Setting a target retirement income
- Learn more about factors to consider when you are setting your own target retirement income
- Understand how you can use the Advantages Retirement PlanTM to set the target retirement income that’s “just right” for you
- The nature of your spending changes over your lifetime, and often retirees find that their spending needs go down, especially in early retirement
- When developing a savings plan for retirement, the concept of a “replacement rate” can help future retirees ensure they are saving sufficiently to meet their spending needs in retirement
- The Advantages Retirement PlanTM uses a 60% replacement rate as a default to help future retirees maintain, on average, their living standards in retirement
Projecting income needs in retirement: the target replacement rate approach
When you’re planning for retirement, an obvious question you must address is how much income you will need in retirement: your “target retirement income.” Only after setting this target will you know how much you need to save up for.
There are several different methods you can use to estimate what number your target retirement income should be. One approach involves developing a line-by-line budget that identifies your expected spending needs for each year of your anticipated retirement. However, as you might imagine, this exercise can be overwhelmingly complex, leaving you with many unanswered questions. It’s also very challenging to predict detailed spending patterns over long periods of time, especially when those periods may start years from now.
An alternative approach involves setting a retirement income “replacement target,” where you estimate what percentage of your current income you will want during your retirement years. This is the method that the Advantages Retirement PlanTM uses to help you figure out and set your target retirement income. As you progress in your career, you can update your current income in your account online.
In a “replacement target” approach, your target retirement income is set as a percentage of your current income. This “replacement ratio” can be a useful way to approximate your income needs in retirement, and is based on the idea that your overall spending during retirement will likely be lower than your overall spending during your working years. The general default for the physician community is a 60% replacement ratio that is calculated based on your pre-tax, pre-retirement income. The 60% figure is based on a study that economist Keith Horner conducted for the federal government. Horner’s study found that higher-income individuals such as physicians tend to require a lower replacement rate than the often-cited 70% figure (which continue to be debated today). While Horner’s study recommended a replacement ratio of ~53% for higher-income Canadians (as a percentage of earnings around age 64), it did not factor in out-of-pocket health care costs such as home care and long-term care, so the Advantages Retirement PlanTM default uses a more conservative and slightly higher general rate for the physician community – 60% – in order to help you prepare for retirement conservatively.
The Advantages Retirement PlanTM can help you set your target retirement income based on the 60% replacement ratio and a handful of data points you input, such as current age, desired retirement age, annual pre-tax income, and the amount of already existing retirement savings (e.g. in RRSPs, TFSAs, and RRIFs). Given this information, the Advantages Retirement PlanTM will calculate how much you need to save through your Advantages Retirement PlanTM, based on the 60% replacement ratio.
The 60% replacement ratio is merely a default. With the Advantages Retirement PlanTM, you can choose to increase or decrease your target retirement income depending on what kind of lifestyle you anticipate and wish to keep during your retirement years. For some physicians, your actual spending needs might drop in retirement; for example, you may no longer have a mortgage to pay off, your children may no longer be dependent on you, and you may no longer need to contribute more to savings once you’re retired. For other physicians, some expenses might increase during retirement years compared to working years; for example, you might travel more often, and you might need to spend money on home care and health care expenses that you didn’t have during your working years.
Keep in mind that there’s no one-size-fits-all method to precisely estimate how much you will need during your retirement years. But thoughtfully creating an estimate and setting a target retirement income can be useful to you as you build up your nest egg and wonder how big it should be.
If you have many working years to go before retirement starts, it may be less urgent to define an approximate target retirement income, but it’s still important to establish a general target that will help guide your savings plans. And as your date of retirement draws closer, you may want to fine-tune your estimates for your target retirement income to check if the target you had previously set is still the right target for you, and assess if you’re on track to meet your revised target. Having a retirement savings goal is important because if you have not saved enough as you approach your retirement date, it will likely be difficult to make up the difference in your remaining working years, and you will likely need to lower your retirement income drawdown rate and adjust your living standards.
Wherever you are in planning for retirement, it’s important to ensure that you plan and act today to meet your needs in the future. Setting a target retirement income years before you retire can be a great way to keep those plans in motion sooner rather than later.