Financial freedom. It is what we really want.
The most common questions I am asked are about retirement and financial freedom. For example:
- Jonathan (age 29) – I want to retire very young and very comfortably. How can I achieve that?
- Emma (age 34) – What do I have to do to be free and live without thinking about money?
- Kristi (age 43) – How can I stop worrying about whether my future and my kids’ futures will be okay?
- Brian (age 56) – We want to retire soon, but don’t have enough yet. What should we do?
- Jennifer (age 61) – Will we have to work until we are 75?
- Nick (age 63) – We are about to retire. How can we maximize our retirement income and pay less tax?
First, 8 insights from experience helping thousands of people become financially free:
- Becoming financially free is worth it! There is a self-confidence people get when I tell them, “You made it. You can live the way you want without having to work.”
- Sorry, but your house is not your retirement. Over 90% of people I have worked with want to stay in their home, or something close to the same value, after they retire.
- You need a much larger nest egg than you think. Investments of $1 million can give you a reliable income of $35-40,000 before tax, which is not a lot. If you are saving to retire in 25 years, inflation will double the cost of living. That means $1 million investments in 25 years gives you only about $20,000/year in today’s dollars.
- It is easier to get there than you think. The “magic of compounding” can give you a huge nest egg over time. Investing $1,000/month at 8% gives you $1.4 million in 30 years. If that $1,000/month goes into your RRSP, it may only cost you $600/month after your tax refund.
- You need a Retirement Plan. Building the nest egg you need does not happen on its own. When I first sit down with people and help them define how they want to retire, what they are doing typically would give them only 20-30% of the investments they will need.
- You probably need stock market investments to reach your goal. They are the asset class with the highest long-term return. Get educated on equity investing.
- Your Retirement Plan means you can stop worrying and start living. It is life-changing when you have the confidence to know your future will be everything you want.
- Creating a Retirement Plan makes you richer. When you have a Retirement Plan, you do things differently. You think long-term. Your decisions are more effective. Therefore, you have more money:
Achieving Financial Freedom
Creating your Retirement Plan is fun! Really. It is all about you and what you want from life. It’s not about your money – it’s about your life.
There are 4 main steps to creating your Retirement Plan:
A. Define the lifestyle you want:
- Start with a list of how you spend your money now.
- Adjust each expense for your desired retirement lifestyle.
- Calculate the before-tax income you would need.
B. Work out your “Magic Number”:
- Adjust your desired income by inflation for the years until you retire.
- Subtract the amounts you expect to get from work and government pensions to get the amount your investments need to provide for you.
- Multiply by 25 or 28 to get your “Magic Number” – the amount of investments you need for the retirement you want. Use 25 if you are an equity investor, 28 if you are a balanced investor, or 40 if you are a GIC or bond investor.
C. Decide how much to invest:
- Calculate how much you need to invest per year. Use a reasonable rate of return based on how you plan to invest.
- Decide whether investing that amount is doable for you. Take into account your tax refunds, using an optimal mix of RRSP and TFSA for your incomes.
D. Create a doable plan to get there. Your first draft probably will not work. You have 4 options:
- Reduce your retirement lifestyle.
- Work longer.
- Invest more now.
- Consider a more aggressive strategy. This could include strategies of borrowing to invest, such as the Smith Manoeuvre or Lifecycle Investing. These only make sense if you are growth-oriented with a long time horizon, comfortable with the risks, and would stay invested in a market crash.
Keep revising your plan until you decide on the best Retirement Plan for you. It should be both doable and give you the retirement you want.
Your plan gives direction to your entire life. If you are not confident that your plan is optimal for you, work with a planning-focused financial planner to create your Retirement Plan.
Your planner should be able to create it together with you in one meeting. Comparing options for your life empowers you.
For example, you may have life choices to make your plan work, such as:
- Retire with $1,000/month less to spend
- OR work 2 extra years
- OR find $400/month more to invest now.
Which would you choose?
What is your desired lifestyle?
Picture yourselves being retired and free to do what you want. Assume, for the moment, that you have all the time and money you want. Dream with your spouse. What is the life you want to live?
Using a rule of thumb, such as “You will need 70% of your income” is not good enough. The lifestyle you want is very personal. I have done plans for people that want to retire at 180% and at 45% of their income today.
I used rules of thumb when I was a new financial planner 20 years ago. I found most people did not really believe they needed that much and were not committed to achieving their plan.
Make your desired lifestyle your own. How do you want to spend your time when you do not have to work? Consider:
- Where will you live? Will you live in your current home (or something similar value)?
- Will you be debt-free when you retire?
- What travelling do you want to do? Are you future snowbirds? How many trips per year, how long and how much will they cost?
- What car(s) will you buy and how often?
- How much do you want for entertainment and spending money? What entertainment and activities do you enjoy?
- Is there a legacy you want to leave, such as for your kids or a charity important to you?
Minimizing Tax, RRSP vs. TFSA, and Maximizing Pensions
Your plan can be much easier to achieve if you optimize your tax and pensions.
Optimizing your RRSPs and TFSAs can make a huge difference for you by minimizing tax over your lifetime. There is an optimal mix for you. It depends on your tax bracket today compared to your tax bracket after you retire.
When you know your retirement income, you can figure out your optimal mix. A big factor often is the clawbacks on government pensions, such as the GIS clawback on seniors with low taxable income and the OAS clawback for higher income.
Your taxable income can be completely different from your cash income, especially if you plan to have a large portion of your investments in TFSAs or non-registered investments. For example, it is possible to have a high cash income, but low taxable income, in order to qualify for more government pensions.
Optimizing the 2 government pensions, CPP and OAS, is helpful. Both pensions will pay you more if you delay receiving them. Optimizing them depends on a few factors. How long you expect to live is one factor, but the most important is how you invest. Equity investors should take the pensions sooner, while balanced and conservative investors usually should delay the pensions.
Effective investing affects every part of your Retirement Plan, including the long-term rate of return, decisions about government pensions and how much you can reliably withdraw from your investments.
You will probably find it difficult to achieve your goal with a balanced portfolio averaging 5%/year. An equity portfolio averaging 8%/year long-term can make your goal achievable.
You need to invest within your risk level, because bear markets and market crashes will happen during your lifetime. You only get the long-term return of equities if you stay invested.
Stock markets are quite unpredictable short-term and medium-term, but have reliably provided strong returns long-term. For example, the worst 25-year return of the S&P500 in the last 80 years has been 7.9%/year. Get educated on stock market history and you may find you are comfortable with a more growth-oriented portfolio.
Financial freedom. It is what we really want.
You get a feeling of security and self-confidence from knowing you are on track for the future you want.
You need a Retirement Plan to get there. It will not happen on its own.
Creating your Retirement Plan is fun. It makes you wealthier.
It’s not about your money – it’s about your life.
Note: This article as seen in October 2017 issue of Canadian MoneySaver.