How do you know if you’re spending your life savings too quickly after retirement? The short answer is you probably don’t. Most retirees are in the dark, which is why they tend to be so cautious in their spending habits.
In theory, you could know where you stand if you had the right software but (a) you have to find it first and (b) you have to trust the output. At present, those are two big ifs. Fortunately, there is a quicker way to check on whether you are spending too much or too little. It involves calculating your leftover savings at a given point in time as a percentage of what you started out with. You then compare that percentage with the right benchmark.
To show how this works, I used a sophisticated spreadsheet to compute benchmarks for a middle-income couple who saved a fairly sizable amount. By “sizable” I mean in the middle six figures, not millions. I am also assuming that this couple derives all their retirement income from their savings plus Canada Pension Plan (CPP) and Old Age Security (OAS), which they take as soon as possible. In other words, they have no defined-benefit pension and haven’t purchased an annuity from an insurance company. Finally, I assume they retire in their early 60s.
After they retire, their savings will continue to grow with interest and capital gains but will shrink to the extent they draw an income. If they invest in stocks, their savings can also shrink due to capital losses. How likely are losses? In the case of professional pension fund managers, their portfolios have suffered a net loss about once every seven years since 1960. This is with 50 per cent to 60 per cent being invested in stocks, which is roughly what I think most retirees should be considering. So yes, the occasional loss is almost inevitable.
Over time, the couple should expect their nest egg to dwindle but not to the point that they run out of money, at least not until they are well into their 90s. The question is, just how much money should they have left at various points after retirement? This is where we come to the benchmarks. To keeps things simple, we’ll consider three milestones: nine years, 18 years and 27 years after retirement. The table shows what percentage of their savings they should still have left:
Table 1 – Remaining Savings (if CPP taken early)
The numbers in the table should shock most readers. A study earlier this year by the Washington-based Employee Benefit Research Institute showed that people who had been retired for 18 years still had assets equal to 89 per cent of their starting amount. That is nearly double the benchmark number in the table. The EBRI study was based on U.S. retirees, but for various reasons, I am fairly certain that the typical middle-income Canadian retiree would have preserved even more than 89 per cent after 18 years of retirement.
As low as they seem, the percentages in the table are conservative – meaning they are skewed toward the high side – for a couple of reasons. First, I rounded up. Second and more important, I produced the percentages by running two economic scenarios and then used whichever scenario produced the higher percentage. In one scenario, the investments do fairly well (achieving about a 5-per-cent annual return) and in the other, they do very poorly. By poorly, I mean an average return for a balanced portfolio averaging just 2 per cent a year over 27 years and even less than that over shorter periods. In either scenario, I assumed the couple adjusted their spending habits to ensure they would still have a modest amount of savings remaining by the time they reached their mid-90s.
Given that the benchmark percentages are so much lower than expected, it is natural to be skeptical. The most likely objection is that surely the prudent retiree wants more than a modest amount of money remaining at the age of 95, just in case he or she lives a very long time. If that is how most people feel, then why do so few retirees buy an annuity to protect themselves against extremely long lifespans? In my book, I suggest that people use 20 per cent to 30 per cent of their savings at the point of retirement to purchase a life annuity as a hedge against living too long.
If the above couple had elected to start their CPP at 70 instead of immediately, the benchmark savings percentages would have been lower still. That is because they are getting so much more pension from the CPP in their later retirement years so they can feel equally secure with a smaller nest egg.
Finally, there is one scenario in which the 27-year benchmark should not even be necessary. The best strategy for most retirees is to buy an annuity with about half their remaining money around 75 and well before the 27-year milestone is reached. If they did that, it would greatly alleviate any worries they might have about outliving their money after 90.
Frederick Vettese is an actuary and author of “Retirement Income for Life: Getting More without Saving More”.