Retirement Comes Sooner Than You Think
Posted by Gail | Filed under Retirement Planning
I’ve been yacking on about RRSPs for years. I figure if the government is going to give us such a huge incentive to save for the future then we’d be fools not to take advantage of it. Yet every year millions of Canadians fail to sock away money in an RRSP. In fact, it’s been estimated that 97% of RRSP contribution room has gone unused. Whazzup with that?
Some people don’t bother with an RRSP because their company pension plans eat up almost all their RRSP contribution room. More often than not the reason people give me for their not jumping on the RRSP bandwagon is that they just can’t afford it. They have no disposable income left over after the rent is paid, the food is bought and the kids are clothed. I empathize. When I left my full time career to spend as much time as possible with my little ones, I’ve often found myself wondering whether the small contributions I manage to make each year would be enough. The answer I keep coming up with is, “It’s more than I would have if I kept skipping my RRSP contributions completely.”
Just $600 a year (which is $50 a month for the mathematically challenged) compounding at an average annual return of 5% a year — not so outrageous a rate of return, eh? — would grow to over $30,000. So, if I put in $15,000 of my own money, over 25 years my RRSP will double. If I have 30 years, my $18,000 grow to over $42,000. And if I have 35 years my $21,000 will grow to over $57,000.
Bump your return up by just one point – from 5% to 6% — and double your contribution, and you’d be amazed at the difference. Your $100 a month will net you more than $70,000 in 25 years, over $100,000 in 30 years, and $142,000 plus in 35 years. C’mon, you can’t tell me you don’t see the point of investing $100 a month to have a nice stash of cash at hand when you finally hang up your spurs.
When presenting the magic of compounding return the media’s focus has been on creating the most impressive story. To make the best case possible, calculations show the maximum contribution compounding at the highest reasonable (and, sometimes, not-so-reasonable) rate of return for a blow-me-away total in the millions. Unfortunately, using this tactic, we’ve managed to blow thousands of would-be contributors away — all those men and women who say, “Well there’s no way I can come up with that kind of cash, so I guess there’s no point in bothering.”
It’s no bother. And there is a point. Opening an RRSP is as simple as filling out a form. In fact, financial advisors have to complete thousands of transactions a day when the deadline draws near, so imagine how easy it must be. And if you accept the fact that everyone has to save, then the only point to be made here is that it’s far more effective to save inside an RRSP than outside one.
Pop into any financial institution and they can do the calculations for you. Or use any of the dozens of retirement calculators on the web to see how the numbers play out. Prove it to yourself.
The nay-sayers often like to position RRSPs as a trap: a way of paying more tax when you finally do start to pull the money, or of reducing our entitlement to government benefits. “Phooey!” say I disdainfully. First off, the tax-deferred compounded growth means you’re earning more inside the RRSP than you could outside a tax-sheltered plan. Second, if you really believe you bear no responsibility to support yourself in your old age, might I suggest you also invest a dollar a week in a lottery ticket.
February 25, 2009 at 7:21 am
“In fact, it’s been estimated that 97% of RRSP contribution room has gone unused”
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While that is high, it would not be foolish to assume that the contribution room will never get to 0%. Why? Because if I’m not mistaken, your yearly contribution room is based on 18% of your income. Even if one were to sock away 10%, which is a target for savings, there is still that 8% difference. Maybe I’m off on that outlook?
Now let me ask (to Gail naturally) about a possible situation. Obviously there are tax benefits to placing money in a RRSP, plus the fact that because it’s sheltered, it would grow faster than outside of one, however, if someone is saving, say 15% of net income, would you advise placing all savings into a RRSP (ignoring short term saving goals)? Because RRSPs are locked in, and get penalized from a tax end for withdrawing, wouldn’t it be better to split – some going to RRSP, other portion going to a non-RRSP investment vessel?
Something else for you to consider discussing Gail is that not everyone benefits from making RRSP contributions. An article had popped up in our local newspaper a while ago about how it may not be beneficial for certain people to invest into RRSPs specifically (but yes, savings are still needed!). If I’m not mistaken, it was regarding low income households, but I’m hazy on the details.
