While the 4% rule has become a standard quick calculation for retirement planning, there is a new rule that is similar, The Rule of 20. Last week BNN’s Money Talk had Irshaad Ahmad, President & Managing Director of Russell Investments Canada, on the show to discuss this new calculation.
The Rule of 20 states that for every $1 of retirement income, you will need $20 saved in your retirement portfolio. At first glance, I thought this might just be a “5% rule”. The extra percentage point is likely due to the fact that this rule already accounts for inflation, where the 4% rule was only first year, then adjusted each year for inflation. Also, this new rule only states that you need $20 in savings for every $1 of annual retirement income, no where does it say you should withdraw 5% each year. So this is likely still around the 4% figure, just as a simpler calculation for determining your retirement needs.
Just as with the 4% rule we’ve discussed, one key thing to keep in mind is that CPP and OAS will cover a substantial portion of most Canadian’s retirement income. So if your goal is a annual retirement income of $50,000 for you and your spouse, the CPP and OAS payments will get you half way there since you can expect $25,000 for the average retired couple.
This leaves $25,000 per year that you will need to have saved for. Using The Rule of 20, you will need to have a retirement portfolio of $500,000. This amount is hard to compare to yesterday’s 4% rule calculation since the portfolio had to be larger to allow the same dollar amount to be withdrawn, so we’ll look at it another way. Using the 4% rule for $500,000 in savings, you would withdraw only $20,000 in the first year and then increase for inflation each year going forward.
Whichever calculation you decide to use, remember that it is just a quick method to plan your retirement. Neither rule can properly account for market volatility or personal factors such as your plans for traveling or leaving an estate to your loved ones.
The rule of 20 and the 4% rule have been with us for ages. Neither address the true complexities for most individuals. For instance, are your savings inside your RRSP or outside (non-reg/TFSA)? Pension? Do you have a loan you are paying off? Will you take early or late CPP?, do you anticipate a future windfall (selling the cottage, downsizing, inheritance)… and the most important aspect of all:- income tax and it’s effect on the different forms of capital (reg/nonreg/equity/tfsa) as they come in and out of play over time.
Remember, you don’t need a financial advisor to do this… you have a better handle on this knowledge base. It’s called financial planning, and everyone should be doing it on their own. Financial advisers will direct you as to ‘what’ kind of investments to choose… the financial plan tells you the ‘how much’ and ‘when’ (the scale and timing)
In summary: Financial plan, DIY. Investment plan, your advisor.