The Most Important Step in Retirement Planning
Topic: Wealth Planning
February 4, 2016
The Most Important Step in Retirement Planning
A recent article in CPA Magazine examined the most important step in retirement planning, and in my opinion, they got it right. Most people will say it is saving money. Saving money inside your RRSP, TFSA or non-registered account feels good because you are doing something for your future. But how much should you be saving?
There is a rule of thumb that says you need 70% of your pre-retirement income to maintain your standard of living after retirement. If only it were that simple. As pointed out in the article,(1) we each have a personal financial situation as individual as our fingerprints. Applying a rule of thumb is fraught with error and could lead to problems during retirement. So what is the most important step in retirement planning? You might be surprised by the answer.
The article rightly points out that the most important step in retirement planning is understanding what you will spend in retirement. You don’t know how much to save until you know what you want to spend. After all, your spending level is what you want to maintain after you retire, not some arbitrary percentage of your income. The best place to start is with what you know – what you are spending today. Therefore, current expense tracking is really the first step when it comes to retirement planning. Once you know your current spending habits, you will be able to project your retirement spending. Many expenses will be the same. But many will change. The biggest expenses that tend to decrease are those involving children and their education. The expenses that tend to increase relate to travel and leisure activities.
According to the article, there are 5 easy steps to figure out roughly how much you need to save for retirement:
- Track your current annual spending to see how much you spend on the basics and how much is discretionary. This way you will know where your money is going.
- Project your annual spending after you retire by adjusting your current spending for those expenses that will disappear like a mortgage payment and those that will increase, like travel.
- Estimate the income required to cover this annual spending and then gross that up for income taxes that you will have to pay on income you receive.
- Estimate how much you will receive from guaranteed income sources like pension plans, CPP and OAS.
- The difference between number 3 and 4 is the annual amount you will have to fund from savings in your RRSP, TFSA and investment accounts.
Of course, this gives you a rough idea of how much is enough. But it is just the first step. You still need to consider the effects of inflation and an appropriate asset allocation to determine how your funds will be invested. You also need to decide if the funds are just for your lifetime or if you want to leave money for your children in your estate.
Often, the first step is the hardest to take. For any financial planning exercise your spending is the most important input. Even small changes to this number can have a dramatic effect on the output. The reality is, most people don’t actually track their expenses. It is boring and time consuming. Everyone knows they should be doing it, but few do. Thankfully, technology has come to the rescue to make this easier. Here are three apps for expense tracking, each with a different degree of detail and attention required. Check them out and start figuring out what you really spend every month. You might be surprised.
Intuit’s Mint (Android, iOS) helps you track not only your income and expenses, but also your balance sheet. Besides allowing for in-depth personal budget management and expense logging, the Mint app lets you sync your bank and card details for an up-to-date and secure look at your finances. It will break down your expenses into different categories. You can set a budget within each category and set an alert for when you go over budget. This app might be too much if all you’re looking for is a little help with simple budgeting, but Mint is great if you’re looking for more financial features.
Wally (Android, iOS) aims to bring all of the financial information you need into easy view so you can quickly take control over your finances. It is an easy to use app that allows you to input your income and expenses and then organizes them into categories. The app’s InstaScan feature captures the relevant details from a photo of your receipt and populates your budget with the information. This means you don’t have to do a ton of data entry. The app also uses GPS to see where you spend your money.
BUDGT ( iOS) is a lightweight app with a clean visual design. It focuses on fast budgeting and expense tracking. You can create and manage a monthly budget with income and recurring expenses, and then enter your own categories that can be displayed in colorful expense charts. Clean screens, bold fonts and pie charts make it easy to input and track your expenses. It might not have all the features of other apps, but Budgt is a great choice for those who don’t want anything fancy.
1. “Putting It Off Can Pay” by David Trahair, CPA Magazine, November 2015. Creative Commons image courtesy of HA! Designs