Why following the 70 p.c rule may smash your retirement financial savings
A commonly cited rule of thumb is that you need 70 percent of the income in your later years of work to be able to live comfortably in retirement.
However, many experts say that when it comes to saving for retirement, the 70 percent figure is no longer reliable, given the varied ways people are saving for retirement today and the unique way of life they have.
“Rules are abbreviations that are often not worthwhile – especially with regard to long-term financial security -” says Rona Birenbaum, founder and certified financial planner at Caring for Clients, a fee-based financial planning company in Toronto.
The 70 percent rule goes back to the time when individual breadwinners were able to fall back on funds from defined benefit pension plans, says Ms. Birenbaum. These pensions are becoming increasingly rare in today’s workplaces. Also, workers are more likely to change jobs these days, which means that even those on defined benefit pensions are less likely to benefit than older generations.
Rather than focusing on income, Ms. Birenbaum believes it is better to look at after-tax cash flow, especially for couples who can use various income-sharing strategies and tax-free savings accounts to help lower the family’s overall tax burden .
The 70 percent rule is also problematic with today’s longer life expectancy, especially with people who invest conservatively in low-yielding products like guaranteed investment certificates (GICs).
“70 percent was easier to get when the interest rates on GICs were 6 or 7 percent. But now it’s 1 percent, and it takes a lot more capital to generate your cash flow, ”she says.
On the expenditure side, Ms. Birenbaum points to the argument that 70 percent overestimate the cost of living in retirement. However, she has had many clients who believe the opposite is true: some seniors continue to make mortgage and other debt payments, and support adult children, while long-term care insurance costs soar.
“I feel embarrassed to say to someone: ‘Your expenses will go down and then it will be a flat rate.’ I just don’t see it that way, “she says, especially as the lifestyles and needs of many people change in their later years.” Instead of spending money on travel, they want to be able to spend it on additional services to improve the quality of life improve.”
Simon Tanner, principal financial advisor at Dynamic Planning Partners in Vancouver, says the ideal retirement income is “an age-old question” that is difficult to answer.
Surviving your money is always an issue, he says, especially now that people are living longer and many retirees are more adventurous and energetic than they were decades ago when the 70 percent rule was developed.
He suggests that people no longer believe that they need a certain percentage of their earned income in their final years, but instead plan active and passive retirement phases and allocate funds to everyone. For example, Mr Tanner says that someone wants to travel a lot in the early retirement years, which requires more spending.
Warren MacKenzie, director of financial planning at Optimize Wealth Management in Toronto, believes the 70 percent rule is problematic as it tends to stay away from using capital.
“Some people may think they need a retirement income and an investment income that is 70 percent of their early retirement income,” he says.
That could be a good calculation for some, he says, for example, if they want to leave a large estate to their heirs.
“But if they are happy to spend their last dollar on the day they die, there is nothing wrong with spending capital,” he adds, including the money they have tied up in their home.
“The most important thing is that they clearly define their goals,” says MacKenzie, including the amount, if any, that they would like to give to children.
He suggests that people put aside the “essential capital” they need to live, which is invested conservatively and left to heirs when they die, and consider the rest as “excess capital” – to do with that , what you want.
“If you have an excess and you know it, you can enjoy it. You can spend more, you can give to the kids now, you can get involved with a charity – you can do what you want, ”he says, recommending that people work with counselors to develop a personalized retirement plan.
“Having the right plan enables you to enjoy your retirement.”
Guidelines like the 70 percent rule, while unreliable, can be useful as a “litmus test” to say, “How concerned should I be? How urgent is it for me to find out? ‘Mrs. Birenbaum says.
Such rules of thumb are also helpful in encouraging people to come up with a financial plan that takes into account their individual needs and wants in retirement, she says.
The benefit of such a plan, she adds, is that it can build in scenarios for unexpected life events such as job loss, a health problem, or even a financial collapse that can affect age goals.
“I can’t tell you how often customers’ lives change that makes their previous projections all but unusable.”