Yep- I went there in my last post. Early RETIREMENT. Me, a 31 year old woman, having the audacity to daydream about when I’ll financially be able to stop working (not to be confused with when I’ll actually stop working). I even started out this whole adulting-thing 3 years ago in a 100k dark-debt-hole, so it’s not as if a lottery win/inheritance/rich spouse gave me a head start! However, I do believe it’s an achievable goal.
- I know how much money I spend (AKA I follow a budget). I can hear the groans whenever I mention the word budget, but they’re actually incredibly awesome. If budgets have never worked for you, give my post a read. It’s the only method that’s ever worked for me. Budgets aren’t restrictive, they’re liberating! They tell you how much you can spend monthly 100% guilt free! Plus, if you know how much money you require monthly you can actually make a realistic plan for how much money you need to retire.
- I track my investments and have a strategy (which I’ll explain in later posts) for ensuring they get to the number I want.
Obviously I recognize retirement planning is far from that simple though. I also recognize that not everyone plans on retiring young (which I personally define as before age 55).
At the point of retirement you’ll likely have money scattered in various sources such as pensions, investments, CPP, properties, etc. This might seem confusing. For example- let’s say in your career you’ve accumulated a guaranteed benefit pension, have RRSP investments, and also qualify for the Canada Pension Plan.
In my retirement post I discussed using the 4% rule to determine how much you need to have invested. For example, if you want to spend $40,000 a year you should have 1 million saved if that’s your only source of money in retirement. However, how does that required amount change once you add in the other income sources like pension or CPP? When some investments are in one huge account and other income sources are paid monthly, how do you know if you have enough in total??
Enter: The Rich Ratio
The rich ratio is something I recently read about in Wes Moss’s book “You can retire sooner than you think” and I found it to be a brilliant way to understand a complex topic.
In his words, your Rich Ratio is: The amount of money you have in relation to the amount you need.
It literally tells you whether you have enough money coming in from various retirement sources to afford to stop working. Before we walk through it so you can calculate yours, I’d first like to discuss the term rich.
For many people, “rich” conjures up images of mansions, sports cars, and copious amounts of jewellery.
That’s not the definition of rich I subscribe to. [If it is for you, and that’s the retirement you want, no judgements from me. It simply means your retirement number is going to be a LOT bigger than mine].
My favourite definition of rich that I’ve found comes from Jen Sincero in “You are a badass at making money” (Yeah, yeah. I read a lot. Deal with it):
Your rich ratio uses the financial independence number you’ve predetermined as your required yearly spending. Now let’s explore how to calculate your rich ratio!
Let’s pretend in this scenario you need $40,000 a year in retirement. You’re 60 years old, so you qualify to start taking a reduced CPP payment.
- You’ve been working for a company that pays a guaranteed benefit pension. You’re guaranteed $1700* a month with this.
- Since you’ve paid into CPP your whole career, the government will give you a $700* reduced benefit.
*These aren’t going to be everyone’s payments. They’re simply realistic projections for this hypothetical scenario.
- You have $400,000 invested in your RRSP. To convert this to what you can draw out yearly without depleting your account:
$400,000 x 0.04= $16,000 yearly or $1333 monthly (16k/12 months)
You already determined that you need $40,000 a year to live on in retirement. This amounts to $3,333 monthly. So do you have enough?
To calculate your rich ratio:
Have/Need = Rich Ratio
So for you in this scenario:
($1700 Pension + $700 CPP + $1333 RRSP) / $3333 monthly required
or: $3733 have / $3333 need
Equals a Rich Ratio of 1.12. So yes, you’re rich!!
If your rich ratio is above 1, congrats! You have enough to retire!
If it’s less than 1, you still have work to do.
Interestingly, you can also change your rich ratio by raising or lowering how much you want to spend in retirement.
For example, let’s pretend your sister has exactly the same amounts as you for pension, CPP, and RRSP savings (clearly she copied you). However, her required spending in retirement is $60,000 a year [$5000 a month]. Can she retire?
Rich Ratio = $3733 have/ $5000 need= 0.75!
Her rich ratio is below 1, so nope! Ha! Beat her to it! (I whisper “it’s not a competition” to myself daily).
As I always declare: your money situation is equally influenced by how much you save AND how much you want to spend.