This & That: Retirement Savings Edition
Posted by Gail | Filed under Retirement Planning
I’m big on savings. Tasha and I were having a conversation the other day about expensive shoes when I said, “I can’t afford those shoes.” Her response, “You so CAN afford those shoes.” Hmm. Seems I should have used the word “Thoil.” Anyhoo, sometimes it’s hard to find a balance between saving and spending, particularly when you’ve spent so long digging yourself out of Debt Hell. And sometimes it’s hard to put retirement savings on to your priority list when there are so many other demands screaming at you. Retirement is sooooo far away for the young, that they totally miss out on how important it is to start early.
Here are some recent questions.
S wrote:
I have 0 [zero] debit… I am curious what percent of my income should I be saving for my retirement? I am 35 years old.
S, that’s a wide open question that depends on two things:
1. How much you’ve already saved, and
2. How much you want to have when you retire.
The “Save 10%” rule of thumb is a guide — only a guide — and if you haven’t saved much to this point, then you may actually need to save as much as 18-20% to meet your retirement goals. I suggest you look around for some retirement income calculators to help you set some goals. Try www.fiscalagents.com to start.
Charlene wrote:
How do you determine the right ratio for RRSP savings versus living in the now? Is there a way to determine the right amount to contribute? My husband recently took over the finances and is driving me crazy with the “we can’t afford” talk. I feel that if things are so bad, we are probably overcontributing to RRSPs at this time. Our daughter is going to school out of province, which is added expense. The RRSP contribution seems excessive. My salary is approximately $44k and I contribute $200/every two weeks. His salary is $48k and he contributes $400/every two weeks plus all his bonuses and overtime. He did have a few years where he didn’t contribute the maximum (approximately half the max) and he seems to think that he now has to contribute huge amounts. He seems to want to pay everything down “now” and either I need a formula to show him his numbers are “out of line” or I need to see the formula that shows he is correct as his contribution seems excessive ($15,000 in RRSP contributions for each of the last two years). That is 30% of his gross pay. His yearly allocation is $9,000.
Charlene, based on your husband’s income he could be contributing as much as $720 a month and still be within the RRSP limits for a single year’s contribution. If he’s missed some years, I understand his desire to catch up. On your income you could be contributing as much as $660 a month. So you have some more contribution room. It sounds as if your husband has had it with spending and has swung the opposite way big-time. I suggest you sit down and talk about where you want to be and how fast you want to get there. The risk you run in focusing too much on the future and not enough on the now is that you have a crappy life while you plan for the future. It would be great if you could hit a better balance. Technically he’s not doing anything wrong if he’s just catching up previously unused room. However, if he goes over his contribution limits (taking into account what he has to catch up an based on your comment about him contributing all his bonuses and overtime), he may find himself penalized since there is a $2,000 life-time over-contribution limit after which a penalty of 2% per month kicks in. I suggest you do the math and then make an informed decision.
G wrote:
I have a SK Government pension plan that has been losing money fast. I no longer work for the SK Government and want to take my pension out, but it is vested. I can purchase a RRIF and not sure what else. . . I am so confused by all these acronyms and am still recovering financially from a divorce. I’m feel so helpless and just sick about my pension funds deteriorating so quickly. Can you please help?
G, the only reason to take the money out at this point would be because you believe you can do a better job of investing the money that the fund managers can. If you’re having trouble with even the basic acronyms like RRIF (Registered Retirement Income Fund, which is the flips side of an RRSP), are you confident you would be a better investment manager? All the markets have been doing weird things, but this is no time to bale from a system that has been working. If you intend to take the money and lock it up at the current interest rate to further protect the principal, have you calculated how long your money will last given returns are very very low right now? I think you should speak with someone who can help you do a thorough analysis and not just jump because you’re frustrated. Take your time with this decision. It’s a biggie.
C wrote:
Gail, I am a 24 year old first time homebuyer, also fresh out of university. Above all that stress I want to start saving for my retirement. On your show i see you talking a lot to couples about putting away a few hundreds dollars a month and by the time they want to retire they will have around a million dollars or more! What type of savings account are you using to make the money compound so much? Or i should say, what type of financial plan is this?
C, the key to having lots of money at the end is to start early and be consistent with your savings. My projections are based on a return of between 5% and 7% (depending on which season of the show you’re watching since interest rates move) which can be achieved with a balanced investment portfolio over the long term. The projections also assume that the tax benefit is reinvested for the long term to grow the assets even faster.
