RRSP Planning
In pursuit of success: RRSP planning for life
The saving years: Under age 40
Building wealth: Age 40 to 60
Retirement years: Age 60 plus
Preparing for retirement is not something to be put off until you are approaching age 60. Building a solid retirement plan is a lifetime project. Ideally, it starts when you are young and just beginning your career. It continues until you are ready to reap the rewards of years of careful planning and investing in your Registered Retirement Savings Plan (RRSP).
Retirement planning is really planning for life, and in this Special Report we provide some important tips to help you go about it successfully. We focus on three key stages of financial life: the saving years, the wealth-accumulation stage and the retirement years.
Remember, though, no matter what your age, if you haven’t put together a retirement plan, now is the best time to start.
The saving years: Under age 40
Start saving early. Those are the three most important words in the retirement planning process. They may also be the most difficult to follow. People under the age of 40 have many financial priorities, all of which may seem more important than an event that is perhaps 40 years in the future. There are cars to buy, mortgages to pay, families to be started and vacations to be taken. Maybe there will be something left for an RRSP contribution at the end of the year. If there is not, many younger Canadians say, “I’ll do it next year.”
From a financial perspective, however, time is precious. Every missed year of RRSP contributions when you are young can add up to thousands of lost dollars later. Let’s look at a 25-year-old who can contribute $5,000 a year to an RRSP and see how much the plan would reach by age 65 at an average return of 10%. Then look at what happens with each year of delay.
Starting Age |
25 |
26 |
27 |
28 |
29 |
Total Contributed |
$200,000 |
$195,000 |
$190,000 |
$185,000 |
$180,000 |
Plan Value at 65 |
$2,212,965 |
$2,007,240 |
$1,820,215 |
$1,650,195 |
$1,495,635 |
Lost by Delay |
– |
$205,725 |
$392,750 |
$562,770 |
$717,330 |
Those numbers may be hard to believe, but they are real. A delay of just one year in starting your RRSP at age 25 could cost more than $200,000 in terms of your plan’s final value. Delay five years, and the price tag could approach three-quarters of a million dollars!
Four tips for saving
Having seen the importance of starting early, you should be ready to develop some good, lifelong investment habits. Here are a few things you should always do:
1. Make saving a habit. When you are preparing a family budget, set aside a specific amount for your retirement plan each month. Don’t wait to see what remains after all the other expenses have been met. Make this a top priority.
2. Match savings to income. The more you earn, the larger the amount you will be able to contribute to a retirement plan-and the more income you will need at retirement to maintain your standard of living. So whenever your salary increases, add a portion of the raise to your retirement budget.
3. Contribute regularly. The easiest way to make sure your RRSP continues to grow is to set up an automatic monthly contribution plan.
4. Make your maximum contribution. The more money you can shelter from taxes inside an RRSP, the faster your plan will grow. If at all possible, make your maximum allowable contribution every year.
Choosing the right strategy
Contributing to your RRSP is just part of building a solid retirement plan. You also need to give careful consideration to how the money is invested.
During your early years, you should focus on maximizing growth in your plan. Equity mutual funds, which invest in stocks, are an appropriate way to do this. Over the long term, stocks have historically outperformed all other types of investments. As well, if there’s a market correction, you have plenty of time for your funds to recover. By emphasizing equity funds when you’re young, you can take full advantage of that potential.
The following table illustrates the huge difference in total plan value among three rates of return: 8%, 10% and 12%. These numbers are based on a relatively small investment of $1,000 per year.
Years contributing Plan Value at 8% Return Plan Value at 10% Return Plan Value at 12% Return
8% |
10% |
12% |
|
10 years |
$14,487 |
$15,937 |
$17,549 |
20 years |
$45,672 |
$57,275 |
$72,052 |
30 years |
$113,283 |
$164,494 |
$241,333 |
40 years |
$259,057 |
$442,593 |
$767,091 |
Remember, time is on your side, so use it!
Building wealth: Age 40 to 60
The years have passed. Your life has evolved and changed. Now you are 40 or beyond. The mortgage is close to being paid off, your income is higher, and your debts are lower. You are now moving from managing debt to building wealth. At this time in your life, it is important to put as much money as possible aside for the future, both inside and outside your RRSP. Tax planning for your retirement years also becomes an important priority.
