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November 21, 2019

Setting a target retirement income

Learn how the Advantages Retirement Plan™ estimates how much you will need during your retirement years

This article will help you:

  • Learn more about factors to consider when you are setting your own target retirement income
  • Understand how you can use the Advantages Retirement Plan™ to set the target retirement income that’s “just right” for you

Projecting income needs in retirement: the target-replacement rate approach

When you’re planning for retirement, an obvious question you must address is how much income you will need your “target retirement income.” Only after setting this target will you know how much you need to save.

There are several different methods you can use to estimate what number your target retirement income should be. One approach involves developing a line-by-line budget that identifies your expected spending needs for each year of your anticipated retirement. However, as you might imagine, this exercise can be overwhelmingly complex, leaving you with many unanswered questions. It’s also very challenging to predict detailed spending patterns over long periods of time, especially when they may start years from now.

An alternative approach involves setting a retirement income “replacement target,” where you estimate what percentage of your current income you will want during your retirement years. This is the method the Advantages Retirement Plan™ uses to help you figure out and set your target retirement income. As you progress in your career, you can update your current income in your account online.

In a “replacement-target” approach, your target retirement income is set as a percentage of your current income. This “replacement ratio” can be a useful way to approximate your needs in retirement, and is based on the idea that your overall spending will likely be lower than during your working years. The general default for the physician community is a 60 per cent replacement ratio that is calculated based on your pre-tax, pre-retirement income. The 60 per cent figure is based on a study that economist Keith Horner conducted for the federal government. Horner’s study found that higher-income individuals such as physicians tend to require a lower replacement rate than the often-cited 70 per cent figure (which continues to be debated today). While Horner’s study recommended a replacement ratio of 53 per cent for higher-income Canadians (as a percentage of earnings around age 64), it did not factor in out-of-pocket health-care costs such as home care and long-term care[1], so the Advantages Retirement Plan™ default uses a more conservative and slightly higher general rate for the physician community — 60 per cent — in order to help you prepare for retirement conservatively.

The Advantages Retirement Plan™ can help you set your target retirement income based on the 60 per cent replacement ratio and a handful of data points, such as current age, desired retirement age, annual pre-tax income, and the amount of existing retirement savings (e.g. in RRSPs, TFSAs and RRIFs). Given this information, the Advantages Retirement Plan™ will calculate how much you need to save through your Advantages Retirement Plan™, based on the 60 per cent replacement ratio.

The 60 per cent replacement ratio is merely a default. With the Advantages Retirement Plan™, you can choose to increase or decrease your target retirement income depending on what kind of lifestyle you anticipate during your retirement years. For some physicians, 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 other physicians, some expenses might increase during retirement 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.

Keep in mind that there’s no one-size-fits-all method to precisely estimate how much you will need during retirement. But thoughtfully creating an estimate and setting a target retirement income can be useful to you as you build up your nest egg.

If you have many working years to go before retirement, it may be less urgent to define an approximate target income, but it’s still important to establish a general goal that will help guide your savings. And as your retirement approaches, you may want to fine-tune your target retirement income to check if it is still right for you and assess if you’re on track to meet a revised goal. Having a savings target is important because if you have not saved enough as you approach your retirement, it will likely be difficult to make up the difference in your remaining working years, 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 future needs. Setting a target income years before you retire can be a great way to keep those plans in motion sooner rather than later.

Key insights

  • The nature of your spending changes over your lifetime, and often retirees find that their spending needs go down, especially in early retirement
  • When developing a savings plan for retirement, the concept of a “replacement rate” can help future retirees ensure they are saving sufficiently to meet their spending needs
  • The Advantages Retirement Plan™ uses a 60 per cent replacement rate as a default to help future retirees maintain on average their living standards in retirement

[1]Keith Horner, “Retirement Saving by Canadian Households” (Finance Canada, Report for the Research Working Group on Retirement Income Adequacy, December 2009)