L wrote:
I have a question about the benefit of RRSP’s vs tax free savings accounts. To give you a little history, i am 24, i make $53,000 a year and have been contributing $50 per month to an rrsp for about 4 years. But i have been talking with a few coworkers and they have all switched their rrsp’s to tax free savings accounts to avoid paying tax on their money down the road when they want to withdraw it for their retirement. This makes sense to me, from a tax relief standpoint, but i’m wondering if there is something that i am missing because it seems to good to be true. If tax free savings accounts were more beneficial than RRSP’s wouldnt everyone be using them?
L, choosing a TFSA over an RRSP means you give up the “tax deferred growth” along with the “tax deferral on your current income”, the two huge benefits of an RRSP. Go read this.
J wrote:
Gail, I love your show and watch it faithfully (my children sing the opening to your show ” Money, money, money..”).Recently, I have been reading a lot about retirement savings and was surprised by the enormous amount of taxes that the government takes from a person’s estate as it passes to one’s children. I have some of my RRSP’s in segregated funds (and some in mutual funds). I see that the SEG funds are creditor protected and will pass to my children without being taxed. I still have 17 years left to work and would like to maximize my retirement savings in a tax effective way. What are your thoughts on segregated funds opposed to mutual funds (assuming the MER and rate of return is fairly similar)? I also see that people are required to draw certain percentages from their RRIF year and can be hammered with taxes if the amount is larger. Is there a point at which is does not make sense to put more into RRSP’s? How I can try to minimize the tax bite out of my savings?
J, the reason the government takes the “enormous” amount of tax is because no tax has yet been paid on that money, as long as it is in an RRSP. When you make a contribution to an RRSP, you make it in before-tax dollars. If you’ve paid tax on that money (through payroll deductions), you get that money back as a tax refund. M’love, it’s a truth of life that the government will get it’s pound of flesh. But that in no way detracts from the additional growth that can be achieved through an RRSP.
The only way a seg fund will pass to kids without being taxed is if it is outside an RRSP. Just as you can hold stocks, bonds or mutual funds inside an RRSP, so too can you hold them outside an RRSP, where there is no tax benefit, and therefore less of a “tax hit” later on. But the decision to buy any investment, be it a segregated mutual fund, a regular mutual fund, a stock or a bond (or whatever else) has to be based on your investment knowledge, goals and time horizon.
As for the MER, I don’t get as hot as some people do about it. I know it’s all the rage to MER-bash, but I don’t give a fig what the MER is if my rate of return is what I want. If you’re concerned about MERS then consider buying the index instead of a mutual fund.
Yes, people are required to take money out of their RRIFs on a regular schedule. But again, with the hammering of taxes, it’s a matter of how you look at it since the growth inside the RRSP (subsequently converted to the RRIF) was on a tax-deferred basis.
If there was a point at which it makes sense not to use an RRSP it would be when you had a big honking retirement pool (RRSP, corporate pension, whatever) to produce a steady income for retirement and were 10 years or less from retirement, at which point you may want to switch to using a TFSA or unregistered portfolio to balance out the “taxable” versus “non taxable” income you would receive.
August 12, 2009 at 9:24 am
TFSA vs. RRSP
The way I understand it, the TFSA growth and withdrawals were tax-free — making it a great retirement savings vehicle.
For someone with my timeline (20 years), for example, contributing $5,000 a year with 6% average annual growth, I’ve calculated that the account will grow to $192,320.54.
For the TFSA, I’ll pay taxes over 20 years on the $5,000 that I contribute each year — so I’ll pay taxes on $100,000.
For the RRSP, I’ll pay no taxes as I contribute. But, I’ll pay taxes on $192,320.54 as I withdraw it.
If I understand this correctly, then the RRSP will offer tax-deferral, but not necessarily tax savings compared to the TFSA.
Due to Gail’s advice and careful planning, I’m planning to have a higher taxable income after retirement than I do now and I thought the TFSA would be a great place for the first $5,000 I put away each year (with the next chunk going into my RRSP).
Please correct me if I’m wrong.
August 12, 2009 at 9:47 am
RRSP vs TFSA… Frankly, if you can afford it, why not do both? Besides, 5k per annum isn’t that hard to save. I managed to trim 4k off my budget this year versus prior year by going through it line by line. (Do I really need to watch one movie per month? Can I plan my car trips better to save on mileage and gas? Can I plan my meals more efficiently? Just how many comics books do I really need to buy every year? Can I use the library more? Is it time to use up my make-up stock instead of whippig out the credit card every time there’s a GWP? etc.)
