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This updated rule of retirement saving has you working longer, running out of money sooner

An epic decade of financial disruption has made it quantifiably harder to save enough for a secure retirement.

Consider the Rule of $20, which says that every $20 you have in personal retirement savings will on average generate $1 of inflation-adjusted, pretax retirement income annually. Developed by global asset management firm Russell Investments a little more than nine years ago, it applied if you retired at the age of 60 and projected that your money would last about 30 years.

The Rule of $20 was just updated, and it’s still a useful gauge of how much income you can generate from your retirement savings. But it’s a more demanding rule than it used to be, largely thanks to today’s thinner investment returns. You now have to retire at 65 for the Rule of $20 to work, and your savings are projected to last about 25 years if you assume an inflation rate of 2.5 per cent.

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You may have read something lately about the approaching 10th anniversary of a pivotal event in the global financial crisis: the collapse of the U.S. investment dealer Lehman Bros. The updated Rule of $20 reflects how the disruptions caused by the crisis are still being tallied.

When I wrote about the rule back in June, 2009, I described it as an alternative to vague retirement savings guidelines such as the replacement ratio. You’re supposed to save enough to replace 50 per cent to 70 per cent or more of your peak working income on an annual basis, but how do you know when you’ve saved enough annually to produce that level of income?

“The Rule of $20 is a different way of looking at the retirement equation,” said Shailesh Kshatriya, director of Canadian strategies at Russell Investments. “If I have $1-million, the Rule of $20 suggests that will give me about $50,000 in annual income in retirement. Or, to take it the other way, if you need $50,000, the Rule of $20 would suggest you need $1-million.”

Russell continues to base the Rule of $20 on a conservative investing mix of 65 per cent bonds and 35 per cent stocks. But while the original portfolio return projection was 5.95 per cent annually after fees, the firm now uses 4.2 per cent. Expected long-term stock market returns are down to 8 per cent from 9 per cent and bond returns are down to 3.5 per cent from 6 per cent.

The updated stock and bond market numbers might still be optimistic. For example, a five-year Government of Canada bond now yields about 2.2 per cent.

On inflation, Russell has lowered its long-term estimate to 2.5 per cent from 3 per cent. Inflation has averaged 1.8 per cent in the past nine years, but it recently hit 3 per cent. One of the biggest financial uncertainties of the moment is whether inflation is a serious threat or likely to slip back to levels that became normal in the past decade.

The key difference in the Rule of $20 is that it now applies at the age of 65 and onward, not 60. Mr. Kshatriya said the change was made to reflect the outlook for lower investment returns and the trend of people both living and working longer. “Having a retirement age at 65 seems more appropriate, given how the demographics have evolved, than 60,” he said.

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The Rule of $20 applies to money apart from whatever you receive from a company pension, the Canada Pension Plan and Old Age Security. Figure out your income from those sources and use the Rule of $20 to get the full picture of how much income to expect from your own savings. Note that your savings under the Rule of $20 are likely to run dry at the age of 90.

Russell says you can make your money last until 98 by assuming it will take $25 in retirement savings to generate $1 of retirement income annually. Your money runs out at 83 if you use a ratio of $15 of retirement savings to produce $1 of retirement income.

Conservative types may want to tweak the Rule of $20 by having $21 or $22 in savings to produce an annual $1 in retirement income. Just in case the next nine years bring as many takeaways as the past nine.

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