$20 Rule a new way to determine retirement income: Russell

Russell Investments Canada’s has developed a new rule of thumb to help Canadians determine how much they will need to collect from investments, benefits, and pensions per year in retirement.

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.

According to the $20 Rule, 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, Russell says.

For example, a couple is heading into retirement with $400,000 in registered savings 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,” Ahmad says.

The rule “can also be applied to plan for two of the biggest threats to your retirement income: market volatility and longevity risk,” he adds.

“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,” says Ahmad.

As for managing longevity risk, 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. Saving $25 per $1 of desired income 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 nine 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.

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