By Jason Heath, Financial Post
There are five main variables that individuals have a degree of control over in their retirement planning: life expectancy, assets, liabilities, income and expenses.
Mike Baldwin did a great retirement planning cartoon about life expectancy. A man is sitting with his financial planner, who is typing away on her computer. She looks up and says, "If you're alive this time next week, you'll be living beyond your means." OK, so there's not much you can do about your life expectancy. You can try to increase the return on your assets and this is commonly the primary focus of the financial industry.
Typically, increased returns can only be earned over the long run by taking on greater risk, though other strategies like tax planning or wise investment decisions can also help increase returns. Liabilities are a drag on retirement planning and reducing interest charges by restructuring debt (or avoiding it as much as possible) can help in retirement planning.
Increasing income is easier said than done. Most employees are limited in terms of salary increases or bonus potential, but they can always get a part-time job or start a side business. The self-employed can always work more to increase their income. Last but not least, pre-retirees (or everyone, for that matter) have a strong degree of control over their expenses. In fact, expenses are probably the variable people have the most control over. It can be a lot more empowering to choose to cut your expenses in advance of retirement rather than being forced to do so in response to a shortfall while in retirement.
And surprisingly, small changes make a big difference. In fact, consider two small changes that most people could easily make to their budget: their home phone and eating out. The base monthly cost of one national home phone provider is $58.61, including 13% HST. That's more than $700 per year and seems unnecessary given most of us also have cellphones.
What about eating out? Assuming someone spends $7.50 a day for lunch from Monday to Friday and they take four weeks a year of vacation, that's $1,800 a year. If they brown-bagged their lunch, they could probably keep their costs around $2.50 a day or $600 a year. That's another $1,200 of potential savings.
What impact would these two small changes have for a 45-year-old? Assuming they make the two notional changes and put those savings towards either paying down a debt at 6% interest or investing them at a 6% return (ignoring tax refunds from RRSP contributions), they will enter retirement at 65 with a net worth $84,356 higher.
What does this mean in the long run? That retiree will be able to spend an extra $6,207 a year for 20 years (indexed to inflation). That's the equivalent of about $4,177 in today's dollars, which could be a significant increase in one's retirement budget. Retirement planning is all about costs and benefits.
People have to weigh today's costs in order to place a value on tomorrow's benefits.
Jason Heath is a fee-only Certified Financial Planner and income tax professional for Objective Financial Partners Inc. in Toronto.
$1,800 Annual cost of buying lunch instead of making it based on five lunches a week at $7.50 per meal and one month of holiday
$48,476 The increased net worth on retirement of a person who had been brown-bagging lunches for 20 years
“And surprisingly, small changes make a big difference.” - Absolutely true! Although these changes might seem small and unnoticed, you will eventually feel the effect in the long run, especially when you are talking about saving for your retirement. Starting early in life is not a bad thing. One can start small, and soon the fruits of his labor will be apparent later in life.
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