As your clients scramble to save enough money for a comfortable retirement, you may be able to take some of the pressure off by setting their savings targets considerably lower. The key is assessing the standard of living clients actually expect to achieve in retirement — modest or more luxurious — and whether they have the assets and the income to do so.

Research released earlier this year by Toronto-based Russell Investments Canada Ltd. challenges the view that Canadian households should aim to replace 70% of their pre-retirement income in order to maintain a comfortable lifestyle in retirement. Rather, Russell’s research suggests that just 60% of a household’s pre-retirement income is sufficient to cover both essential and discretionary expenses in retirement.

“The 60% income-replacement ratio is good news,” says Frederick Pinto, managing director of distribution services with Russell Canada, “because that’s certainly lower than what other estimates in the marketplace have been, such as 70%, 80% or even 90%.”

The Russell Canada study is based on an analysis of Statistics Canada’s 2007 Survey of Household Spending. Russell Canada’s study found that the average retiree, aged 65 to 74, spent $34,400 annually. This included $27,100 on essential items, such as food, shelter and transportation.

Lifestyle spending, however, was dramatically lower: just $7,300 was spent on items such as travel, dining out and discretionary purchases.“The reality is that is a very small number,” says Pinto. “Most people probably expect to spend much more than that.”

Indeed, many people don’t realize the extent to which their household expenses will drop in retirement. For instance, most retirees no longer face such major expenses as mortgage payments and support for dependent children, and income taxes generally drop substantially in retirement. In addition, retirees no longer have the “expense” of saving for retirement, which can chew up a sizable chunk of their income during their working years.

Lifestyle expenses also tend to decline in retirement, as individuals become less active with age. “When you’re in your 80s, you don’t spend like when you’re in your 50s,” says Malcolm Hamilton, senior partner with New York-based pension and retirement consulting firm Mercer LLC in Toronto. “The older they get, the more the things they enjoy doing seem to be simple, relatively inexpensive things.”

An individual’s personal consumption can fall by as much as 47% when they retire, according to Russell Canada’s report. And the older retirees get, the more their expenses decline. People between the ages of 75 and 79 spend $30,300 per year on average, those 80 to 84 spend $27,700 and those over the age of 85 spend $23,600, according to the report. By age 85, retirees are spending up to 32% less than they were at the age of 64.

Government transfers, such as the Canada Pension Plan and old-age security payments, cover about half of these expenses for the average retiree, according to the Russell Canada report. This leaves retirees responsible for covering the remainder of their expenses through private investments in RRSPs, pensions and annuities. For the average retiree between the ages of 65 and 74, the income from these investments must add up to $16,100 a year. “That’s a reasonable number,” says Pinto. “That is good news for people who are in the average income level.”

Given that these figures represent national averages, they won’t provide an accurate projection of every client’s spending habits in retirement. There is a wide range of spending patterns among retirees, depending on their income level, their lifestyle, their health and many other factors.@page_break@“What this suggests is that people do, and can, get by on a relatively modest income,” says Dan Richards, president of Toronto-based Clientinsights. “That doesn’t mean that there aren’t going to be lots of folks who are spending well above this.”

Indeed, the Russell Canada study found that individuals earning a higher level of income were spending substantially more in retirement. Those earning $60,000 or more spent an average of $71,900 per year — more than twice the national average — split into $51,000 in essential expenditures and $20,900 on lifestyle.

Government transfers comprise a much smaller proportion of income for these higher earners compared with the average retiree, representing just 24% of the former group’s total income in retirement; individuals in this category are responsible for coming up with an average of $52,000 per year from private investments to cover their total expenses.

These higher figures could be used as a helpful guideline when setting savings targets for clients in higher income brackets who may balk at the idea of spending only $7,300 a year on lifestyle expenses.

“I think that probably would be, for an awful lot of typical clients that people work with, a more relevant and sensible comparison,” says Richards. “The average client, for many advisors, is not going to want to live on $30,000 per year.”

To help clients set an income-replacement rate that’s appropriate for their circumstances, begin by assessing their current expenses and standard of living, suggests Hamilton: “You need an understanding of how much of your current gross income is actually going to things that you would have after you retire.”

In many cases, Hamilton says, more than half of a family’s pre-retirement spending goes toward debt servicing, dependent children, savings and other expenses that won’t continue into retirement. He agrees with the Russell Canada study’s conclusion that most families could get by on an income replacement rate of 60%, or even 50%.

On the other hand, if a client’s current spending patterns show that a majority of income is being used on aspects of their day-to-day life that will carry on into retirement, they are likely to need a larger proportion of their pre-retirement income to sustain that lifestyle. “They need to save heavily to maintain their standard of living in retirement,” Hamilton explains, “because their standard of living is high.”

But he believes that only a minority of individuals will need to replace 70% or more of their pre-retirement income. Pushing all Canadians to aim for this level of income replacement is putting people under unnecessary pressure, he adds: “I think we’re pushing people to save beyond what’s reasonable for them to save.”

The Russell Canada study acknowledges that a higher income-replacement ratio is always preferable in order to provide additional security. But the study found the majority of retirees aren’t treating themselves to many luxuries during their golden years.

While many people dream of a lavish retirement, with regular vacations and country-club memberships, most won’t be able to sustain this level of spending. Says Pinto: “Those who have ambitious lifestyle goals have to do a lot of saving to be able to achieve those things in retirement.”

Some of your clients may need to lower their expectations. Talk to them about some of the specific things they hope to do in retirement, suggests Pinto, and whether their income level could realistically support those plans.
IE