1. The 4% Rule is now 5%
How much should I be taking out of my retirement funds year-to-year once I retire?
Bill Bengen, a financial adviser in southern California, created the “4% rule” in 1994. This rule recommends an individual withdraw 4% in year one of retirement and adjust the fraction in subsequent annual withdrawals to reflect the rate of inflation. Benegen recently revisited his rule due to lower inflation. Back in the 90s inflation was much higher than it is today. Canadians, for example, are expecting inflation of just 1.6% in 2021. Lower inflation means investors can “safely” pull out more than the 4% rule. That’s good news for investors seeking passive income. For example, if you believe you need $70,000 a year in passive income, you need to accumulate $1.75 million in savings under the 4% rule, but only $1.4 million under the new 5% rule.
(Source: The Creator of the 4% Rule for Passive Income Just Changed it!)
2. The 25x Rule
How much should I be saving?
How much you should be saving goes directly to how much you think you will need to live on each year that you are not earning an income. One quick tool used by financial planners is the 25x Rule. The Rule invites you to guesstimate how much you will need in a given year in retirement and then multiply that number by 25. Therefore, the Rule suggests you need an aggregate of twenty five times the one year of retirement expenses. The Rule is admittedly sloppy but it might give a person who has yet started saving for retirement a “ballpark” estimate as to what they might require if they intend on ceasing earning income at a relatively young retirement age of 60/65. The equation is straightforward.
(Expected Annual Retirement Expenditures) x 25 = Required Savings Amount
Let’s say, for example, you plan to spend $70,000 a year during your retirement (including bills, living expenses, travel, etc.). To calculate how much retirement savings you require, you would take $70,000 x 25 = $1.75 million. Easy peasy. For those nearing their intended retirement a more involved calculation should be employed under the guidance of a licensed financial planner.
Save Early; Save Wisely
Ok, how do I get there?
But how does one achieve this $1.75 million (as an example)? By saving early, and saving wisely.
The vast majority of Canadians use their RRSPs (Registered Retirement Savings Plans) to make contributions to their retirement savings, whether in an individual or spousal plan. RRSPs have many advantageous qualities for individuals planning their retirement. The main three can be broken down as follows:
- Contributions are tax-deductible – “RRSP Season” as we like to call it runs for the first 60 days of the year, just before “Tax Season.” Effectively, this means that you can make RRSP contributions with pre-tax dollars, allowing you to deduct RRSP contributions from your income each year. This provides immediate tax relief in any given year.
- Earnings are taxed sheltered – If you use your RRSP to invest, any earnings made are sheltered from taxation as long as it remains in the plan.
- Tax deferral – RRSP contributions and earnings will be taxed when you withdraw them. However, it is likely that upon withdrawal, your marginal tax rate will be lower than when you initially made the contributions.
Most people are aware of the benefits of holding your retirement savings in a registered account such as an RRSP or RRIF. However, they quite often pigeonhole themselves into only investing in a handful of assets such as publicly-traded equities and bonds.
So, where exactly does real estate come into play?
Many Canadians tend to focus their attention (and RRSP contributions) on a small handful of asset classes and are unaware that RRSPs can also be used to invest in:
- Canadian mortgages,
- Mortgage-backed securities, and
- Income trusts
Real estate is what we call a “Hard Asset,” meaning you can physically kick it. And, having asset-backed investments, provides greater security and lower risk to your portfolio.
Fundscraper has numerous real estate backed offerings that are eligible for investment with your registered capital (RRSP, RRIF, TFSA, etc.), helping you contribute to your retirement savings. You can learn How to Invest in Real Estate using Registered Capital here.