Monday, April 16, 2007

How Much Do You Need to Retire? - Part I

Welcome to my post for the first ever Canadian PF Blog Tour. I hope you enjoy it and I encourage you to check out the other participating posts.

Over the years you most likely have heard numerous 'rules' about the amount of income you are going to need in retirement (For example, 70% of your pre-retirement income). The problem with many of these 'rules' is they don't account for what your retirement is going to be like personally so in the end they are useless.

So how do you come up with how much your going to need? You do some math and a little soul searching.

First find your last couple of pay stubs and figure out how much money you took home last month after taxes, CPP and EI (if you have a spouse you can do this together).

Then minus anything you were saving for retirement, after all when your retired you don't need to save for it anymore.

Then minus any directly work related monthly expenses. For example you won't need too many suits when you retire or that parking space downtown. Also your bill for the gas to commute is likely to drop. Don't forget about dry cleaning or the fast food for supper that you keep buying since you don't have time to cook.

Then minus your mortgage payment (don't forget to leave your property taxes in if they are combined into your mortgage payments). We are going to assume that you were smart enough to ensure your home is paid for when entering into retirement.

Then minus what you spend on the kids every month on average (after all they should be out the door or close to it when you retire) and don't forget about that RESP contribution you've been making.

Then take that monthly amount and times it by 12 to get a yearly amount. This is your base number. Now we have to start adding a few things.

Add $1000/year for each property and/or car you plan to own in retirement. So if you have the house, cottage and a car you add $3000 to your base amount. This is to cover maintenance and depreciate costs for your home and car, respectively.

Then think about what hobbies you want to do in retirement and add in an estimate on the yearly cost for those. Keep yourself from going crazy here as this might make your total look way higher than it needs to be. Also I don't recommend including travel here. I'll get to that in a minute.

If you have an ongoing medical condition which you spend money treating regularly you want to also add an estimated yearly cost for that as well.

When the math is all done you now have an estimate figure of yearly costs in retirement.

For example your numbers could look like this:

Take home pay $3850/month
- retirement saving $700/month
-work expenses $130/month
-mortgage $1020/month
-kid $270/month
= $1730 Base Amount

Base Amount $1730/month * 12 months/year = $20,760/year
Add in one house and one car + $2000
Add in hobbies + $2000
Add in medical + $0

Total amount to live in retirement $24,760/year.

Now once you have your number you can divide that by two if your doing this with your spouse. So that would be $12,380/year/person. Now take your new yearly income and do an estimate to determine your tax bill. So let's use some rough numbers.

If the basic tax exemption is around $8000 that would mean only $4380 a year is taxable. Let's assume a 25% combined federal and province marginal tax rate. So the tax bill for each person would be $1095/year. So add that back in to your total amount to live. $1095*2 + $24,760 = $26,950.

This amount represents how much you need to live for your desired retirement lifestyle. It will not be a perfect estimate, but it should at least land you in the right ball park. As I mentioned early I do not suggest including travel money in this amount. Why? After your 75 birthday you are likely going to start slowing down a bit and not traveling as much. So if you include a set yearly travel amount your going to end up with an artificially high number because your assuming your traveling until your assumed death age which isn't all that realistic.

Instead your better off just starting a slush fund for travel. Take your yearly estimated travel spending and times it with the number of years you expect to be traveling. For example, if you want $3000/ year for travel from age 75 to 45 you would need $90,000 ($3000 * 30). When calculating how much you need to retire early you just add this amount to your total.

Come back tomorrow as I start into revisiting my first try of retirement calculations (Part I, Part II, Part III, Assumptions) to see if I can really save enough money to stop working at 45.


Customers Revenge said...

In-depth and interesting post although I don't like the concept in general. Why do you want to retire at 45? I have almost the same goal (age 40 for me). I also used to find the calculations of how much to save interesting but I think eventually, if you're serious about retiring that early, you would have to make some big decisions. Either that or live like a pauper for a long time. I currently put my money at considerable risk in order to make my desperate dream happen. It is bordering on starting a business, but not quite yet. So far it is just passive stuff like real estate and taxes, but it won't be enough to retire by 40. I would have to take a big step!

Canadian Dream said...


You've got a bit of point that as you push towards a very early retirement you need to increase your risks to make it happen.

That being said I don't think I'm going to need to take any big steps to hit my goal at 45. I actually started doing all the right things before I formed this goal in my head. I live below my means, be careful with my spending and avoid debt.

As to why I want to retire at 45? Well the short answer is I have way too many other things to do with my time than just work. I have a few novels that I want to write, a mountain of books to read and some traveling to do.