And, there’s the lesser popular option of simply earning more money. (Can I make my editor happy and write more?) Sure, this option gets taxed, but it’s usually a larger impact.
August 12, 2009 at 9:48 am
Argh!
whippig = whipping
August 12, 2009 at 9:49 am
Argh x2!
lesser = less
August 12, 2009 at 9:56 am
RRSP vs TFSA
With a TFSA you pay taxes on the income you contribute, however; you DON’T pay taxes on the interest you earn.
With an RRSP you DEFER all tax on the income and the interest. Typically you withdrawal from an RRSP when you are in a lower tax bracket and thus pay lower taxes.
I feel sad an amazed for/at all the folks who think they won’t pay taxes on the $5000 they contribute each year YOU WILL, just not on the interest it earns.
August 12, 2009 at 10:13 am
I think the appeal of TFSA’s is knowing EXACTLY how much you will have, instead of trying to figure out how much you will have minus taxes. But I am curious, and perhaps I am missing something….the TFSA’s I looked at (a while back admittedly) had really low interest rates, equivalent to a regular savings account. I thought the appeal to RRSP’s was the ability to lock it in longer at a higher rate? Or did I miss something in here entirely?
August 12, 2009 at 10:30 am
Mellow et all — one of the biggest misconceptions is that a TFSA is ONLY a savings account. Like an RRSP, it’s a “bucket” that can hold a savings account, stocks, bonds, gics, mutual funds, etc. For instance you can also hold cash in an RRSP that will pay similar interest rates, just as you can with a TFSA. One thing I’m going to do next year when I have more cash is buy some riskier pharmaceticaul stock in my TFSA, just incase it hits the medical lottery in which case I don’t pay taxes on the 2,000% return I’m hoping for… That’s just me though
As for “locking in at a higher rate” that might mean a variety of things — for instance a progressive GIC, but that reflects the product (GIC) and not the bucket (ie RRSP or TFSA or RESP for instance).
August 12, 2009 at 10:35 am
I agree with you Mellow about knowing how much you will have. I have always liked paying up front and then being able to look at my account balance and know there are no creditors (ie CRA) waiting for a chunk of it. I love the TFSA.
Also agree with Denboo, with all of the planning we do we should have the same income at least in retirement that we do now so the lower tax bracket wouldn’t apply.
August 12, 2009 at 10:40 am
Gail, thank goodness for your common (uncommon?) sense answers to these questions. You have a way of cutting through the fog to get to the essence that I envy and emulate. I’m an advisor (non-commissioned) and I find the greatest part of my time with clients is spent demystifying the same concepts you are covering here, and I always worry – what about all the other people who haven’t taken the time to talk with a knowledgeable person who can help them separate the grains of truth from the massive amounts of questionable assumptions? I refer many of my clients to your books and website so they can get a good dose of your tough love and good sense. Another website I recommend is http://www.investored.ca, for the more specific investment questions. There is so much biased information out there, including what the national newspapers often print, and people have a hard time differentiating what is relevant to their own situations… Anyway, thanks again for being a terrific resource!
xoxo
Jenny J
August 12, 2009 at 11:34 am
Taxes and RRSP after retirement:
Assuming (mostly wrongfully) that the goverment will give you no money during retirement:
- if you put money in an RRSP and NOT get taxed 35% between the provincial and federal
when you withdraw at retirement:
- the first ~ $10000 does not get taxed
- the first bit to get taxed is probably around 25-30%
- the second bit around the 35%
The average tax is LESS that the initial 35% at the time of the investment. If you have extra pension money and/or if you investments did very well, you might have to reconsider. How do you get around that? Early retirement with a part-time job or volunteering to keep you brain busy.
I know I can be good about leaving my RRSP growing. I prefer using the TFSA for the emergency fun, saving for a house downpayment, pre-planned long-term savings (holidays, vet visits, house renos, next car). If find the TFSA very easy to use up for regular life stuff, so it does not leave much room for anything else. I could handle a bigger amount than $5000/yr. That is a personal choice.
August 12, 2009 at 11:43 am
Gail, with respect to the questions and answers from Charlene, I must respectfully disagree. Based upon their income of $48K and $44K, they should only contribute sufficient amounts to reduce their income to the “next” tax bracket (approximately $40,500). Reducing your income below that amount means reduced tax savings (in ONT is means moving from a 31% refund to a 21% refund). I would then suggest putting the balance of savings into TFSAccounts. In future, assuming their income justifies it, they can withdraw funds from the TFSA and shift them into their RRSPs.
