Much is said and written about retirement planning in Canada, and every financial expert will give you different views or advice on when or how to start a retirement plan. Ultimately, retirement planning is all about securing finances to meet your expenses and life goals during your golden years. However, traditional retirement planning methods and strategies may not be practical or relevant today.
Here’s why you may need a more dynamic retirement strategy than ever before:
- Greater life expectancy: With an average life expectancy of 83 years, Canadians are living longer, which means retirement may last as long as 20 to 30 years. The traditional plans that were backed by robust company pension plans and shorter retirement periods will unfortunately no longer be practical in the current scenarios.
- Unconventional retiree aspirations: Canadian retirees no longer conform to stereotypes. Instead of downsizing or moving into senior housing communities, many prefer to age in place, and aspire to live fuller and more active lives. The higher the activities and pursuits, the higher the expenses and need for disposable cash in hand during retirement.
- Economic factors: Steadily climbing Canadian inflation rates are pushing up the cost of living, and causing markets to behave more erratically. Over the last few years, the real estate market has been at best, unpredictable. This potentially impacts the financial ability of Canadian retirees looking to downsize or seek refinancing or line of credit options.
When to start planning for retirement?
In Canada, you are encouraged to save for your retirement as soon as you start working. Not only does this give you a head start on your retirement funds, but it also allows you to put aside less each month, and steadily build up your pool of funds. The power of compounding returns for wealth building is simply phenomenal. For example:
Let’s assume you start saving at age 25, putting aside $2,500 a year in a tax-deferred retirement account until you reach 35, after which time you stop saving completely. Even if you do not contribute anything for the next 30 years, by the time you reach 65, your $25,000 ($2,500 x 10) investment will have grown to around $300,000, (assuming a 7% annual return).
Here’s a second scenario. Let’s say you start saving only after age 35 and keep aside $2,500 per year for the next 30 years. By age 65, you will have set aside $75,000 ($2,500 x 30) of your own money, and it will grow to about $255,000, assuming the same 7% annual return1.
|Investment Details||Scenario 1||Scenario 2||Percentage Difference|
|Age to start saving||25||35|
|Investment Amount Per Year||$2,500||$2,500|
|Years of Contribution||10||30|
|Total Personal Investment||$25,000|
|Annual Interest Rate %||7%||7%|
|Approximate Investment Value at Age 65 (with annual interest compounding)||$300,000||$255,000||15%|
|Total Interest Component||$275,000|
So, what exactly does the power of compounding do?
- Even after saving $2,500 per year from age 35 to age 65, your total retirement funds will be about 15% lower than what you can potentially create by saving for just 10 years if you start at age 25.
- The compounded interest you earn by investing for 10 years at age 25, is 35% more than the interest you earn by investing for 30 years, starting at age 35.
Hence, the sooner you start saving, the more time your money has to grow, and the more disposable income you can enjoy in later years.
Depending on when you were born, your spending and savings habits may be quite varied: For example:
- Saving preferences by generation: On average, baby boomers are passionate about saving for the future, generation X is big on spending and less on saving, while millennials tend to save but mostly for short term goals, instead of long-term ones.
- Spending tendencies by age: In the early 20s, you may be heavily tied down by student loans. The 30s and 40s are prime years for spending on homes, vehicle(s), family and children’s education. In your 50s, you may reach your highest earning capabilities, while in the 60s and beyond, you may start gearing up for retirement.
Essentially, your age, saving habits and spending patterns will have a strong bearing on how you plan your retirement strategy.
How to start a retirement plan in Canada
- Set your retirement goals: How much you need to save for retirement will depend on how you want to spend during those years. If your retirement goals are focused on spending time with family at home, rather than traveling or dining out, you may be able to work with a lean retirement fund. However, many Canadian retirees are quashing outdated beliefs and thinking differently about aging. Are you looking forward to a fuller and active retirement, filled with travel, adventure, and pursuit of new hobbies? Do you know the type of lifestyle you want? When to start planning for retirement, and how much to accumulate is also a factor of:
- The age you would like to retire (and if you plan to continue ‘working’ after you retire)
- Financial commitments, such as a conventional mortgage, credit card debt or other sizeable debts
- Any children or grandchildren you need to support financially
- Compare current spending with expected retirement spending: Keep track of how much you are spending now (on your needs vs. wants) and think about how these expenses could change once you retire. Since you would no longer pay for your daily commute, work outfits or lunches, your post-retirement expenses could drop significantly. However, making a post-retirement budget will help you to calculate exactly how much you will need to finance your dream retirement. You can also consider using tools, such as a budget calculator for systematic financial planning.
