Planning your spending for retirement – the side of the coin no one talks about.
Planning for retirement is a two-sided coin, with planning your savings on one side, and planning your spending on the other. It is easy to set a savings figure, but without contrasting it against a spending figure, what is the value? Your spending will dictate the amount that you should save, and your saving will determine how much you can spend. The two are linked, there is no one without the other! Planning for saving and planning for spending are both crucial facets of your retirement lifestyle and thus should be considered equally when beginning to prepare for retirement.
Replacement ratio: A method for planning your retirement spending.
A great way to plan your retirement income is to find your Replacement Ratio. The definition here, in the context of retirement planning is simple.
“A Replacement Ratio is a person’s gross income after retirement, divided by his or her gross income before retirement.”
An example of this is imagining Chris – Chris makes $40,000 a year, but falls unemployed. He is able to claim $20,000 a year in benefits, but is left with a shortfall of $20,000. You take the $20k/$40k and thus, his replacement ratio is 0.5 in this scenario.
In terms of retirement, this is usually done by dividing a person’s gross income after retirement, by their gross income during their final year of earning. What this essentially tells you is the percentage of income that you think you will spend every year. If you expect to be travelling a lot in retirement, you will want to focus on landing on a larger replacement ratio. A 75% replacement ratio is usually enough for most people to continue enjoying their current lifestyle. This indicates that your spending will be roughly similar to your pre-retirement spending, and you’ll be able to draw down your savings to cover the remainder.
If it isn’t looking like your replacement ratio is that high, it will be valuable to look into finding ways to improve your retirement income through investments or looking at reducing your lifestyle costs. This can be anything from moving to a cheaper area – think moving from Vancouver out to Vancouver Island. A move like this not only reduces your costs of living but may also allow you to pursue your retirement lifestyle easier. There are ways to improve your financial standing without taking shots at the lifestyle. Additionally, watching out for the inflation of your lifestyle will help you manage your finances and retire comfortably.
Break down your retirement planning into two components.
Retirement planning can be broken down into two equal areas: planning your saving and planning your spending. Spending is often overlooked, but is crucial in ensuring a smooth and comfortable retirement. There are tools out there to help, such as the replacement ratio, which can help you visualize and diagnose your situation. It is always helpful to use tools like the replacement ratio to analyze your own financial positions and make the best informed decisions.
Thanks for reading!
Planning for retirement can be complex. Hopefully this article has been able to clear up some questions or form the basis for some of your own research. If anything on this blog interests you further, please do not hesitate to reach out to me via email at [email protected] I’d love to talk about my financial services and advice in Vancouver, British Columbia’s lower mainland, and Canada in general.
- Brad Blair, CFP, CIM, FCSI, CHS.