This article was originally published in Maclean's Magazine on January 4, 2010
The Retirement Crisis: Part 6: How Much Is Enough?
Stu Lach's retirement dreams were relatively modest. The former heavy equipment mechanic wanted to be able to eat well and dress "sharply." He also wanted to go see classic rock legends Kiss. But when the '70s band comes to Sault Ste. Marie, Ont., in mid-December, with its face paint, spandex and copious pyrotechnics in tow, the 61-year-old won't be soaking it in from the front row. Instead, he plans to be at home, in his recliner, staring at the TV set. "I would love to go see them, but at $95 a pop I'm not going to do it," says Lach. "I will hear them on the radio now and again and that will have to be good enough."
Like many Canadians, Lach has recently discovered that retirement plans can fall well short of retirement reality. While he never envisioned himself trotting the globe or playing daily rounds of golf, he also didn't foresee himself foregoing simple pleasures like a live music event. He and his wife have already sold their house and downsized to an apartment in the city. They pay constant attention to their monthly spending and have put off plans for an annual trip to Eastern Canada this year to visit relatives. "I'm not where I thought I would be," Lach says. "I'm pinching pennies." Suffice it to say, it's not the sort of "freedom" typically portrayed in glossy retirement planning brochures.
Lach blames a combination of factors for his predicament: a retirement savings plan that was slow to get off the ground, last year's devastating market crash and government rules that limit the amount he is allowed to withdraw from his PENSION funds each year. But while his experience is unfortunate, it's far from unusual at a time when companies are backing away from gold-plated pensions, putting the onus on employees to make sure they have enough socked away for their golden years.
Many Canadians believe that $1 million is the magic figure when it comes to retirement savings. That was exactly how Lach saw things too - that is, until he realized it was never going to happen. "The closer I got to retirement, the idea of having a million bucks wasn't realistic. I couldn't have that much money."
The good news is that you probably need far less to retire comfortably, despite what financial planners may tell you. But figuring out the right number is easier said than done - particularly once you consider that unexpected swings in the STOCK MARKET can throw a serious wrench into the equation.
Financial advisers like to say that people spend more time planning their vacations than they do their retirements. That wouldn't come as a surprise to anyone who has spent time with an adviser being bombarded with pie charts, brochures and phrases like "guaranteed minimum withdrawal benefits." However, there's good reason not to rush through the proceedings: you're essentially making preparations for as much as a third of your life. That's a long time to go without sufficient income.
As a rule of thumb, many financial planners say the average person can retire comfortably on about 70 per cent of their previous income and that it is best to start squirrelling away money in RRSPs in your 20s in order to enjoy the benefits of compound interest. But there are a growing number of skeptics out there who say the financial industry has a vested interest in telling Canadians they need to save more money than is really necessary. After all, they are making money off your hard-earned savings through fees and charges. "It doesn't make sense for financial institutions and financial advisers to tell people they really don't need to save that much, and that they can comfortably start saving in their mid-40s," says Malcolm Hamilton, an actuary with Mercer Human Resource Consulting.
Hamilton argues that the 70 per cent figure is simply unrealistic for many people and probably unnecessary as well. For one thing, the target is often thrown at people who are closing in on their retirement age - a time when most are at the height of their income-earning potential and already have most of their major investments (house, car, children's education) paid off. The reality, he says, is that most people live off substantially less than 70 per cent of their income for most of their lives because the bulk of their paycheques is going toward paying for their house and their families.
Also missing from the equation is the fact that most retirees' daily expenses are a fraction of what they were during their working years. They're not driving to work and paying for gas and parking every day, and they're likely spending less on eating out or treating themselves to pricey specialty coffees. Many also choose to move into smaller homes or apartments, which can result in a reduction in property taxes. It all adds up.
In fact, the average Canadian retiree lives on about 50 per cent of their previous earnings, according to Hamilton. And nearly a third that could come from the CANADA PENSION PLAN or QUEBEC PENSION PLAN and Old Age Security benefits.
Of course, just because most people retire on half their previous income doesn't mean you should too. It all depends on what you plan to do during your retirement years, says Diane McCurdy, a financial planner in Vancouver. If your dreams include travelling the world, playing golf and restoring vintage automobiles, you will likely need considerably more money than someone who plans to watch television and eat the occasional meal out with friends. McCurdy adds, however, that even if people have an idea of the type of lifestyle they would like to lead following retirement, they often have no idea how to go about achieving it. "People don't know what to do. They do what their friends have said, or their advisers, or what they read in the paper."
Simply having a plan is half the battle. Lach, for one, says he wishes he'd spent more time thinking about his retirement while he was still working, but like most of us he was distracted by more immediate financial concerns. "I never really sat down and thought about it. It's one of those would've-could've-should've things," says Lach, adding that provincial rules about accessing locked retirement funds also played a role in aggravating his situation. Locked-in accounts are usually set up when a person transfers money out of a pension plan because they are leaving a job or, in the case of defined contribution pension plans, have retired and want to manage their own investments. Unlike money accumulated in RRSPs, most provinces limit retirees from accessing more than a small percentage of the cash each year.
