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compare to yesterday’s 4% rule calculation since the portfolio had to be larger to allow the same dollar amount to be withdrawn, so we’ll look at it another way.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.
How Much Do You Need To Retire? The Rule Of 20,Related Posts:
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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.
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[...] Drake presents How Much Do You Need To Retire? The Rule Of 20 | The Canadian Finance Blog posted at The Canadian Finance Blog, saying, “While the 4% rule has become a standard quick [...]
[...] How Much Do You Need To Retire? A look at two simple calculations, the 4% Rule and the Rule of 20. [...]
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.
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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.
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?)
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
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.
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.
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!