Income Matters, Expenses Matter More!

So,... you’re ready to retire,... now what? I guess the question really is, “why do you think you’re ready to retire?” Many people have set some retirement target; their ages, pension unlocking rules, the size of their portfolios, their CPP/OAS eligibility, or maybe they just asked their Advisors and were told that they were good to go? Maybe they are just unhappy at work? When I told my advisor I wanted to retire he said, “why do you want to retire?”, “what are you going to do?”. I swear he wanted me working for him forever, ... another reason I fired him! Your Advisor may have asked you to fill out a questionaire describing all your assets, time horizon, and expenses then they run it all through their mystery programs. They will run retirement plan calculations with complex data sets and hidden formulas, showing your withdrawals over time, charts and graphs, and summerize it all at the end with things you might have missed. I would find out over 12 years of managing my own investments that much of the savings and income planning and forecasting I would do myself during my latter accumulation phase would factor heavily into my own decisions for retiring. The budget tracking I also did would help further in “retiring comfortably” and “without worry”. I didn’t really need an Advisor, much less one trying to talk me out of retiring, or creating unecessary doubt in my mind.

There are a couple really important questions to ask yourself and have the details on before you even think about retiring:

1. Do you clearly understand all your income streams?

2. Do you know your planned fixed and variable expenses in retirement?

If you can’t answer these questions, you can’t retire. Not with any confidence anyways. Your income streams may include many sources. Fixed expenses are expenses you have no choice but to pay them, while variable expenses can be reduced or stopped any time.

Below are some of the common income sources if you contributed and saved during your life, which might include some or all of these:

• Non-registered savings

• RRSPs

• Work pensions

• TFSAs

There may also be government sources that include:

• CPP (Canadian Pension Plan)

• OAS (Old Age Security)

• GIS (Garanteed Income Supplement)

There are some other less common sources which may include:

• Rental income from properties you own

• Royalties from a product/service you own rights to

• Inheritances or cash gifts

This is not an exhaustive list, but rather a list that explains some common and less common income sources, and the fact that you need to take stock of the value and ability of these sources to create cashflow for you. Not only do you need to understand what these sources are, but you need to understand how they can be converted to retirement income. They all have different rules and therefore act differently to provide income depending on a few variables. You need to first identify these sources, then understand how much they will contribute annually and collectively over a given time period in order to fund you through the different stages of your plan. If you understand your income sources, where it’s going to come from in retirement, and the amount per year, you can move to step 2.

Step 2 is understanding your expenses in retirement. There are fixed expenses; e.g. mortgages, loans, rent, strata, income tax, property tax, heat, power, water, property insurance, groceries, etc. These are usually expenses you are obligated to pay monthly, quarterly, annually or on some required schedule. Then there are variable expenses; e.g. phones, TV subscriptions, fuel, vehicle maintenance, toiletries, travel, recreation, dining, savings, gifts, some insurance items (medical, dental, car), credit, etc. Say you add up all your expenses and it comes to a modest $80k per year? And you also figure you have $80k coming from your investment withdrawals, CPP, or otherwise. Do you have enough income to support $80k in expenses? Likely not because taxes also need to be considered.

The simple rule of thumb is to divide your annual expenses by 4%, or multiple them by 25 (yrs), to establish a safe level of retirement savings. Either way, if you do this with $80k you wind up with a value of $2MM, which in theory is more than enough to pay you 4% for 25 years, if you were invested properly and draw it down regularly at that value. This is a simple way of getting an idea what you might need, but is it a plan? No... and I’ll try and explain why.

The income you generate from your investments is taxed. If you are smart and pre-planned, you can split your income with your spouse and pay ~15% tax. This is provided you stay under $45k income each and can efficiently utilize all available tax credits. Pension splitting is allowed on your company pensions (immediately), CPP, and RIFs (at age 65). Splitting is allowed at different age targets for different assets, and unless you are the same age this will factor into the timing during different years, so some planning needs to go into this as well. Inflation is also always at work eroding your buying power year over year. 2% inflation is a safe bet given recent history, but it has approached 3% and been over 5% in the past. 4-5% in the near future is not unfathomable given where we are at today. Inflation in it’s simplest terms is the increase in the costs of good and services over time, and it is inherently upward and annual. So at 2% a year over 5 years, an average 10% of your buying power is eroded, unless your income sources and budget has some inflation-fighting qualities.

Also, many Canadians are not aware CPP is taxed and OAS has clawback rules. So there are other considerations, planning, and forecasting that have to go into your decumulation plans. This includes balanced withdrawals, income splitting, efficient tax plans, hedges to inflation, etc.

One thing that really gave me more comfort and direction was insight into my aging parent’s budget when my Dad passed away. I was somewhat responsible for looking into and getting my Mom set up for income:expenses, and when the smoke cleared I realized they were both getting by very comfortably on $35-40k per year. When I was done, I figured my Mom could live comfortably on $28k per year. Back to the simple calculation, if your expenses are $28k/yr and you multiply by 25, then theretically you only need $700k to retire at 60. Granted she owned her own condo which helps. At the time she was in her slower years at age 75, so she was already 20 years into decumulation. She turned 80 last year. Your expense levels and savings will reduce over time, being higher at the start in your go-years and less in your slow-years. I would learn a few things about where her income was coming from, and how the withdrawals were staged, and that helped me set my own up later. I also learned how living minimally can be a hedge against the money you need and any future inflationary pressures.

In order to retire, you need to have your expenses and income dialed in to meet your needs and plans. You may need to have more money and withdraw more to service your expenses if you are living larger. You may need to reduce your expenses to match your income level. Or, a combination of both. But it’s unlikely you’re ready to retire until you can can answer basic budget questions. It’s advisable to have some variability built in so you can manage to inflationary pressures, the inevitable bumps in life, and sleep better at night. Downsizing is one way to achieve this, smart shopping another, and knowing your variable expenses yet another. And, .. you can’t forget the taxes. If you can manage to stay under CRA limits for the lowest tax rates, use pension splitting techniques, and utilize tax credits, you’ll maximize your income. I have set up my own plan to have ~20% in free cash flow, and have the ability to reduce another ~30% in variable expenses if required. We can survive comfortably on half our planned retirement income with some planned sacrifices. There are many different strategies for how to draw your assets down AND manage those expenses. But that’s another BLOG.

*** Income matters, expenses matter more! ***