm believer that people underestimate how much they really spend each year. The easiest way to realize this is to ask yourself how much you spend on gifts and special occassions. Write down the number and then do the exercise of seeing how much you actually spend on gifts and special occassions on everyone you actually spend on. I've made an exercise of it for you to follow here. 

I've recently started to track my own daily expenditures in a spreadsheet to see how sustainable retirement is for me. So far I've been spending less each month than the dividends I receive each month. So it looks like retirement is financially sustainable for me. Intellectually, I do miss the challenge of the work I used to do and I do miss the collegial interactions with coworkers, so I may go back to work if an interesting opportunity comes my way. (Update... I have found an interesting opportunity working with some great former colleagues, so I'm back to work... but don't worry I'll keep the SmarterSquirrel going so you can keep going on the 12 Month Financial Plan!) But I don't have a financial need to go back to work, and that financial freedom is very liberating. With this financial freedom I've been enjoying travel, taking my bicycle to the beach and having a swim, morning walks to have a latte, and improving my tennis game, among other things. I can't recommend enough that you make the changes in your own finances to strive for financial liberation. (Even being back at work with no real financial need for the job is very freeing, I feel I am choosing to do the work and that brings a whole new level of enjoyment to the work!)

So as for tracking your spend, there are many apps for doing that, I prefer to use a home made spreadsheet where I track all the small and large categories of spend. Those include:

  • rent/mortgage
  • electric/heat/water 
  • cable/internet/homephone 
  • mobile phone/mobile data
  • video services (Netflix, Amazon Prime, DVDs (if you still buy those), etc)
  • insurance (home, auto, mortgage, credit rating like Equifax)
  • gaming (Xbox service membership, games, apps)
  • groceries (including alcohol, drugs, etc.)
  • gardening supplies
  • take out dinners and dining out
  • entertainment (movies, theatre, concerts, rollercoasters, etc.)
  • furniture and electronics
  • coffee/tea/croissants (and those little items you don't consider dining out)
  • gifts (hope you've followed the earlier mentioned exercise to get a real picture of your spending on this one)
  • clothing and sports gear
  • books and other reading materials
  • travel (everything travel related, planes, trains, automobiles, hotels, massages, tours etc.)
  • music services (Sirius, Spotify, CDs/records (if you still buy those), etc.)
  • hair cuts, nails, make up, grooming and beauty
  • bike/transit/Uber/taxis /parking
  • car maintenance, repair, gas, tire changes, other car expenses
  • interest on any and all debt you carry including credit card debt
  • health care, drugs, dental, massage, chiropractic, physiotherapy, gym
  • educational expenses
  • professional dues/fees
  • childcare, nannies, diapers, cribs, car seats, toys, etc...
  • pet feeding, veterinarian fees, pet food, pet gifts (sigh...)
  • bank fees
  • major purchases
  • etc...

In short, track every single dime you spend (you should have already done this exercise in Month 1 so just use that number less the amount of savings we included as expenses) and you may be amazed at what you are really spending every month compared to what you think you are spending. If you track it in different categories you can quickly see where you are spending more than you should. 

As an example my average monthly spend including all the above examples is coming in around $5,730 a month for someone living in a nice area of Toronto. That includes a month where I bought a nice bicycle and I went on a 10 day trip including flight and a hotel stay, a month where I went on a week long trip and stayed with family, and a month with no travel but with some gift giving. So it's perhaps an accurate reflection of how I want to spend retirement, with a big trip once every three months and a family visit once every three months. The most eye opening amount on my spreadsheet is the dining out/take out total each month. It's made me realize I need to do a lot more home cooking. It may be easy to eat out or to order from skipthedishes but it sure isn't easy on your budget.

Figure out the amount you spend annually or every month (it's preferable to get a year long view). I'll take my example of $5,730/month, averaged out after collecting three months data, and I'll multiply it by 12 months to get an approximation of what my annual expenses are. Excluding the travel month where I also bought a bicycle, the average is closer to $4,700 a month... that's why it's good to do a year long view rather than just taking one month and multiplying by 12. Annually I spend about $68,760. For you, certain current expenses may change, maybe you're spending a lot on your mortgage right now but that will go away once your house is paid off, so maybe your expenses will be less. Maybe you're paying for your child's education and that expense will go away when you retire. Of course as you grow older maybe you'll need nursing care or a nursing home and your expenses may go up. As a wise green guy once said... ​difficult to see... always in motion is the future. Try to get to your best estimate of future expenses (which you should have from the Month 1 look at your Cash Out Flow... minus your savings) though rest assured it's not likely to be accurate (another reason why I like to have the buffer of an ever growing portfolio rather than trying to plan to get to $0).

