In reality, it is difficult to know exactly how much income someone will need in retirement, so the replacement ratio should be viewed as a basic measure that can help you establish a retirement savings goal. To determine an appropriate savings goal, it is important to understand how your major expenses change throughout your lifetime.
Taxes and government deductions are by far the biggest expenses for the average working pharmacist in Canada. Federal and provincial taxes, employment insurance (EI), CPP and health premiums all combine to cut almost 40% from gross income. So a pharmacist who earns $100,000 per year is really only living on $60,000 per year after tax.
Another thing to recognize is that expenses change depending on your stage in life. Malcolm Hamilton, an actuary with benefits consulting firm Mercer, has identified three distinct stages in life:
- Your 30s and early 40s: Individuals at this stage typically pay 30% of their gross income to taxes and government deductions, 20% to mortgages and debts and 10% to raising children. Paycheques always seem stretched because these individuals are living on only 40% of their gross income.
- Your late 40s and 50s: People tend to feel richer as they transition into this stage. Typically the kids grow up and the mortgage gets paid off, so cash flow increases to 70% of gross income. However, people tend to focus on retirement during this time, so most of that extra cash flow gets pumped into higher savings. The 10% or 20% in savings drops cash flow back down to 50% to 60% of gross income.
- Retirement: The final life stage is retirement. For pharmacists who are no longer earning a paycheque, the biggest savings is the reduction of taxes and deductions. Federal and provincial taxes fall in dollar terms and as a percentage of gross income, EI payments stop and CPP premiums end. According to Mr. Malcolm, the amazing truth is that most people can live on 50% to 60% of pre-retirement income because that is what most people lived on while they were working. The news gets even better for those who expect to receive CPP in retirement: a portion on that 50% to 60% of pre-retirement income will be covered by the government.
High income earners like pharmacists can replace a smaller percentage of their gross salary and still maintain the same standard of living. That’s because taxes and lifestyle expenses are significantly lower in retirement, so fewer dollars are needed to be replaced. As a starting benchmark, pharmacists should save enough to provide 50% to 60% of their pre-retirement income. That level should be able to provide a comfortable, no frills retirement. Once you saved enough to meet that baseline, you may want to consider raising your target percentage to 60% or 70%. If you expect to live large in retirement, shoot for an even higher replacement percentage.
Again, it is important to remember that income left over after all major expenses is what counts. High income earners tend to have high income expenses while working. The replacement ratio is a good tool to use to determine a general savings goal, but keep your expenses in mind when setting the level that is right for you.