But perhaps the biggest challenge faced by Lach and millions of other Canadians is recovering from last year's stock market crash. During the darkest days of 2008, it was common to see economists and financial experts telling Canadians to avoid "crystallizing" their losses by selling into a falling market. It makes sense to avoid buying high and selling low, but it's also incredibly difficult to sit on the sidelines and watch your retirement dreams slide away by the hour. Lach gave in and began selling last September. "I said, 'Whoa, this has got to stop.' "
The economic crisis of the past year has underscored one fundamental weakness of retirement plans. No matter how well thought out, most end up relying heavily on an equity component to do the heavy lifting. And even a modest plan can be thrown out the window when promised returns evaporate. While the markets have regained ground over the past year, it will still be some time before the levels reached in early 2008 are pierced.
Not everybody is buying the prevailing wisdom about the stock market's ability to deliver superior performance over the long term. Jim Otar lives in Thornhill, Ont., near Toronto, and is the author of Unveiling The Retirement Myth, a book that challenges many of the assumptions made by the financial planning industry. He claims that the average baby boomer hasn't saved enough money and, as a result, is at risk of running out of money in their retirement. That's not because they have underestimated what level of income they will need, but because they may not have enough assets to generate it. Most traditional retirement plans are not designed to withstand traumatic events such as a severe market downturn or an extended bear market, he argues. Instead, he says they rely heavily on unrealistic growth projections that don't match the market's actual performance. As a result, someone who is fortunate to retire at the start of a bull market might be okay, but Otar believes that most retirees who retire at some other point in the cycle won't be as lucky.
He uses an engineering metaphor to highlight the point. A civil engineer would be fired on the spot for designing a skyscraper in Miami that was only able to withstand the city's average wind speeds. What happens when a hurricane comes along? Similarly, retirement models that assume "average" market returns gloss over the fact that many people will enjoy significantly less upside from their investments, although a much smaller number will enjoy substantially more. In fact, Otar claims that, based on actual market history, the risks of having one's retirement portfolio ravaged by the market are actually greater than meeting or exceeding the average rate of return.
"The good news is that most people overestimate how much they need after retirement," says Otar. "That forces them to save more." Starting at age 35, he says a person who makes $100,000 a year and saves about a third of his or her income in RRSPs, tax-free savings accounts and through contributions to CPP will be able to finance their retirement "reasonably well." As for the assets required, he says that for every $10,000 in pre-tax annual income that a retiree hopes to have indexed fully to inflation, he or she needs about $300,000 in investment assets to start with at age 65. "Based on market history, this amount of assets can provide income for at least 30 years."
On the other hand, asking someone in their mid-30s to part with 30 per cent of their income is probably unrealistic given other financial demands such as home mortgages and the cost of raising a family. Indeed, one of the biggest dilemmas Canadians face when planning for their retirement is balancing their savings with the need to pay off increasingly weighty home mortgages. Hamilton says the trend toward bigger mortgages amortized over longer periods is troubling from a retirement perspective. "The problem that we have in Canada right now is not a savings problem, it's a borrowing problem."
McCurdy generally recommends that clients contribute to RRSPs and then use the refund to pay off a mortgage quicker. However, a growing number of advisers argue that people are likely better off paying down debts by the time they are in their 40s, and then turn their attention to saving for retirement. "My philosophy is to get totally debt-free and that includes the home mortgage," says David Trahair, a chartered accountant who has written books challenging the thinking behind traditional retirement planning strategies. "The vast majority of people are going to need money in their RRSP. But if you're trying to save while you're in debt, you're essentially cancelling out the saving."
As well, Hamilton warns that there's a point where an unwavering focus on retirement can become counterproductive if "you have to live like a pauper your whole life, like it was a prison sentence."
At the end of the day, the key is investing that hard-earned cash wisely. For many, that will mean a traditional portfolio that consists of a mix of stocks, bonds and guaranteed investment products such as GICs. Many advisers also recommend that the percentage of funds invested in stocks and other risky instruments be re-calibrated to become increasingly conservative as the age of retirement draws closer. "For our clients, we have a rule: 100 minus their age," says McCurdy. "That's the most they should be investing in the stock market." Still, if there's any good that came from last year's market meltdown, it's that it taught people a badly needed lesson about the immutable relationship between risk and reward, which had apparently been forgotten after a half-decade of ballooning market returns.
Back in Sault Ste. Marie, Lach says he would do things differently if given a second chance. "You have to get in early, put some money away every month and let it snowball," he says. While that doesn't guarantee freedom from financial headaches, it could help make sure you will have enough extra cash to Rock and Roll All Nite when your favourite band comes to town - providing that security doesn't confiscate your walker.
CANADIANS SAVE FAR LESS THAN WHAT MANY CONSIDER THE IDEAL AMOUNT
MOST PEOPLE assume they should have $1 million for their dream retirement. But even those close to retirement age end up well short.
THE MAGIC NUMBER
MEDIAN FAMILY SAVINGS
MEDIAN SAVINGS BY AGE 55-64
Maclean's January 4, 2010