How Much Do You Need to Retire? The Rule of 20

Retirement rules of thumb are all about trying to help you determine a sensible rate of withdrawal from your account, as well as helping you figure out how much money you need to set aside now so that you can enjoy a successful and comfortable retirement later.

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. A recent Money Talk on BNN featured Irshaad Ahmad, President & Managing Director of Russell Investments Canada, on the show to discuss this new calculation.

What is The Rule of 20?

The Rule of 20 states that for every $1 of retirement income you want, you will need $20 saved in your retirement portfolio. At first glance, I thought this might just be a “5% rule”. How Much Do You Need to Retire? The Rule of 20The extra percentage point is likely due to the fact that this rule already accounts for inflation, where the 4% rule only addresses the first year, and then adjusts each year for inflation. Also, The Rule of 20 states that you only need $20 in savings for every $1 of annual retirement income; no where does it say you should withdraw 5% each year. So the end result is likely similar to the results you see with the 4% figure. It’s just as a simpler calculation for determining your retirement needs.

Something to Keep in Mind with The Rule of 20

Just as with the 4% rule, one key thing to keep in mind is that CPP and OAS will cover a substantial portion of most Canadians’ 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.

Since you have CPP and OAS to help you out, the amount that you actually have to base your retirement savings on (in our scenario) is $25,000 per year. Using The Rule of 20, you calculate that you will need a retirement portfolio of $500,000 in order to retire comfortably.

This amount is hard to compare to the 4% rule calculation since the portfolio has to be larger to allow the same dollar amount to be withdrawn. Let’s look at the comparison 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.

This means that, with the 4% rule, you are withdrawing $5,000 less the first year. By the time you add the $25,000 for OAS and CPP to the $20,000, you only end up with $45,000 a year in income. You either need to adjust your withdrawal, or become used to the idea of dipping into your capital more than you had expected.

How Should You Calculate Your Retirement Planning?

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 travel or leaving an estate to your loved ones.

With retirement planning, it makes sense to thoroughly consider your options, and make your plans accordingly. Rules of thumb can help you, but you shouldn’t become a slave to them.

Written by Tom Drake

Tom Drake is the owner and head writer of Canadian Finance Blog. While you’re here, consider signing up for the RSS feed or email subscription. Both deliver the latest articles directly to you everyday! Have a Twitter account? Then follow me for all the latest posts or to send me any comments or questions!

12 Responses to How Much Do You Need to Retire? The Rule of 20

  1. Steve says:

    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.

  2. Perry Torres says:

    One common rule of thumb states that you will need about 80% of your pre-retirement income during retirement. The rule of thumb might be a good starting point for younger people, but as you approach retirement it is important to take a serious look at how much money you’ll really need. The best way to estimate how much money you’ll need is by looking at your expected income expenses in retirement.

  3. JoeTaxpayer says:

    What method of withdrawal does the 5% author suggest?
    In good times , no problem. It’s creating a method that can survive decades like the 00′s that’s the trick.

  4. Dr Dale Rathgeber says:

    For the reasons noted above, isn’t it preferrable and safer to continually use a good calculator like the free one at retirementadvisr.ca? (and to use it as an ongoing monitoring device to ensure that your draw-down rate isn’t excessive?)

  5. Wade Pfau says:

    Hi,
    This blog entry just showed up in my Google Reader, but it seems like maybe it was posted a long time ago.

    I have a couple items on my blog that might be of interest for you. Most studies about sustainable withdrawal rates seem to be about the U.S., but I included a chart of the historical path of sustainable withdrawal rates for Canada at the end of this blog entry:

    http://wpfau.blogspot.com/2010/09/for-my-first-blog-post-i-would-like-to.html

    Also, I recently finished a paper which says this whole idea of trying to save enough to use a 4% (or 5% in your case) withdrawal rate is not really the right way to think about retirement planning:

    http://wpfau.blogspot.com/2011/02/safe-savings-rates-new-approach-to.html

    Best wishes, Wade

  6. david says:

    With interest rates so low, and expected to rise, bonds and annuities are out; the stock market is risky except, perhaps in the very long term; real estate is high and falling in most areas; cash loses to inflation – I’m getting .88% in my premium money market fund; precious metals are subject to gut-wrenching fluctuations and are really more of a store of wealth than an investment; and government programs will be subject to erosion by inflation and clawbacks.

    I think this is a hard time to be planning for retirement; I’m pretty sure it’s not just my imagination.

  7. Paul Browne says:

    Useful information. However is the $50,000.00 per year figure before or after taxes? I am assuming that this figure for those who are mortgage and debt free.

  8. David says:

    Seems to me all these rules are a little on the stupid side given they take a top down approach! Simple rule add up your expenses over a year! Make sure you can cover them for the expected life expectancy of a man or woman ignore CPP and OAS they become a bonus ie covering extras new car new roof vacation etc! I call it the rule of common sense!

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  10. arnold says:

    It is an interesting article. It shows a use ful strategy. However, $500 k may be too short of a retirement fund for the gen x and y. Make it 1 million instead. It is possible through saving at an early age…
    Arnold
    handygutters.com

  11. I agree that using any one percentage is not a good idea. People need to look at what their expenses will be, what their CPP and OAS will be, and how much extra they’ll want to have.

  12. Michael says:

    I’ll preface my comments by stating that I am a retired (6 years) financial planner, so I’ve been on both sides of the fence. These “you need x-percentage”” articles are entertaining but useless. Only you can figure what you need.

    You start by figuring out you living expenses (fixed plus discretionary) then put them on a timeline. Don’t forget to plug in capital “lumps” which may hit, e.g. trips, a new car or a new roof. Allow for inflation and for the fact that as you age, you will do a little less and buy a little less. You will now have a picture of your outgoings for several years. Now factor in CPP, OAS etc. You can now calculate how much you must draw from you investments.

    Setting up your portfolio to yield dividends rather than interest will give you a tax-favourable income. By testing your taxable income by seeing what adjusting your RRIF draws will do, you can find the best combination of registered v non-registered income. Put as much of your investments into a TFSA as you can, and you will save even more tax. Before retirement, make sure that you and your spouse’s retirement incomes will be about equal.

    This is not rocket science, it just requires some work.

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