The surprisingly low cost of retiring well

One thing you have going for you in planning your later years is that the cost of a fulfilling retirement lifestyle is cheaper than many people think.

While that’s reassuring, you still need to get a handle on just what those costs actually are, if you’re going to plan properly. As it turns out, there are several ways to estimate it, which we’ll describe in a minute.

But first, consider why a retirement lifestyle is often surprisingly affordable. While this phenomenon doesn’t benefit everyone equally, the fact is a lot of mid-life costs tend to drop off by the time you retire, without detracting from your personal lifestyle. So maintaining a similar standard of living in retirement usually requires a lot less income than it did in your middle years.

The costs of raising a family drop as your children become self-sufficient. Homeowner costs fall as you pay off the mortgage. When you stop working, you no longer pay into Employment Insurance, the Canada Pension Plan and, sometimes, an employer pension plan. You may have lower expenses for clothing and transportation. When a busy work life no longer causes you to spend for convenience, you may adopt savvier spending habits like shopping the sales and making more meals at home.

You’re done saving for retirement, so you no longer have to set aside a big chunk of income for that. You pay much less income tax. By the time you reach 65, you’re eligible for tax perks like the age credit, the pension income credit and pension income splitting for couples.

Of course, you may spend more for dental bills that were previously covered by employment benefits. And you may end up spending more on health care costs later in life. But in general, it costs a lot less to maintain the same standard of living in retirement than it did your middle years.

Now, let’s come up with an estimate for your retirement spending. If you are many years from retirement and just need a “ballpark” figure for rough planning purposes, you can apply a simple rule of thumb known as the “income replacement ratio.”

The ratio provides the percentage of gross earnings in your working years that you expect to replace in retirement in order to maintain your standard of living. So if you use a ratio of 60 per cent and your salary is $80,000 a year, then you would require $48,000 a year (60 per cent of $80,000) in retirement.

The tricky part comes in determining what ratio to use. An income replacement ratio of 70 per cent is often recommended in the financial industry, but experts such as Malcolm Hamilton, a senior fellow with the CD Howe Institute and retired pension actuary, and Fred Vettese, a former actuary and partner at Morneau Shepell, think that is too high for most people, and I agree.

In my view, if you’re a homeowner with children, you should be able to maintain your standard of living in retirement by spending 50 per cent to 60 per cent of peak earnings. If you’re a renter who never had children, 60 per cent to 70 per cent is probably more reasonable, since you wouldn’t have a drop-off in mortgage and child rearing costs.

Some people do spend more than 70 per cent of their pre-retirement income, but others get by on much less. I know of one couple who live comfortably but frugally in retirement on less than 20 per cent of their peak earnings.

Either way, when you get close to retirement, you should figure out how much you will need to get the lifestyle you want in actual dollars, rather than just a percentage. This requires a bit more work, but is worth it if you’re looking for a concrete figure to rely on.

First, get a handle on what you spend now while you’re still working. Track current spending by major categories such as shelter, vehicles, groceries and health. Then review the costs in each category and assess how much you think you will need to spend in each category once you retire. If you’ve been free-and-easy with current spending, this exercise may also help you get a tighter rein on costs.

While there is no substitute for understanding your own spending requirements for your own retirement lifestyle, having a few benchmarks to compare with can help.

I estimate that a “bare bones” but fulfilling middle-class retirement for a single person in Canada starts at about $33,000 a year for singles and $44,000 a year for couples. That applies to retirees 65 and over who own their own homes and are debt-free and includes the cost of income taxes (if you rent, carry debt into retirement or you retire before you’re 65, it will cost a little more). That should be sufficient for a fulfilling retirement that includes all the key middle-class trappings, albeit at a modest level.

If you’re looking for a middle-of-theroad benchmark, consider that an average Canadian senior’s spending — including income tax — is about $43,000 a year for singles and $65,000 a year for couples. That’s my estimate based on Statistics Canada Survey of Household Spending data that I’ve adjusted in several respects.

And how much would an affluent retirement cost? Of course, the sky is the limit for the truly well off. But if you’re looking for a rough number to typify the deluxe end of middle class — not the truly wealthy — I would suggest a figure (including income tax) of about $80,000 for singles and $100,000 for couples, assuming they own their own homes mortgage-free.

Any marker used to define the upper reaches of middle class spending is somewhat arbitrary. But I believe that sets a possible goal that is substantially above average but still within reach for what fairly average Canadians might reasonably aspire to without relying on exceptional financial success or a big inheritance.