6 Misconceptions in Retirement Planning
Posted on: February 18, 2016
Trying to sort through the vast amount of information available on retirement planning can be time consuming and confusing. It can also very easily lead you to leap to the wrong conclusion.
In this article, I review 6 of the most common retirement planning theories in order to help you determine what’s best for you.
1. “Government pensions will be enough.”
Previous generations believed that the government would take care of them, but that’s not quite how it works.
These days Canada Pension Plan (CPP) and Old Age Security (OAS) will pay a 65 year-old a maximum of about $1,450 a month ($2,900 for a couple) and that would have to cover your rent (or mortgage if you have one), condo fees, taxes, insurance, food, clothing, transportation, entertainment and any other expenses you might have.
However, not everyone is entitled to the maximum; it depends on how long you have worked and contributed to the plan. And if you retire early, then you are entitled less than the maximum because you’ll probably be receiving it for longer.
Don’t forget that CPP and OAS is fully taxable, so if you have other sources of income that put you over a set amount annually you may have to pay back some of your government benefits in tax.
Takeaway: Government pensions are a good foundation for your retirement, but will not necessarily be enough to live on depending on the kind of retirement lifestyle you are looking forward to.
2. “I’m fine; I have a company pension plan.”
If you have a company pension, consider yourself fortunate because 6 in 10 people don’t have one.
There are two main types of company pension plans: defined contribution and defined benefit. It’s important to know which kind you have because it will affect the value of your pension in retirement.
With a defined benefit plan, you receive a set amount each month for the rest of your life. This amount is taxable and often not adjusted for inflation, so it can lose some purchasing power over time. You’re also at the mercy of the company if they change the benefit plan or go bankrupt.
A defined contribution plan does not pay you a set monthly amount. Upon retirement, you receive the lump sum to manage yourself or purchase an annuity to provide lifetime income.
Takeaway: Having a company pension plan is certainly better than not having one, but having one is not always enough to guarantee you will have enough income during retirement years.
3. “I need 70 to 80 per cent of my pre-retirement income.”
Most people’s expenses go down in retirement. They aren’t working, so they don’t need the same clothing or transportation budget and there are tax benefits for seniors.
So by looking at your lifestyle and specifically, who you will be spending your time with, what you will be doing, where you will live, and how your health might impact your plans, you will have a clearer idea of how much you will need.
Takeaway: Some people find they can live on much less and others spend just as much or more during their retirement. Understanding what type of retirement benefits you are entitled to and identifying your guaranteed retirement income sources are also important in determining how much you need in personal savings.
4. “I’ve heard I need to save $1 million.”
People have a better understanding of how much money they need each month to pay their bills, than what the lump sum amount is that they need saved at time of retirement to generate that monthly income.
This is one reason why the $1 million amount should not be used as a common benchmark. The $1 million figure is based on the assumption that you should have saved 20 to 25 times the annual income you will need once you are retired. For example, if you need an after-tax income of $50,000 a year, it assumes that you will need to save $1 million (20 times $50,000).
However, depending on your other retirement income sources, i.e. company pension, CPP and OAS, or the proceeds from the sale of your house, you might not actually need to save $1 million for your retirement. In this case, with additional income from other sources, your dream retirement may only require an income of $20,000 a year from your personal savings.
Takeway: Regardless of what you will need to live on once you are retired, there are tax implications, unexpected expenses and perhaps a desire to leave an inheritance that will affect how much you will need in retirement savings.
5. “I will be fine if I only withdraw four or five per cent a year from my savings once I retire.”
Whether this is true or not depends more on how much your retirement investments are earning. If you are earning more than you’re withdrawing, you’ll investments will continue to grow. But if you’re earning much less than you’re drawing, you run the risk of running out!
In some cases you have no choice in how much you withdraw. For instance, if you have a Registered Retirement Income Fund (RRIF), your withdrawals are based on your age. But if you don’t need that money for your monthly expenses, you can always reinvest it in a Tax-Free Savings Account (TFSA).
Many retirees spend more in the first five years of retirement because they do the things they had put off during their working years, such as travelling extensively, making major purchases and living out of the country for part of the year.
Takeaway: To make your money last longer, the best practice is to not spend more than you normally would in the first five years of retirement so you are not depleting your saving so quickly in the early years.
6. “Delaying my retirement a few years will not make that much of a difference.”
There are many social and mental benefits of working as long as you can. Plus, as long as you are working and earning income, you’re not withdrawing retirement funds and they are continuing to grow.
Takeaway: Delaying retirement even a few years can make a big difference in your savings and how long those savings will last.
Retirement planning is a dynamic process. You may find that your retirement goals and lifestyle choices change over time and consequently, the amount of money you need will change.
Retirement planning is also unique for each individual and can get complicated.
That’s why it makes sense to talk it through with a professional. Our door’s open and we’re happy to talk any time.
BMO Nesbitt Burns Inc. ("BMO NBI") provides this commentary to clients for informational purposes only. The information contained herein is based on sources that we believe to be reliable, but is not guaranteed by us, may be incomplete or may change without notice. The comments included in this document are general in nature, and professional advice regarding an individual’s particular position should be obtained. ®"BMO (M-bar roundel symbol)" is a registered trade-mark of Bank of Montreal, used under licence. ® "Nesbitt Burns" is a registered trade-mark of BMO Nesbitt Burns Inc. BMO Nesbitt Burns Inc. is a wholly-owned subsidiary of Bank of Montreal. Member-Canadian Investor Protection Fund.