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 \u2014 modest or more luxurious \u2014 and whether they have the assets and the income to do so.
Research released earlier this year by Toronto-based Russell Investments Canada Ltd. <\/b> 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\u2019s research suggests that just 60% of a household\u2019s pre-retirement income is sufficient to cover both essential and discretionary expenses in retirement.
\u201cThe 60% income-replacement ratio is good news,\u201d says Frederick Pinto, managing director of distribution services with Russell Canada, \u201cbecause that\u2019s certainly lower than what other estimates in the marketplace have been, such as 70%, 80% or even 90%.\u201d
The Russell Canada study is based on an analysis of Statistics Canada\u2019s 2007 Survey of Household Spending. <\/i> Russell Canada\u2019s 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.\u201cThe reality is that is a very small number,\u201d says Pinto. \u201cMost people probably expect to spend much more than that.\u201d
Indeed, many people don\u2019t 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 \u201cexpense\u201d 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. \u201cWhen you\u2019re in your 80s, you don\u2019t spend like when you\u2019re in your 50s,\u201d says Malcolm Hamilton, senior partner with New York-based pension and retirement consulting firm Mercer LLC<\/b> in Toronto. \u201cThe older they get, the more the things they enjoy doing seem to be simple, relatively inexpensive things.\u201d
An individual\u2019s personal consumption can fall by as much as 47% when they retire, according to Russell Canada\u2019s 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. \u201cThat\u2019s a reasonable number,\u201d says Pinto. \u201cThat is good news for people who are in the average income level.\u201d
Given that these figures represent national averages, they won\u2019t provide an accurate projection of every client\u2019s 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@\u201cWhat this suggests is that people do, and can, get by on a relatively modest income,\u201d says Dan Richards, president of Toronto-based Clientinsights<\/b>. \u201cThat doesn\u2019t mean that there aren\u2019t going to be lots of folks who are spending well above this.\u201d
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 \u2014 more than twice the national average \u2014 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\u2019s 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.
\u201cI think that probably would be, for an awful lot of typical clients that people work with, a more relevant and sensible comparison,\u201d says Richards. \u201cThe average client, for many advisors, is not going to want to live on $30,000 per year.\u201d
To help clients set an income-replacement rate that\u2019s appropriate for their circumstances, begin by assessing their current expenses and standard of living, suggests Hamilton: \u201cYou need an understanding of how much of your current gross income is actually going to things that you would have after you retire.\u201d
In many cases, Hamilton says, more than half of a family\u2019s pre-retirement spending goes toward debt servicing, dependent children, savings and other expenses that won\u2019t continue into retirement. He agrees with the Russell Canada study\u2019s conclusion that most families could get by on an income replacement rate of 60%, or even 50%.
On the other hand, if a client\u2019s 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. \u201cThey need to save heavily to maintain their standard of living in retirement,\u201d Hamilton explains, \u201cbecause their standard of living is high.\u201d
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: \u201cI think we\u2019re pushing people to save beyond what\u2019s reasonable for them to save.\u201d
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\u2019t 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\u2019t be able to sustain this level of spending. Says Pinto: \u201cThose who have ambitious lifestyle goals have to do a lot of saving to be able to achieve those things in retirement.\u201d
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.\t
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