While many banks, especially around RRSP season, will try to convince you to save as much as possible if you ever want to be able to retire. One simple way to decide for yourself what you’ll truly need to retire is the 4% rule. The 4% rule states that you can withdraw 4% of your investment portfolio in the first year, then adjust for inflation each year after that and not run out of money for 25-30 years. A portfolio of at least 50% bonds at retirement will reduce volatility and increase the odds of this general calculation being reliable .
One other thing to keep in mind is what you can expect from the Canada Pension Plan (CPP) and Old Age Security (OAS). While many things can effect the amount, including when you start withdrawing from the CPP, as well as OAS clawbacks based on income, a good average for a retired couple is $25,000 per year. Of course, if you have an employer pension you’re even closer to your target retirement income.
So lets say you want to have an income at retirement of $50,000. With a mortgage paid off and children out of the house, this is actually a pretty comfortable amount. As we’ve discussed, CCP and OAS will likely cover $25,000, leaving you with another $25,000 to fund yourself. You can calculate the 4% rule by taking the amount you need, in this case $25,000, and dividing by 4%. Using the 4% rule, you would need $625,000 at retirement.
Since the 4% rule also covers for inflation, the only time you ever take out 4% in the first year. There will be enough room for you to increase your withdrawal by the amount of inflation. So in the first year, you may have withdrawn $25,000. However, in the second year inflation may have increased 2%, so you would now take $25,500 out of your investments. You then continue to adjust your withdrawal amount each year with the rise of inflation.
While the 4% rule is a simple way to calculate for retirement, it may not work out that way in real life. Say for example, you retired in early 2008 and watched your portfolio lose 20-40% by the end of the year, you would then need to adjust to a lower withdrawal rate to continue your retirement. This is why you should consider having the majority of your portfolio in bonds at retirement as it might help reduce the odds of such a large loss.
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Of course, it is important to note that $50,000 at retirement might not be much if you plan to retire in 30 years.
In “How Long Will It Take To Double My Money? The Rule Of 72″ (http://canadianfinanceblog.com/2009/08/04/how-long-will-it-take-to-double-my-money-the-rule-of-72.htm), we can see that “a 3% inflation rate would mean your money will lose half it’s spending power in 24 years”
Don’t forget to factor that in.