August 12, 2009 at 12:24 pm
Jeff:
An alternative to your statement is to put the money in the RRSP as your are entitled to contribute but to delay the claim on taxes until you move up in tax bracket.
1- contribute to your max (and let it grow).
2- claim on taxes ONLY what brings you to a different tax bracket.
3- when you move up your tax bracket, claim old contributions to keep you in the lower bracket.
(That way you do not use up your TFSA max.)
August 12, 2009 at 1:20 pm
Is the 10% rule gross or net?
August 12, 2009 at 1:26 pm
[...] See the original post here: This & That: Retirement Sa­… [...]
August 12, 2009 at 1:42 pm
Denboo…I think Gail has recommended RRSPs over TFSAs in regards to taxes in a previous post.
The difference between the RRSP and TFSA is that with the RRSP would actually contribute more than $5000…you would contribute $5000+the taxes you didn’t pay on that $5000. So you end up earning interest on the money you didn’t pay in tax (because you don’t pay taxes until you withdraw). If you rerun the calculations that way you would be comparing apples (TFSA $5000) to apples (RRSP $5000+deferred tax $).
August 12, 2009 at 3:01 pm
I love the TFSA idea! I have a great pension and very little contribution room available to me. I have opened two TFSA accounts: a savings attached to my chequing account my emergency fund and a Mutual fund account (as of today!!) for my planned spending. I just have to be careful not to contribute more then $5000 between the two of t hem!
August 12, 2009 at 3:14 pm
Hello all,
I’m really enjoying this discussion of TFSAs and RRSPs! I have a questions about TFSAs that perhaps you can all help me with.
Back in January I initially opened my TFSA with my regular bank (TD) and made a New Years resolution to learn more about money management this year. It’s going really well! In the course of my learning I’ve been looking around and have also opened a TFSA with ING (at a MUCH better interest rate than my TD one). I didn’t max out the TD one initially (about $2500 in it right now) so I have some room to put money in the other account. I want to know if I can move the money from the TD account to the ING account (for the better interest rate) or if taking it out of the TD account would count as withdrawing it and would mean that I couldn’t recontribute that money until 2010.
Thanks for any insight anyone has on this!
Cheers,
-M
August 12, 2009 at 4:41 pm
Michele:
As far as I understand, the better way to transfer would be to wait until the end of December to take the money out of your TD account and then to put it in your ING account in January of the following year. This results in a few days without tax-free-interest.
If you take the money out now, your cannot put it back until 2010.
August 12, 2009 at 5:36 pm
Hi Marie,
Thanks for the reply. I feared that would be the case. Your suggestion is my current plan, I was just hoping that maybe a ‘transfer’ right into another TFSA would be different than a ‘withdrawal’. Ah, wishful thinking. At least I didn’t max out the TD TFSA!
A good lesson in shopping around for the best interest rate if nothing else. Lesson learned!
-M
August 12, 2009 at 8:27 pm
Michele:
I don’t know if the contents are accurate, but you can also check:
http://www.four-pillars.ca/2009/02/25/tfsa-institution-transfer-strategies/
If you Google “transfer tfsa to another institution”
A TD Waterhouse pdf states
“Q. Can I transfer my TFSA from one financial institution to another?
A. Yes, you can transfer your TFSA from one financial institution to another financial institution. A transfer fee may
apply.
Q: Is the transfer of a TFSA between financial institutions treated as a withdrawal or contribution?
A: No. Provided that a transfer between financial institutions is processed as a direct transfer, it will not be considered a
withdrawal or contribution.”
If there is a fee, you may end up with less money than your current situation.
August 12, 2009 at 8:29 pm
Michelle,
you can request a TFSA to TFSA transfer. Ask ING about it. Its called a T2033 transfer (same as RRSPs). ING will send the request to TD to transfer the funds without withdrawing – you won’t lose any of your room.
I have both RSP and TFSA savings. I’m not maxing out either at this time because I’m trying to pay off debt, but I see RSPs as helpful for the tax deduction to bring my taxable income down. The TFSA right now is for my emergency savings which is in a savings account.
August 13, 2009 at 10:15 am
ING doesn’t charge transfer fees. For any type of transfer.
August 13, 2009 at 12:43 pm
Hello all,
Thank you so much for the information. Wow, you folks are mighty helpful! It’s much appreciated and I’m going to contact ING straight away about the transfer.
Have lovely days!
-M
August 18, 2009 at 5:55 am
[...] This & That: Retirement Savings Edition [...]
September 8, 2009 at 12:16 pm
[...] This & That: Retirement Savings Edition [...]