Step 4: Estimating your retirement income
You can now begin working with the future values you have calculated for your assets to estimate the income that these can generate to help finance your retirement. Namely, the sub-total of your Financial Assets will represent the value of your investment portfolio while your home, rental properties, and businesses may present opportunities as sources of retirement income or capital.
Note: If you plan to sell the family home and retire to the family cottage or a smaller home, the sale of your home may provide extra capital that can be invested to further enhance your retirement income. Or maybe you plan to sell your business and the sale results in a lump sum that can be invested or maybe the terms of the sale result in annual payments for the next five to ten years. These are options that may be considered as you enter retirement. If you wish to plan around events such as these, you will need to include these in your Retirement Net Worth Statement. For example, if you plan to sell your family home and move to the cottage and you estimate the future value of the home to be $600,000, then in the Projected Value at Retirement column you would enter $0.00 on the line for your current Home. At the same time, you would add $600,000 to the value entered on the line for Non-Registered Investments. These entries will reflect that the capital from the sale of your home will be invested to enhance your income in retirement.
Required tools: Estimating your retirement income will require the following tools and information:
Pension Plan Information, such as pension statements from private pension plans, Service Canada (Canada Pension Plan), Regie des rentes Quebec (Quebec Pension Plan), Old Age Security, etc.
As you begin, try to envision your transition into retirement. A few of the questions you need to ask yourself in order to plan your retirement properly include these types of questions:
Do you plan to work part-time at the beginning of your retirement?
- During your retirement will you pick up short-term contracts? Or will you quit working cold turkey?
- If you have insufficient pension and investment income to support your full retirement, would you be prepared to work part-time?
- Are you willing to use a portion of your accumulated savings to supplement your retirement income?
- Are you flexible in your chosen retirement date? Would you be prepared to delay your retirement date and save more?
- How flexible are you in your desired retirement lifestyle?
How you answer these questions will shape how you approach estimating your income and the ultimate success you achieve in developing a workable, realistic retirement plan.
In retirement your income may originate from any or all of the following sources
- Government pensions (CPP, QPP, OAS, etc.)
- Employer Pension Plans
- Annuity Income
- Registered Savings Plans (RRSP, RRIF, LIF, etc.)
- Taxable Investment Income
- Accumulated Savings
- Employment Earnings
- Rental income, etc.
Estimating some of these income streams in retirement can be difficult, but you need to do the best that you can in obtaining accurate numbers to properly plan for your retirement.
Begin working with the sources of retirement income that have the most certainty concerning the dollar amounts to be received, and then move on to those sources that require you to make estimates and assumptions about future investment outcomes, as outlined below (each of which is discussed in further detail below):
- Sources of income that are documented by statements (for example, employer pension plans, government pension plans (CPP, QPP, OAS, etc). Then
- Sources of income that are based upon contractual or government requirements (for example, sale agreements, rental revenue, mortgages, Registered Retirement Income Funds (RRIF), Life Income Funds (LIF), etc.). Then, finally,
- Sources of retirement income that you must estimate based upon economic, business and investment assumptions (for example, income earned by your investment portfolio – capital gains, dividends and interest income or income from part-time or contract employment).
Note: If you are going to be receiving payments from an RRIF or LIF account, do not include these accounts values when estimating the income earned from your investment portfolio. Each RRIF and LIF account should be viewed and treated as a separate source of retirement income. This is because payments from these types of accounts are made according to government formulas. If you do not plan to receive payments out of your retirement accounts, by converting your RRSP or LRSP/LIRA accounts into RRIF or LIF accounts, then the value of these accounts should be included in your investment portfolio total when estimating the income earned from your investment portfolio.
Sources of income that are documented
Prior to completing the section on Sources of Annual Income, obtain statements of your anticipated pension income and annuity payments, if you were to retire on your chosen date. These statements will provide you with your retirement options and the corresponding amounts that you can anticipate to receive. In the Retirement Budget Estimator, enter this information in the dedicated lines for each pension type. Attempting to estimate these retirement income amounts is almost impossible, so you are best to make the extra effort to obtain a statement for each pension source.
Sources of income that are based upon contractual or government requirements
Sources of income that are the result of contractual agreements such as rental agreements, mortgage/loan repayment, or the sale of a business can be estimated and added as retirement income.
Note: If the payments are received as the result of a mortgage/loan repayment or a sale agreement, you will need to decide whether or not to include the returned principal portion of the payment as retirement income or as an addition to your investment portfolio’s capital. Typically each payment received will be comprised of two parts - an interest payment and loan principal repayment. Normally, the principal portion would not be included in the calculation of your retirement income. It would normally be added back into your investment portfolio’s capital for future reinvestment.
If you have decided to convert a registered savings account (RRSP, LRSP/LIRA, etc.) into a registered retirement account (RRIF, LIF, etc.), then the governments (provincial or federal) will dictate the dollar amounts that must be withdrawn each year. As mentioned in the Note above, you should treat each RRIF and LIF account as a separate income source and estimate the payments separately.