Maximum contributions
Ideally, you have been making your maximum allowable RRSP contributions all along. If you haven’t, now is the time to start.
You should also catch up on any unused carry-forward entitlements. If you did not make your full RRSP contribution in any year from 1991 on, you can make up the investment at any time. The sooner you get the money into your plan, the sooner it will start earning tax-sheltered income for you.
Here’s a special tip. If you don’t have the cash to make your maximum RRSP contribution (including any carry-forward entitlements), consider borrowing the money. Special RRSP loans are available at very attractive interest rates.
Maximizing foreign content
You can invest up to 30 per cent of your RRSP assets in foreign securities. Review your plan to make sure that you are taking full advantage of international potential. Making the best use of the foreign-content allowance ensures that you will have good geographic diversification in your plan, thus decreasing your risk and improving potential returns. As well, you will have some protection against future volatility in the value of the Canadian dollar. Today it’s relatively easy to add international investments to your retirement portfolio, using international mutual funds.
Tax-saving strategies
From a taxation perspective, the worst situation is to have one spouse with very high income and the other with little or none after retirement. Dividing income more evenly usually produces a lower combined tax bill.
One good way to achieve this is to set up a spousal RRSP at this stage in your life, if you and your spouse are expecting to be in different tax brackets at retirement. The spouse with the larger income should contribute to a plan on behalf of the other.
Contributions to a spousal RRSP count against the contributor’s contribution limit and are deductible as an RRSP contribution on the contributor’s income tax return, subject to the contributor’s total RRSP contribution room. The long-term payoff could be substantial-perhaps to the extent of thousands of dollars in after-tax income every year after you retire.
(Note: There are attribution rules that will tax the contributor spouse on withdrawals from a spousal RRSP if the contributor has made any contributions to any spousal RRSP in the year of the withdrawal or either of the two preceding calendar years.)
Do-it-yourself
As you accumulate wealth, you may want to set up a self-directed RRSP. A self-directed plan provides the maximum in flexibility-you can invest in anything you like, as long as the security is RRSP-eligible and you observe the foreign-content rules.
For some people, this is the most effective way to maximize RRSP returns and to create a plan that most perfectly fits their needs. However, you should continue to receive expert investment advice and help in monitoring your portfolio.
Retirement years: Age 60 plus
Retirement allows you to enjoy the benefits of the years of careful planning and saving. Before you can put up your feet and relax, however, there are a few more things that need to be done.
First, you need to plan your retirement income. Should you set up a Registered Retirement Income Fund (RRIF) or buy an annuity? That’s the basic decision facing retirees who are deciding how they will convert their RRSP capital into income. A RRIF is a mirror image of an RRSP. An RRSP is designed to help you accumulate assets, while a RRIF is designed to distribute those assets, under your direction, as retirement income. An annuity is a contract with a financial institution that provides you with regular income in exchange for a fixed sum of money.
Both options have advantages. The choice depends on your personal desires. See the accompanying tables for the pros and cons of each.
Don’t rush to convert
You can retain your RRSP until Dec. 31 of the year in which you turn 69. If you do not need the income immediately, keep your RRSP intact for as long as possible after retirement. But make sure that you convert your RRSP to a RRIF or annuity prior to the end of the year in which you turn 69. Even if you make no further contributions, your plan will benefit from the extra years of tax-sheltered compounding. In fact, the greatest growth takes place in the final years of a plan.
Protection against inflation
Even at today’s modest levels, inflation can have a serious impact on purchasing power during your retirement. One way to protect yourself is to continue to include some growth assets (such as stocks and equity mutual funds) in your investment portfolio. This will make it possible for your asset base to increase in value over time, and provide a cushion against future cost-of-living increases.
This strategy can be used in an RRSP, a RRIF and for your non-registered investment portfolio. However, it cannot be applied to assets that are used to purchase an annuity.
Advantages
- Retain control over capital and investments
- Flexible payout schedule-no ceiling on annual withdrawals
- Income may be continued to surviving spouse or residue goes to estate
Disadvantages
- Capital may run out
- Ongoing investment decisions needed
Advantages
- Payments made for the lifetime of the annuitant
- No investment decisions
- Steady, predictable income
- Guarantee periods available
Disadvantages
- No control of capital and investments
- No residue left for estate unless there is a guarantee period and annuitant dies within that period
- No lump-sum withdrawals and little flexibility in payments