As he neared his 60th birthday earlier this year, Rick Sanderson knew he was fed up with the sales job he had held for 34 years. “It was starting to affect how I felt about everything,” says the resident of Crowsnest Pass, Alta. (whose name and identifying details we’ve changed). “I was kind of cranky, had some depression. I just felt that if I kept going to work my health was going to be affected.” Like many Canadians of similar age, Sanderson had long been counting on retiring before he hit 65. He and his wife, Heather had accumulated ample money to cover basics. But they wanted more. Their retirement wish list included a home renovation and extensive travel to Europe and South America.
The market collapse of this past year put those dreams in jeopardy. At one point, the Sandersons’ investments had lost 35% of their value. If Rick retired at 60, the couple was no longer sure that they would have enough to afford their entire wish list. Should Rick continue to do a job he disliked to ensure the retirement they desired? Or follow his heart and say good-bye to the office forever?
If you’re in your 50s or early 60s, you may be facing exactly the same dilemma. Many Canadians have had to re-evaluate their early retirement plans after watching their portfolios plunge in value over the past couple of years.
But don’t give up on your dreams of early retirement just yet. You may be able to make early retirement affordable if you’re willing to cut back, just a bit, on how you plan to enjoy life after you quit work. “I think most people do have an ability to cut back on the extravagances and live a life that’s less expensive but not much less enjoyable,” says Malcolm Hamilton, a consulting actuary with Mercer, a human resources consulting firm in Toronto.
Rick Sanderson is a case in point. After weighing the alternatives, he decided to plunge into early retirement despite his depleted portfolio. “I just had enough [of my job] and figured it was time to go,” he says. “If we have to, we’ll change our lifestyle to accommodate what we have.”
Rick is enjoying the early days of his retirement, doing small jobs around the house and golfing. Heather, 58, is still working, but hopes to also retire in the next few years. They’re confident they have enough money, even if they’re not so sure they can afford all their dreams. “If it’s a choice between renovating and traveling, we decided that we would travel,” Rick says. They are planning to drive across Canada with a trailer and visit Australia, but aspirations for further trips to South America and Europe will depend on how their finances hold up. “We just decided to do what we can with what we’ve got.”
How much is enough? As the Sandersons demonstrate, an early escape from work may be more affordable than you think, especially if you’re willing to scale back on some of your ambitions.
Consider a typical Canadian couple who earned average incomes during their working lives and don’t have a defined benefit pension plan. A nest egg of about $400,000 should be sufficient for them to retire at 65 and continue to live at the standard they enjoyed while working, says Hamilton. For that same couple to retire at 60 and live their accustomed lifestyle would require a nest egg of more like $600,000, estimates Hamilton. Yes, that’s still a fair amount of money, but it’s not anywhere close to the million dollars that many people think you need.
The 3% solution. If you plan to leap into retirement early, you must be careful about how much money you withdraw from your nest egg every year. That’s because you have to make your nest egg last a longer time. Let’s assume you have a balanced portfolio of both stocks and bonds. If you retire at 65 and want to minimize your risk of running out of money, researchers advise you to plan on withdrawals of no more than 4% annually of your initial portfolio value (plus inflation adjustments). If you retire earlier, you need to go even easier on your withdrawals.
How much easier? If you retire at 60, you would be wise to scale back your withdrawals to around 3.5% a year, say some experts. Retire at 55 and a withdrawal rate closer to 3% makes sense. But use these withdrawal rates as rough guidelines, notas precise markers. You may want to withdraw a bit more in the early retirement years when you’re most active, and less in your later years when you have less get-up-and-go. Moshe Milevsky, a professor of finance with York University’s Schulich School of Business, says it’s fine to withdraw more if your investments do particularly well—but you should also withdraw less if they do poorly.
No helping hand. Don’t expect a lot of help from government if you want to retire early. Government programs are geared to benefit you once you turn 65. If you retire at that age, you can expect to receive a combined total of up to $18,100 a year from three programs: the Canada Pension Plan (CPP) or its Quebec equivalent, Old Age Security (OAS) and the income tax age credit. You can also tap the Guaranteed Income Supplement (GIS) if your income is particularly low.
Early retirees get a lot less. While you can begin taking CPP as early as 60, it’s at a permanently reduced level. Except for a few special cases, you will not be eligible for other government stipends until you turn 65. A typical 60-year-old retiree can expect to get $7,600 a year or less from government, all of it in reduced CPP.
It’s all in the pension. If you’re fortunate enough to have a defined benefit pension plan where you work, it can be a big help in making early retirement affordable. In fact, if you work in the public sector, your pension may be sufficient for you to retire in your mid- to late 50s even if you have no other savings.
A defined benefit pension provides you with a set amount every month—the “defined benefit”—once you retire. The amount you get is usually based on how much money you were making toward the end of your career, as well as how many years you were covered by the plan.
Public sector pensions usually pay 2% of your peak earnings multiplied by your number of years of service. Someone who worked 35 years for a government department could typically expect an annual pension worth 70% (35 times 2%) of his or her final salary. The resulting amount is often fully indexed for inflation.
Most private plans are nowhere near as generous. Pensions are typically calculated based on only 1.5% of your peak earnings,multiplied by years of service. The payouts are often not adjusted at all for inflation.
In most cases, this pension math is based on the standard case of retiring at 65. If you retire earlier, you’re more expensive to the plan because it has to pay you for additional years of retirement. Who pays for that extra cost? It depends. Sometimes your employer pays through higher contributions. Sometimes you pay through a reduced pension. In fact, with many private sector plans, you can lose 4% or more of your annual pension for every year before 65 you start collecting.
But other plans are more generous to early retirees. Many public sector employers and a few private sector ones allow you to retire years early with no reduction in pension. To qualify, you must satisfy a formula that combines age plus years of service. Federal government employers, for example, can retire at 55 with no reduction in their pensions if they have 30 years of service. In that case they get a fully indexed pension that is at least 60% of their peak salary. Many experts say that should be enough to retire comfortably, even without additional savings. Thus, while the dream of Freedom 55 may be dimming for many Canadians, it continues to shine brightly in the public sector.
David Aston writes about personal finance. He is a certified management accountant with an MBA and MA in economics. For more Reward Years columns by David visit moneysense.ca.