While everyone discusses how grand RRSPs are, no one ever mentions the opposite side, and because nothing is ever perfect, there has to be a “dark” side to RRSPs.
February 25, 2009 at 7:48 am
I’m in my mid 40s and work for an ontario municipality and contribute to the OMERS pension plan. Every year, we get a “pension statement” that shows what our total contributions plus interest are, and it also shows what our earliest no-penalty retirement date is. For years I didn’t really pay attention to that date because it seemed to be so far into the future. I can retire in 2019, and in the last couple of years, I’ve FINALLY realized that it’s not as far away as it seemed! My years of service are directly related to my age…imagine that! I’m continuing to contribute monthly to my RRSP, diligently working on eliminating debt, building my emergency fund and saving for a house/condo down payment.
February 25, 2009 at 9:12 am
@ Erran – Gail would never recommend putting all available savings into RRSP and nothing into more accessible savings account for emergencies or short-term goals. I think her main point is that people need to think not only of the immediate future but longer term as well.
There are dark sides to any financial decision. A primary benefit of RRSPs is to lower taxes that have to be paid; however if someone is already in a lower income bracket that benefit is minimized and the drawbacks (heavy taxation at withdrawal time) are maximized. Most experts (of which I am not) say that the new TFSA is a better vehicle for here in this case. Even for those in a higher tax bracket, rrsps are fairly inaccessible without incurring big fees, unlike an investment held outside of one which also allows for capital gains loss declarations for instance.
The best solution is to maximize resp payments, maximize mortgage pre-payments, maximize rrsp payments, maximize TFSA contributions, have 6 – 8 months savings and carry no consumer debt. Unfortunately, most people can not accomplish all these tasks and so are forced to pick and choose, to the benefit of some and the drawback of others. For instance, my wife and I max out RESP, then TFSA, then regularly contributions to rrsp to get us down a tax bracket, and manage to carry no consumer debt, but do not make accelerated payments on our mortgage or maximize our RRSP contributions.. we’re in the 97% group. I’m hoping that maxing out TFSA will build up our emergency fund, and at some point increase our rrsp contributions… but we’ll see…..
February 25, 2009 at 9:12 am
I agree that if you don’t have any type of retirement savings or if your pension plan with your employer is not that great then you should look into RRSPs.
However there is a down side to them if you have a good pension plan and so does your spouse. If you try to take the RRSPs out even during your retirement years you are taxed heavily. This is what is now happening to my retired parents who invested lots of money in RRSPs during their working years thinking they were doing a great thing. Yes they do get a little extra money now but they also have to save about 1/2 of what they take out in RRSPs for the taxes they end up owing at tax time.
So I think that anyone with good pension plans – espicially duo pension couples should ensure they talk to a financial advisor to see if their money would be better saved elsewhere.
February 25, 2009 at 9:40 am
The pension/RRSP equation has become more complicated lately with the markets in seeming freefall. I’m 20+ years away from retirement, but my public sector pension plan has taken a couple of big hits lately. It doesn’t have guaranteed inflation protection or medical benefits, and while retirees have effectively been enjoying these benefits for several years, the medical benefits have just been axed. And as the number of retirees swells (all those boomers are going to retire, perhaps when the market picks up) and the number of contributors can’t quite keep up, the plan is simply not going to be able to pay for inflation protection.
I’m not maxing out my RRSP, but I’m looking at raising my contribution, because when I’m retired, the RRSP income I have to pay tax on might be the income I need to cover medical expenses and protect against inflation.
February 25, 2009 at 9:46 am
I try to pay into my RRSP every paycheque. I contribute 1hr/day at my hourly rate. About $230 every two weeks or $460/month. I still have lots of room in my RRSP, but I have no company pension, so I am trying to catch up! As one financial planner recommended, putting your tax refund into your RRSP, if you have room.
February 25, 2009 at 10:11 am
My husband and I contribute as much as we can but I don’t think could ever get to 18% each, and I wonder if you did do 18% each for 25 years how much would that be? They say you will need about 60-70% of your income in retirement so it would be interesting to see how long you would have to contribute 18% to reach that goal.
