The article “Retirement math you need to know, from how long you’ll live to deferring CPP” was originally published in Financial Post February 5, 2024, by Jason Heath.
Jason Heath: Go beyond how much you need to save with this surprising math.
It is important to know your numbers as you approach or enter retirement. However, questions about how much you need to save to retire get too much attention. Especially because the honest answer is that it depends. So, instead we are going to consider some surprising retirement math that can be applied to just about everybody.
Retirement is cheaper than you think
Spending tends to decline in retirement. Statistics Canada reports the average expenditure per household for those aged 40 to 54 in 2021 was $120,646. For the 55 to 64 cohort, it was $99,623, and for Canadians aged 65 and older, $61,855. So, for anyone in their 40s or 50s wondering how they are ever going to retire, there may be hope.
If you look beneath the surface, income taxes for the three groups were $25,463, $22,416 and $11,788 respectively. Taxes tend to decline in retirement for most retirees, though it depends on the individual.
Personal insurance payments and pension contributions were another contributor to the decline, with $8,418, $6,756, and $1,469 reported as the average annual expenditures for the three groups. Life and disability insurance tends to be dropped in retirement, and pension, registered retirement savings plan (RRSP), Canada Pension Plan (CPP) and employment insurance contributions disappear.
Shelter costs were $26,294, $20,473 and $13,814 respectively. There is no specific breakdown of mortgage payments, for example, but becoming debt-free or downsizing an owned or rented home tends to lower those costs.
If you look closely at your annual budget, some of your pre-retirement outlays will decline or disappear in retirement. Do your own math to figure out what your expenses will be when you retire. The data supports an average decline in total expenditures of nearly 50 per cent comparing those aged 40 to 54 to seniors who are over 65.
Investment fees really are the enemy
A retiree paying high investment fees could seriously compromise their ability to spend in retirement.
As an example, a 65-year-old should probably be planning for a time horizon of 30 years if they have no serious health issues. If a $1-million investment portfolio earns a five per cent return each year, an investor could take withdrawals of $65,051 annually for 30 years. By comparison, if the investments earned only four per cent per year, the annual withdrawals would decrease to $57,830. That represents more than a 12 per cent annual premium for the investor with the higher return.
In real life, a retiree would probably take smaller withdrawals earlier, increasing them over time, and the investments would rise and fall with the markets. But the point is a one per cent lower return would decrease the potential annual withdrawals and the cumulative lifetime withdrawals in the example would be $216,640 lower.
The thing with investing is that it is not like buying a mattress. With some exceptions, paying more for a mattress tends to be correlated with higher quality. The same may not be true for your investments. When you own a diversified portfolio of stocks and bonds, your mutual fund or investment adviser is unlikely to earn a one per cent higher return to offset a one per cent higher fee.
In our practice, we are finding it is increasingly common for investors to be told they are only paying a one per cent fee for their investments, which would be a competitive rate — if, in fact, it was true. Often, we find advisers use investment products that have embedded fees of their own, generally in the one per cent range as well. So, even when an investor thinks they are only paying a one per cent fee, and the fees they see on their investment statements and their annual fee disclosure appear to be one per cent, they may in fact be paying much more.
You may live longer than you think
Statistics Canada recently released data on deaths in 2022 and found the life expectancy at birth for Canadians fell for the third consecutive year. It stood at 81.3 in 2022 after falling from 81.6 in 2021.
Most Canadians rely on this broad life expectancy figure to anticipate their own life expectancy. However, since it is based on the entire Canadian population, it is skewed downward by people who die at a younger age. Indeed, Statistics Canada noted an “increase in deaths among younger age groups” in 2022.
A better gauge may be the Canadian Pensioner’s Mortality (CPM) tables used by public and private pension plans. According to the tables, a 65-year-old couple consisting of a woman and a man has a 50 per cent probability that one of them will live to age 94. There is a not unreasonable 25 per cent probability that one of them will live to age 98.
Deferring CPP and OAS can add up
The maximum Canada Pension Plan monthly payment in 2024 for a 65-year-old is $1,365. But the average payment, as of October 2023, was only $758, in large part because the average recipient does not have enough years of maximum CPP contributions. People approaching retirement should check their CPP entitlement with Service Canada by requesting a statement of contributions.
If you are in good health and worried about the risk of living too long, or if you are still working because you cannot yet afford to retire, deferring your CPP can make sense. CPP can be deferred as late as age 70. A 70-year-old beginning their CPP in 2024 could be entitled to as much as $23,253 per year. Combined with a deferred Old Age Security (OAS) pension, also subject to an increase for deferral, a retiree could get as much as $34,894 of annual pension income at age 70 this year. Both pensions are indexed to inflation, and while they might not cover all of a retiree’s expenses, $2,907 per month could be a pretty good start.
A CPP recipient entitled to the maximum pension could receive $425,159 of cumulative payments by age 90 starting their pension at age 60 this year, assuming two per cent annual inflation in the future. If someone turning 60 in 2024 waited until age 65 to start their pension, they could receive $579,093 of cumulative payments. Deferring to age 70 could yield cumulative payments of $688,709.
You can start CPP as early as age 60, even if you are still working. You must continue to contribute between 60 and 65, but you can opt out of contributions if you are still working after 65 if you are receiving your pension. Contributions made after you begin your pension will result in a post-retirement benefit that will increase your pension the following year. Starting CPP early can make sense for some seniors, especially for someone with health issues or a shortened life expectancy, those with cash-flow issues or high-interest-rate debt, or investors with a high investment risk tolerance and low investment fees.
Summary
Retirement planning requires a personalized approach because no two retirees are the same. Rules of thumb may be helpful as a starting point, but planning for and funding your own retirement should be based on data that you can relate to your own situation.
Estimate your retirement spending, watch your investment fees, be intentional with your pension planning and do not underestimate your longevity.
Jason Heath is a fee-only, advice-only certified financial planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever. He can be reached at jheath@objectivecfp.com.