For RRIF accounts, the federal government sets minimum annual amounts that must be withdrawn from each account. To estimate the minimum annual RRIF payments to expect in your retirement you can use our RRIF Payment Planning Calculator, which is found in the InvestingForMe Tools section. Simply fill in your date of birth, the date you plan to begin your RRIF account, the estimated value of your account on the start date and your estimated annual rate of return or Interest Rate. This calculator will produce a printable report that estimates the required annual minimum payments you can expect to receive from the RRIF account. These annual estimates can be used for completing the Sources of Annual Income section. Repeat this process for each RRIF account.
Note: The RRIF Payment Planning Calculator also gives you the flexibility to base your annual RRIF payments upon a set payment period, i.e. the next 20 years, and a fixed monthly payment amount, i.e. $2,000 each month.
For LIF accounts, the government sets annual minimum and maximum withdrawal limits for each account. These limits are established each year and are based upon a financial formula as set out in the pension legislation. If you are planning your retirement to begin in three or more years, estimating the minimum payments from your LIF account can be difficult as you will have no idea what the calculated limits will be, but you still need an estimate. Use the table provided in our section Class Room – Account Types – Life-Income Funds – Withdrawals to find the minimum percentage pertaining to your age at retirement. With this percentage, you can calculate an estimated minimum payment by multiplying the estimated value of your LIF account by this percentage. This calculated minimum payment can be entered in the Sources of Annual Income. Repeat this process for each LIF account.
Note: For ease in planning you may want to use the RRIF Payment Planning Calculator to estimate the feasibility of establishing a fixed monthly withdrawal amount for your LIF account. For example, according to this calculator, a $200,000 LIF account paying out $1,000.00 a month, while earning an average annual 5.0% rate of return will last for approximately 33 years. If the same LIF account pays out $1,500 per month, the account will last for approximately 16 years. For more information about the annual minimum and maximum guidelines you can visit our section Class Room – Account Types – Life-Income Funds – Withdrawals.
Sources of retirement income that you must estimate
Finally, the last source of retirement income to be calculated and entered in your Retirement Budget Estimator should be those sources that rely heavily on financial assumptions and estimates (for example, investments in the stock market and commodities such as Gold and Silver that can be worth more than you paid or can just as easily be worth less). These types of investments may pay a regular income, such as dividends, or they may not pay any income, like investments in precious metals.
Remember: Companies that pay dividends to common shareholders are not contractually obligated to continue paying those dividends; the company has the ability to increase, decrease and, even stop all dividend payments. Prior to declaring a dividend payable to common shareholders, the company’s board of directors has complete discretion in the declaration of dividends. Shareholders have no say in the company’s decision.
In the case of those common shares with a long history of declaring and paying dividends, a significant portion of the expected investment return is dependent upon the share’s market price increasing after it has been purchased. This expected price appreciation is unpredictable and extremely uncertain.
Given the uncertainty in the returns earned from investments with no guarantees (common shares, mutual funds, ETFs, etc.) and the uncertainty that surrounds their future market values, extreme caution should be used to ensure that your forecast future investment returns remain realistic and conservative.
If your investment portfolio and asset allocation will remain the same in retirement as it is today, then the simplest method for estimating the investment income amounts would be to use your investment portfolio’s past results as a gauge for the future. You can refer to your investment account statements or your most recent income tax returns to obtain these numbers.
Note: If you are using dividend income information from your income tax slips, be sure to use the Actual Dividends –T5 – Box 10 and 24, not the Taxable Dividends in Box 11 and 25. You want to know the actual dollar amount of dividends you have received, not the increased amount used to calculated the dividend tax credit amounts.
On the other hand, if you anticipate that your investment portfolio and asset allocation will change as you approach and enter retirement, then estimating your future investment income amounts is a little more involved. In our Class Room, under the Portfolio Design section, we discuss a method for estimating rates of returns based upon a portfolio’s asset allocation and conservative rates of returns for each asset category. See Portfolio Design – 12 Step Process – Allocation for a more complete discussion on establishing a forecasted rate of return for your investment portfolio.
Note: The discussion that follows will require a bit of math to calculate and follow the rate of return estimation process for investment portfolios.
Example: As out lined in the 12 Step Process – Allocation, an investment portfolio that is invested approximately 75% in Fixed Income investments and approximately 25% in Growth investments will have an estimated average annual rate of return equal to 6.88%. With this asset allocation, we accept that 75% of the portfolio will generate interest and dividend income equal to 3.937% of the required 6.88%, the stock market investments will generate dividend income of equal to 1.0625% of the 6.88% and capital gains will generate the remaining 1.88% of the 6.88% rate of return. Stated another way, we estimate that approximately 57% (3.937% divided by 6.88%) of the portfolio’s rate of return will be interest income, 16.0% (1.0625% divided by 6.88%) will be dividend income and 27.0% (1.88% divided by 6.88%) will be capital gains. Applying these percentages to an investment portfolio that generates $10,000 in a given year estimates that $5,700 or 57% will be Interest Income, $1,600 or 16% will be Dividend Income and $2,700 or 27.0% will be Capital Gains. These amounts would then be the estimates entered on the Interest Income, Dividend Income and Capital Gains lines.
Once you have an estimate for your investment portfolio’s annual interest, dividend income and capital gains, you can now complete the estimate of your income in retirement.