February 25, 2009 at 10:52 am
Erran:
Remember that it is 10% towards savings AFTER taxes and 18% RRSP room BEFORE taxes. That 18% could be around 23-25% after taxes (depending on your tax bracket …). The number can be reached in you have a pension plan at work and get used to contributing into your RRSP before you get used to the money. This is means that your budget from your first job must include RRSP contributions and you must verify your contribution amount every pay increase.
Doable if you do it before you get used to spending too much. It is harder to cut back than if you never accounted for it in your budget.
February 25, 2009 at 11:55 am
Low income households:
There are some who believe that contributing to an RRSP could reduce their government-sponsored income during retirement. For information on the ‘Guaranteed Income Supplement’, go to:
http://www.hrsdc.gc.ca/eng/isp/pub/oas/gismain.shtml
However, think about whether you are planning on improving your standard of living before retirement!
February 25, 2009 at 12:23 pm
My brain hurts!
(just kidding)
All fooling aside, RRSPs are a tough decision. Too much thinking for the average impulsive person. How much of today are you willing to sacrifice for tomorrow? 10% or more? Especially in this volitile market where it feels like the money is just getting tossed in the fire. It doesn’t help when there are the high-pressure sales people trying to confuse you with universal plans and scare tactics (it has happened to me).
I have tried since the beginning to put away at least 10% (and on maternity leave that was only $50 a month that hurt like hell to part with)!
February 25, 2009 at 12:28 pm
I’m not feeling that great about RRSP’s right now. I put $17K in an RRSP in 2006 and I now have $15K to show for it. No high risk investments either. It was only a one time investment in RRSP’s because we are a duo pension plan couple with guaranteed pensions. I think I’ll stick with the pension plan contribution.
February 25, 2009 at 12:40 pm
RRSP’s are an individual matter, we are not all cookie cutter products. Some folks, like the people I deal with in the entertainment industry will be in a low tax bracket now, and then nearing age 65 or more, may be in a higher tax bracket,so an RRSP won’t make any sense. Also some “starving actors” get no benefit from an RRSP, yet if they are union members, and get automatic RRSP contributions, they are discouraged from removing funds from their RRSP by the Administrators of the Plan, and the actor is penalized/taxed by CRA for having too much money in their RRSP. They should be educated to look at their RRSP situation once a year and make movements for their best interests
February 25, 2009 at 1:19 pm
@ Diana – it’s a bit of a misnomer to say that RRSPs are bad because you are down on yours. An RRSP is simply a type of account, you could hold a GIC in an RRSP, what you mean is you choose low-risk equities to invest in and those are down… but low risk isn’t no risk. For me personally, I take the approach that I don’t want stocks to be doing well in my 30s or 40s and so am actually putting more in right now, but hopefully they start going up in my 50s and 60s… but we’ll see. It’s a risk but so is if I’m going to see my 60s or 70s, you never know.
February 25, 2009 at 1:50 pm
Not sure if anyone can answer my question.
Gail stated in this article that, “Some people don’t bother with an RRSP because their company pension plans eat up almost all their RRSP contribution room.”
In my situation, a few years ago I was contributing about $1500 / yr to my company DB pension plan, and the company contributed about another $1500 / yr = $3000 / yr. Yet, this $3000 pension contribution ate up almost my ENTIRE RRSP contribution room (at that time, likely about $18,000). Why is this? What is the correlation? I have asked the HR/Pension people at my company, and no one really has an explanation.
Anyone have an idea?
February 25, 2009 at 3:05 pm
Mike:
Under the defined contribution plan, that row (contribution room used up)in your taxes should read $3000 (your contribution + your employer’s). Check your T4 slips and pay stibs. If it reads $18000 instead, I would go back an question. They should be able to explain your T4 slip.
Under defined benefit pension plan, the rules might be different.
February 25, 2009 at 9:22 pm
Gail, which bank is offering 5%? Do you mean in one of those Stepper RSPs or GICs where the rate starts at 1% and grows to 5% in its fifth year because that’s the best I’ve been able to find.
