When you’re planning for retirement, a question you must address is how much income you will need in retirement: your “target retirement income.”
There are several different ways to estimate what your target retirement income should be. You can develop a line-by-line budget that identifies your expected spending needs for each year of your anticipated retirement. However, this exercise can be complex. It’s challenging to predict detailed spending patterns over long periods of time, especially when those periods may start years from now.
A more straightforward approach involves setting a retirement income “replacement rate,” where you estimate what percentage of your current income you will want during your retirement years. This is the method that Common Wealth uses to help you figure out and set your target retirement income.
In a “replacement rate” approach, your target retirement income is set as a percentage of your current income. This “replacement ratio” can be a useful way to estimate your income needs in retirement and is based on the idea that your overall spending during retirement will likely be lower than your overall spending during your working years. The suggested rate is calculated based on your pre-tax, pre-retirement income.
Here are the replacement rates that Common Wealth uses:
| Income from | Income to | Target replacement rate |
| – | $39,999 | 85% |
| $40,000 | $59,999 | 80% |
| $60,000 | $79,999 | 70% |
| $80,000 | $99,999 | 65% |
| $100,000 | 60% |
The goal of a target replacement rate is to approximate the income you will need in retirement in order to maintain your lifestyle. The target replacement rate is higher for modest- and middle-income members than for upper-middle and upper-income members because the former are likely to:
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- Have a lower savings rate pre-retirement
- Be renters rather than homeowners
- Continue paying a similar level of taxes in pre- and post-retirement because many will already be in the lowest tax bracket during their working years
The 60-85% figures are based on a study that economist Keith Horner conducted for the federal government, with slight adjustments upwards for higher-income groups to account for out-of-pocket health care costs such as home care and long-term care, which were not included in Horner’s study, and to allow for a margin of conservatism.1 The study was done across a large group of Canadians and individual circumstances can dictate a higher or lower income replacement ratio. We can help you set your target retirement income based on information you provide as part of your enrollment, such as your age, desired retirement age, annual income, and existing retirement savings (if any). Given this information, we will calculate a suggested savings plan to help you reach your retirement income goals.
The suggested target replacement ratios are just that – suggestions. With Common Wealth, you can choose to increase or decrease your target retirement income depending on what kind of lifestyle you anticipate and wish to keep during your retirement years. For some, your actual spending needs might drop in retirement; for example, you may no longer have a mortgage to pay off, your children may no longer be dependent on you, and you may no longer need to contribute more to savings once you’re retired. For others, some expenses might increase during retirement years compared to working years; for example, you might travel more often, and you might need to spend money on home care and health care expenses that you didn’t have during your working years.
If you have many working years to go before retirement starts, there’s no need to come up with a precise, line-by-line budget for your retirement savings. But as your retirement draws closer, you may want to fine-tune your estimates for your target retirement income to check if the target you had previously set is still the right target for you, and assess if you’re on track to meet your revised target. Having a retirement savings goal is important because if you have not saved enough as you approach your retirement date, it will likely be difficult to make up the difference in your remaining working years, and you will likely need to lower your retirement income drawdown rate and adjust your living standards.
Wherever you are in planning for retirement, it’s important to ensure that you plan and act today to meet your needs in the future. Setting a target retirement income years before you retire can be a great way to keep those plans in motion sooner rather than later.
1 Keith Horner, “Retirement Saving by Canadian Households” (Finance Canada, Report for the Research Working Group on Retirement Income Adequacy, December 2009)
