When and How to Save for Retirement
I meet with people in their 50's and 60's to talk about their finances and they often share how they want to retire early and all the nice things they want to do when they retire. Unfortunately, sometimes when I analyze their situation further, how they want their retirement lifestyle to be isn't sustainable with the savings they have. I often have to recommend to have more "realistic" expectations or expect to work a few years longer than they would like. As a financial planner, it's one of the tough conversations to have because there isn't much I could do when they're only a few years from their ideal retirement age.
It's much easier to prepare for retirement 10, 20, 30 years in advance so that you have time on your side. So when is the perfect time to save for retirement? The answer might be obvious… now! Whether you're in your early twenties or near 50, it's never too early to start. The earlier you start, the less you have to put aside every month. This is because you can take advantage of compounding interest!
"I'll start saving when I make more money"
This is one of the most common excuses I hear people make when people don't want to start today. You could definitely start saving later when you earn more money. The problem though is that it's a lot harder in practice than it is in theory. Life happens. When you earn more money, your expenses go up. You get a new car, a new home, children, and before you know it you're already in your 50's.
It's much easier to start today, even with a small amount of $50 or $100 per month. You'll be surprised by the compounding effect it has on your retirement savings after 20 to 30 years!
Think about this example (the numbers are just for easy math): Because you start saving in your twenties, you will have to put about $500/month to reach 1 million dollars by age 65. If you start in your 40's, that number would closer to $2000/month to reach 1 million dollars by age 65. If you can't afford to put aside $500/month today, how likely are you to be able to save $2000/month in your 40's when your obligations are a lot higher? In this sense, you benefit from saving early even before retirement. If you started in your twenties, it means you'll have $1500/month more in your 40's for the things that are important to you.
The next question becomes…
How much should I save?
There is no magic number you have to put aside every month. What you need to do is figure out the lifestyle you want during retirement and work backwards to see how much you need to put aside every month to get there.
Here is a series of steps to help you better understand what I mean:
1. Think about the lifestyle you want during retirement: How often do you want to travel? What activities would you like to do regularly? Where would you like to live? What reoccurring expenses do you expect during retirement?
2. Calculate how much you would need every month or year to sustain that lifestyle until you pass away (you can use the average life expectancy to calculate)
3. What age do you want to retire?
4. How much money do you need at your retirement age so that you can live the lifestyle you want without working?
5. How much money do you need to put aside every month now so that you could have the amount of money I need by my retirement age?
As you can see, there's a very methodical way to help understand how much you need to save for retirement. It's going to be different for everyone, as your lifestyle then will be different from everyone else.
"I don't plan on retiring"
I meet many people who are passionate about what they do and don't see themselves retiring. They would do their work, or another passion at that time, for the rest of their lives. I think that's awesome! I agree entirely with the saying "choose a job you love and you will never have to work a day in your life."
However, you want to consider that there are many times when you want to work, but you are unable to physically or mentally. Especially as we age, our bodies and health deteriorate. There is a lot within our control, like our diet, stress levels, and lifestyle, but there are also many things that aren't in our control. Even if we feel youthful in our 70's and 80's, we might not have the same capacity to work as we did in the past. In that time, we need to have money set aside so that we can "work because we want to, not because we need to."
Factors to Consider
When starting to save for retirement, there are many factors to consider. You want to be aware of these so that you can make a more informed decision of how to save. Here are just a few:
1. You might have a pension plan or group RRSP through your employer. You want to make sure you take those into consideration in your retirement planning.
2. The government offers different government benefits to help retirees maintain their lifestyles. These include Canada Pension Plan (CPP), Old Age Security (OAS), and Guaranteed Income Supplement (GIS). Note though that because OAS and GIS are government-paid programs, there is no guarantee that they'll still be around the time you retire. You might want to consider these as an "extra" if you have decades before retirement.
3. Choosing the right investment vehicle is important. It's not about putting aside every month, but making sure the money is working for you so that you don't have to put aside as much every month. You want to consider how much risk you're willing to take, your retirement goals, how long you have before retirement, and if your situation can allow for you to take risk.
4. When you're calculating the amount you need to save every month, you want to consider inflation and taxes in your calculation. These two factors erodes the value of your money, so it's important to factor them in so that you don't fall short of your retirement goals.
For those in your 20's and 30's:
For many of you who are younger, it make seem very hard to think that far ahead. There are many unknowns between now and 10 years from now, let alone 30 or 40 years from now. What's important is to understand the importance of saving for retirement and starting to save early.
Many younger clients I work with find that saving anywhere from 10-20% of their income every month is a sustainable amount to put aside every month. This will allow them to take advantage of compounding interest, while still leaving money to enjoy their 20's and 30's. I know many people who go beyond the 20% in hopes of becoming "financially independent, and retire early," or "FIRE." If you have ambitious goals to retire in your 40's or 50's, you can definitely reach it by following the steps above and by being diligent with your money.