Planning 101 -Where to Draw the Line
Updated: May 17, 2020
Over the years we have been asked the question “can I afford to retire?” in many different ways. Our typical response is that you should go through the process of developing a comprehensive wealth plan that will provide you the answer to that question plus others that you may not have considered yet. Although there is no true replacement for a full Wealth Plan, there are some general guidelines that can be used to at least determine if you are on the right track.
Ultimately the first step is to calculate how much you will need to spend in a given year. For purposes of this calculation you need to consider both spending as well as taxation. Surprisingly, most Canadians do not have a detailed understanding of how much they spend on an annual basis.
Quick Tip: To determine your annual spending requirements, review your credit card and bank statements for the past year. Cancel out any duplication such as credit card payments from your bank account. Add up all the bank account withdrawals and credit card charges and you will have a fairly strong estimate of your annual spending. If 12 months of documents are not available, use the information you have to annualize the requirement.
Some households are fortunate to have pension income during retirement. Subtract this amount (adjusted for income tax) from your annual spending requirements. At this point you now know the deficit which must be covered by your savings. If you are preforming this calculation well in advance of retirement, adjust your figures accordingly if your debts are scheduled to be paid off by retirement (ie mortgage payments). In the example below, let’s assume that your portfolio needs to support annual spending of $120,000 or $10,000 per month. Another way to determine your spending is to consider your lifestyle at your current annual income less savings.
Quick Tip: One of the largest obstacles to financial success during retirement can be inflation. It is imperative that inflation is considered in your planning.
There are numerous studies on recommended portfolio draw limits known as Portfolio Success Rate Analysis, however there tends to be a common consensus amongst those in the wealth management industry. Assuming a 50/50 stock/bond portfolio, it has been suggested that a maximum draw rate of 4% should be taken from a portfolio annually on an inflation adjusted basis to ensure portfolio longevity.
Therefore in our example, the quick calculation of how much savings are required to sustain a $10,000 per month spending requirement is approximately $3,000.000. $120,000 divided by 4% equals $3 million, or $1 million is required for every $40,000 of annual spending.
Quick Tip: For those of you who are still saving for retirement use the Rule of 72 – 72 divided by an interest rate approximates the number of years to double the money.
This is of course based on the premise that individuals desire to preserve capital and cover retirement costs without encroaching on principal. This may or may not reflect your current plans. Regardless, your highest priority should be reaching your goal.
However, if this article has provided any revelations by highlighting the differential between what you believe you want and what you need to generate, it would be strongly suggested that taking the time to develop a comprehensive Wealth Plan could be worth its weight in gold. Wealth Plans are a complimentary service provided to clients of Northland Wealth Management.
To get the process started on your comprehensive Wealth Plan please contact our office.