​For me, that means I need about $70,000 after tax income to retire today. Knowing this amount we can go back to the process we used in Method #1. Given the same CPP amount of $7,999 and using the Taxtips.ca basic tax calculator, I'd need about $66,000 in dividend income to supplement my CPP. That would be a total pre tax passive income of $73,999 which would get me $70,033 after tax in Ontario for 2018. 

Dividing $66,000 in dividends by a 5% dividend yield would mean I'd need a $1,320,000 dividend portfolio to retire. So I'd need just a little less than someone trying to replace an employment income of $100,000 as calculated above.

Starting as a 40 year old, that $66,000 in today's dollars would be $108,280 by age 65 due to inflation, and if you had $100,000 in savings to start with, you would need to add $20,300 each year to get to a $2,168,898 dividend portfolio paying annual dividends of $108,445. That's a monthly savings requirement of $1,691.67. That's to have a portfolio that never runs out. If you want to aim for $0 by age 101, your monthly savings would only need to be $875.

Again I prefer the comfort and security of a portfolio that never runs out so I have a financially stress free life. I think that's worth the additional savings required each month. Decide what makes sense for yourself. It may be somewhere in the middle of that range. Maybe if you know you won't run out of money until age 120 you'll feel totally safe. If that works for you, go for that. 
​​
To make it as simple as possible, here is a chart that shows you how much you need to save each month depending on how many years you have left to retire and how much income you will need in today's dollars before it runs out at age 120 (that should create a decent buffer but you can always save more if you like) with the assumption that you are starting from $0 savings right now. To get more detailed on your specific situation, for example if you already have a bunch of savings to start with, there is a spreadsheet that follows where you can calculate the amount you'll need. If the monthly needed to be saved is more than $5,000 a month I am not putting it in the table, and I refer you to the spreadsheet. But from this table, it's easy to see that the earlier you start saving, the easier it is to have a lot of income in retirement. If you know someone who is 15 and has a good 50 years before they turn 65, tell them to start now putting away that money from their part time job! Putting away just $588 a month until they turn 65 will give that 15 year old $100,000 in today's dollars when they retire. If that person waits until they are 40 before they start saving for retirement, they will need to save $2,780 every month to get $100,000 in today's dollars when they retire. Start saving for retirement as soon as possible!!

​​

I'm putting up a spreadsheet that I use to see how much you need to start with and how much you need to save annually depending on your age to get the amounts discussed in this article. Just make changes to the yellow cells for your age, desired retirement age, dividend income desired in todays dollars, starting savings, and annual savings until retirement, to see how much you will have by what age. This assumes you reinvest all dividends and never take money out until the day you retire. At retirement age I assume you stop adding savings and instead any growth comes from growth of the portfolio and dividends. The cells you should change in the spreadsheet are highlighted in yellow. Play around with the numbers in the yellow cells until you see your money looks like it will last long enough to make you comfortable with your retirement plan. Maybe if it turns negative when you are 101 that's fine for you. Maybe you prefer it last until you're 120. Maybe you prefer it to never run out. Have a look and play around with the numbers. (ONLY CHANGE THE NUMBERS IN THE YELLOW CELLS)

To figure out your after tax employment income and to figure out how much dividend income you need to replace it, don't forget to go to the Taxtips.ca basic calculator.

Retiring comfortably does take effort, planning, and a lot of saving. Make sure present day you is taking care of future you by saving and investing for your retirement.

This was the Month 2 portion of the SmarterSquirrel 12 Month Plan to Improve Your Finances: Month 2 - How much do you need to retire? Stay tuned for Month 3 coming out the first week of March 2019.

For Month 1 - Where Are You Now? Click here

For Month 3 - Pour More Into Your Bucket... Click here

Be a SmarterSquirrel... Save. Invest. Enjoy... and have a great present and future.


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SmarterSquirrel 12 Month Plan to Improve Your Finances:
Month 2 - How much do you need to retire?
​​
Lessons Learned:
  • Create a passive income stream so you can retire
  • Because of lower taxes on dividend income, you need less dividend income than you currently get in employment income to wind up with the same after tax income
  • Inflation from now to retirement means you'll need more saved than you might think
  • You can plan to run out of money when you hit 101 but if you live that long and run out of money you're going to have a lot of stress
  • Be just a little more frugal and make a passive income stream that never runs out so you can have a financially stress free life
  • Start saving and investing now
  • Download and use the spreadsheet to figure out how much you'll need to save to hit your goals

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