Approach retirement like a business
Successful retirement planning involves identifying the factors that you can actually control.
Although some like to think of retirement as a time of leisure, attempting to live off the money you've saved is actually more like running a business.
Most people who work for themselves establish an annual salary draw that they believe the business can support, through both good and bad times. Then, if they're lucky, they may take bonuses that are in line with the company's profitability.
In the bad years, you forgo the bonus because you want to ensure you stay in business. If all goes according to plan, the good years outweigh the bad, and the business grows steadily.
Sustainable enterprises have the ability to withstand economic setbacks because their cash flow is more than their required expenses. More importantly, occasional reductions in that cash flow generally don't drive them right into bankruptcy.
So why should your retirement be any different?
On the face of it, the arithmetic of retirement is fairly simple. When your income is high, just don't consume it all, saving money instead for the years where you transition from investing your paycheque to creating a new one.
Financial planners often estimate that people need to replace at least 70 per cent of their pre-retirement income, on the assumption that you'll drop into a lower tax bracket and won't incur many expenses associated with work.
Not only is this the formula that backstops most guaranteed plans (two per cent of salary per year for 35 years) but it's also typically what's left over when most of us subtract our mortgage costs, which are generally about 30 per cent of income.
But some mavericks like Laurence Kotlikoff, author of Spend 'til the End, believe the so-called replacement ratio could be as low as 50 per cent for certain individuals.
In other words, half of what you're making now would probably suffice as of the day you stop working, he suggests.
Kotlikoff bases his formula on what he calls "consumption smoothing." That means factoring in more spending during your working years, when there are all those mouths to feed, and less in retirement, when it's just you and your spouse, or perhaps just you alone.
In his view, spending on children slows once they finish school and eventually move out of the house. This, coupled with a paid-off mortgage, means that many expenses simply disappear in retirement.
He could be right, of course. But most people I know prefer to err on the side of having enough money to work with, rather than risking running out before they're through. Which means they need a balance sheet.
When you move from saving to spending, expenses quickly become paramount. And you have to track them that much more diligently.
Here are a couple sample worksheets to help you get started. Keep in mind that this template is U.S.-based, but can easily be modified for Canadian numbers.
The first sheet is an itemized list of expenses that most retirees will see. The example is pre-loaded with expected expenses for a $6,000 monthly budget, but that needn't be your number.
The second sheet allows you to load your own expense and income estimates and to calculate your net worth throughout retirement, including the ability to vary income, taxes and inflation over time.
Study those external factors and assumptions and you'll quickly realize that month-to-month expenses are really the only thing you can control.
So, before you settle on an initial withdrawal number, think about what you're going to need and what you think you'll want.
Once actually retired, you can adjust your cash flow based on your actual expenses and the size of legacy you wish to leave — another common retirement assumption that Stephen Pollan, author of the controversial book Die Broke, suggests you reconsider.
"By choosing to die broke," Pollan writes, "you turn the future from something to fear to something to embrace and rejoice over. Dying broke offers a way out of your current misery and into a place of joy and happiness."
Readers were horrified when the book first came out since people are often measured by the size of their estates. But leaving it all behind seems less important to me, as well as many of my tuition-weary fellow boomers.
The truth is, there is no universal pattern when you're talking about retirement. Real-world outcomes can certainly screw things up and not everyone agrees on where to draw the line when it comes to spending.
But one thing is pretty clear: Since taking too much out of your newly minted retirement business, particularly early in the process, clearly increases the risk of going broke, somebody has to be in charge of the expense account.
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