TORONTO, June 3, 2009 – Some investment experts estimate that retirees will need to replace as much as 80% of their pre-retirement income for a financially healthy retirement.
But according to Russell Investments Canada’s new “Retirement Rule of $20”, it’s not a question of how much income replacement is needed – it’s how much you’ll need to collect from investments, benefits, and pensions per year in retirement. These factors can combine to help retirees combat market volatility and longevity risk.
“If you are close to retirement or already there, this rule of thumb gives you an estimate of the amount of investment income you can expect to earn annually over the rest of your lifetime. Remember that your investment income may be supplemented by other sources such as pension plans and government programs,” explains Irshaad Ahmad, President and Managing Director of Russell Investments Canada.
The $20 Rule of Thumb
The Russell Retirement Rule of $20 simplifies retirement planning by breaking it down as such:
- For every $1 of annual income you expect to need over your retirement, you will need $20 saved at the day of your retirement (with inflation indexing).
- The $20 Rule is based on current data regarding average life expectancies and the long-term rate of return from a balanced retirement portfolio consisting of 35% equities and 65% bonds.
- Example: A couple is heading into retirement with $400,000 in registered savings. They can expect that $400,000 to generate about $20,000, increased by an annual inflation rate of 3%, in annual retirement income (exclusive of other sources such as CPP, OAS, etc.) for a period of over 30 years.
“Even in these volatile times, Canadians have a lot to be optimistic about when planning their financial futures. The Retirement Rule of $20 can help you determine the level of income you’ll generate in retirement based on your registered savings. In addition, these savings may also be supplemented by other sources of income, such as government pension plans,” says Ahmad.
“Based on Russell’s Rule of $20, a couple’s $400,000 in registered savings can expect to generate $20,000 in retirement income. Combine that with an estimated $25,000 worth of CPP and OAS income and a couple’s total yearly retirement income can be approximately $45,000. This is just one example, since other scenarios could feature various levels of savings and potential income, depending on the retirement lifestyle that a couple has in mind.”
The Rule of $20 is a quick and powerful way to measure your expectations of post retirement income based on your current retirement savings. It can also be applied to plan for two of the biggest threats to your retirement income: market volatility and longevity risk.”
“Even with a conservative 35% allocation to equities, the obvious concern for retirees is the impact of significant volatility in the early years of retirement, especially taking into consideration the markets of late,” says Ahmad.
“When the Rule of $20 is tested in a previous challenging historical return environment for both equity and fixed income – using the mid 1920’s as the starting point of retirement, the results are encouraging.”
As Figure 1 shows, there is significant up and down market volatility right at the onset of retirement, but interestingly, the payout potential is not reduced as longer term probabilities of capital markets come to fruition. The black line shows how long a $20 investment would have lasted using actual historical data beginning in 1924. The result is that the portfolio achieved payout expectations that lasted more than the 30 years base case scenario (the orange line).
Figure 1: Rule of $20 Adjusted for Duration of Payouts
Managing Longevity Risk
According to Russell research, the Retirement Rule of $20 projects a retired couple’s funds to deplete in about 30 years or around age 90, assuming retirement at age 60. While that’s a decent lifespan by most standards, it does leave open the possibility of running out of money during a lifetime. In order to alleviate some of this risk, a couple could aim to save more. Figure 1 shows the impact of saving $25 per $1 of desired income; this would project payouts to last slightly beyond age 100. Conversely, if the couple only saves enough for $15, all else being equal, payouts would be expected to end around age 80.
“There are of course ways to work around this potential shortfall. Reducing the payout rate to something less than $1 is an example. If $15 was the only achievable amount, the couple can reduce their payout expectations to $0.76, which increases the duration by 9 years to the initial 30 year projection. Other approaches may be to take on part-time employment or curtail spending, all viable means to aid in bridging the gap,” says Ahmad.
“The Retirement Rule of $20 gives you a retirement asset target and can help you to plan your retirement savings to meet your long term goals. However, it is still highly recommended that you talk to your advisor so that you are introduced to programs that can provide you with enough income to provide for Essentials and Lifestyle while leaving enough for your Estate.”
The Retirement Rule of $20 is part of Russell’s complete retirement investment solution, which features a full range of retirement portfolios, such as the Russell Retirement Essentials Portfolio.
Russell Investments provides strategic advice, world-class implementation, state-of-the-art performance benchmarks and a range of institutional-quality investment products. With nearly US$213 billion in assets under management (as of 3/31/08), Russell serves individual, institutional and advisor clients in more than 40 countries. Russell provides access to some of the world’s best money managers. It helps investors put this access to work in corporate defined benefit and defined contribution plans, and in the life savings of individual investors.
Founded in 1936, Russell Investments is a subsidiary of Northwestern Mutual Life Insurance Company and headquartered in Tacoma, Wash. Russell has principal offices in Amsterdam, Auckland, Johannesburg, London, Melbourne, New York, Paris, San Francisco, Singapore, Sydney, Tokyo and Toronto.
Russell Investments Canada Limited is a wholly-owned subsidiary of Frank Russell Company. For more information, please go to www.russell.com/ca.