How does retirement planning work in Canada?
Whether you're a long-time Canadian or a newcomer, it's essential to understand how retirement works in Canada.
There are two main programs that fund retirement: the Canada Pension Plan (CPP) or Quebec Pension Plan (QPP) and Old Age Security (OAS).
CPP and QPP are funded through contributions from employees and employers, and the benefits you receive will depend on how long you've worked and your income during that time.
OAS, on the other hand, is a universal benefit available to all Canadians, regardless of their work history, based on how long they've lived in Canada between the ages of 18 and 65.
Together, these programs are designed to replace about 33% of your pre-retirement income, but that still leaves a significant gap.
The good news is that you don't necessarily need to cover the entire 67% shortfall. Generally, spending tends to decrease significantly in the early years of retirement. It’s crucial to assess what your needs will be and what will be covered by CPP and OAS.
Figuring out the rest can be complicated, as your spending patterns will change over time. Initially, expenses might drop, but they can increase later in retirement, especially as you age beyond 95, a phenomenon known as the "spending smile."
As a retirement advisor, I often start by estimating a 25% reduction in spending needs and then adjust for inflation as we model future expenses.
There are two main strategies for funding retirement: a probabilities-based approach, which looks at how assets typically perform over time, and a safety-first approach that involves pensions and annuities.
While defined benefit pensions provide reliable monthly payments after years of service, those without access to such plans might consider purchasing an annuity, which operates similarly.
It's important to remember that each approach has its pros and cons. The safety-first strategy can leave beneficiaries without support after the annuitant passes away, while a probabilities-based approach allows for the possibility of passing on remaining assets to loved ones.
If you're feeling uncertain or curious about your retirement planning, I encourage you to reach out.