February 26, 2009 at 5:51 am
Mike, the rules are very different under a defined benefit plan. When you belong to any pension plan, a Pension Adjustment (PA) is made to offset your RRSP contribution limit. With a defined benefit plan a formula is used to calculate the value of the PA. Only your benefits administrator can explain this to you since only (s)he has the formula used under your plan. Go and find out more. BTW: most people would kill for a defined benefit plan.
February 26, 2009 at 8:52 am
Donnarino — Gail is probably taking that 5 or 6% as an example, not a specific RSP account. And I think it’s important that it’s an average return of 6% over many years, which will include some years at -10% and some at +10% historically.
February 26, 2009 at 9:45 am
Diana C – I tend to agree with you….as of Sept 1st I had an RRSP with almost $60K in it that is now less than $30K. That money was $11K I rolled over from a pension plan that I had in 1996, plus added about another $10K of my own money, so it grew about $40K in 12 years, and I’ve lost almost all of that.
I still contribute to an RRSP but fortunately the company I am working for gives me 10% of my salary a month to save as I like (no pension plan) and I don’t have to match it, so I am using their money, not mine. That’s over $10K a year going to an RRSP, that’s enough for me.
My own savings now is going to top up my emergency fund to have one year of expenses saved instead of 6 months and after that I will finish paying off my mortage. As far as I’m concerned right now that’s a better investment – it might not bring me a tax refund, but my house has increased in value $300K in 13 years so a much better return on my investment (in my uneducated opinion).
February 26, 2009 at 1:15 pm
Diana C – I feel your pain about the loss of value of RRSPs, but they have never been presented to me as a way to make money in 2-3 years. My understanding is they are meant to be for long-term plans, like retirement.
February 26, 2009 at 1:57 pm
donnarino and diana – keep in mind that rrsps are just a holding cell for your money – the outcome (gains/losses) will depend on what you invest in. whether your money is gone into a high-interest savings account (which actually is not a bad place to start in my opinion, if you are looking to make a profit in the next couple of years and roll it into your mortgage through the homebuyer’s plan), GICs, stocks, etc. The outcome will depend on the investment choices you make on the money inside your RRSP.
the 5% is just an average number. obviously the amount of interest you make will depend on what you invest in and the length of time.
winkwink – true, but then again it depends on your life stage. you might continue to contribute to an RRSP right up to the time of your retirement. Your investments will change as your needs and risk tolerance change also.
March 1, 2009 at 1:20 pm
I contribute a minimum amount to my RRSP because I have a stock option with my employer where they give me 50 cents to each dollar I contribute up to 4% of my salary. I actually contribute 8% and the other 2% goes into my RRSP. Right now, bank stocks are down a lot, but I look at it as an opportunity to buy more shares. Once they go up, it’s going to be a nice profit! It is hard to wrap my head around the numbers when I check my balance and it’s down considerably, but I remind myself that it’s only the total on paper. It’s not the big a deal until I’m ready to withdrawl.
I would love to max out my RRSP but right now debt reduction and building an emergency fund is more important.
Gail, I’d love to see a post on what to look for in a pension plan. What IS a good plan? For example: My husband doesn’t believe in RRSPs because he has a pension plan – but how good is it going to be? Will he still have medical/dental etc? I realize you can’t answer those questions, but a guide to what to ask our employers about might be a benefit to your readers. I’m so far from retirement that I haven’t given it a lot of consideration.
March 4, 2009 at 11:14 am
@ MelaniesD — be careful about your asset allocation. Many financial people advise against having more than 5% of your total investments in any one particular company. Many employees of WorldComm or Enron had lifelong investments of stock purchases in these companies and were completely wiped out and made no other investmetns along the way (in other words, a 100% allocation to a single company). Although it’s true that its unlikely a bank might fold, I suspect I would have written about US banks three years ago too. Investing in RRSPs is a good way to diversify your portfolio especially if you invest in index funds or another widely diverse mutual fund.
As for your pension question re benefits, it depends on your pension, it will be outlined in your husbands pension terms. You should also make sure you have survivors benefits so that you get a % of his pension if he dies first (usually about 60%).
November 23, 2009 at 2:06 pm
I can’t give you a sure-fire formula for success, but I can give you a formula for failure: try to please everybody all the time.