- Start saving early: As we saw in our example above, the age at which you start saving can have a significant impact on how much you need to save for your retirement – and how much it can help increase your overall savings pool. Try to put aside as much as you can from each paycheck. Take advantage of pre-authorized plans that automatically take a set amount from your income, and tuck it away into a savings account, or investment of your choosing. The interest you earn on these deposits could grow significantly over time.
- Plan for unexpected costs: As with life in general, you may face unexpected expenses that arise when you retire (or just before your planned retirement age). Make sure you set aside some money for such contingencies. An emergency fund will help cover such surprises, without disturbing your retirement plan. Financial experts usually suggest that you set aside at least three months of living expenses for this purpose.
- Consult a financial planner: Meeting with professional financial planners is useful. They could help you to:
- Evaluate and select different types of retirement plans (RRSP, TFSA, Investment Accounts, etc.) that work for your retirement goals
- Re-structure your accounts in a tax-efficient matter
- Modify your savings goals to fund your retirement
- Minimize your post-retirement financial commitments: No matter how strong your retirement planning strategy, in order to enjoy your golden years, you may have to look at keeping your post-retirement financial commitments to a minimum.
- Try not to take on any additional credit cards
- Plan to completely repay your conventional mortgage before retirement, or as soon as possible
- If you have multiple debts on hand, consult your financial planner for debt consolidation options, including a debt consolidation loan, refinancing options, or a reverse mortgage
What are the different types of retirement plans?
There are many ways that Canadians can save for their retirement. Some of the retirement savings plans include:
- Registered Retirement Savings Plan (RRSP): Contributing to an RRSP helps you grow your money while also enjoying significant tax benefits. Based on your previous year’s tax return, the government gives you a maximum RRSP contribution limit every year. You can carry forward unutilized limits to the next year. Maximizing your RRSP contributions could help lower your taxable income, while your retirement planning contribution continues to grow tax-free. For more information on RRSPs, visit the Canada Revenue Agency website here.
- Tax-Free Savings Account (TFSA): A TFSA allows Canadians over the age of 18 to save and/or invest money in an account that is not taxed at withdrawal. It is similar to a regular savings account, but it lets you hold a range of investment products and allows your savings to grow tax-free. There is an annual limit on how much you can add to the account, but if you are opening a TFSA account for the first time ever, you could contribute a maximum of $63,500 (as of January 2019). Some financial advisors believe this to be the best type of retirement plan, among all available options. For more information on TFSA, visit the Canada Revenue Agency website here..
- Company pension plans: If your company offers a pension plan, you should take advantage of that as soon as you start working. Making the maximum contributions from the start can really pay off. In the absence of a pension plan, check if your company offers any TFSA or RRSP matching programs – it’s like free cash! They can also act like an insured retirement plan, since the company is providing the match.
- Investment accounts: In addition to a RRSP and TFSA, many Canadians consider taxable investment accounts to grow their retirement savings. These accounts can hold a wide variety of products such as stocks, bonds, Exchange Traded Funds (ETFs), mutual funds, Guaranteed Investment Certificates (GICs) and cash. Depending on your time horizon and risk tolerance, the mix of investments that are suitable for you may differ.
Sources of post-retirement income in Canada
Retirement planning is not just about planning, its about how much to put away and when to start saving. It is also about ensuring a potentially steady income stream during your golden years.
- Canadian Pension Plan (CPP) and Old Age Security (OAS): CPP is funded by your contributions, while OAS is funded by the government. It is based on several factors, including your age and the number of years you’ve lived in Canada. Though the average Canadian will receive funds annually from these sources, the amount may not be enough to cover existing lifestyle requirements, or sudden unplanned expenses.
- Employer-based pension plans: Many employers use Defined Contribution pension plans where both you and your employer will contribute towards the fund. The maturity amount depends on the success of the investments. Some employers may use a Defined Benefit pension plan, which uses your earnings history, tenure of service and age to provide monthly benefits upon retiring.
- Personal savings: Investments such as a RRSP or TFSA, could give you additional money in retirement. The amount will depend on when you started saving, the amount you put in, and the interest or dividends you received over the years.
Financial strategies that aid retirement planning
Although most post-retirement income sources may put some money in your hand when you stop working, these funds may not nearly be enough to cover your entire retirement. In addition to greater life expectancy and longer retirement, there are many reasons why your retirement funds and savings may not be sufficient enough to support you and your family:
- Your retirement planning strategy may have suffered due to an economic downturn or a stock market crash
- You may not have worked for as many years as you had planned to, due to health issues, layoffs, etc.
- You may have spent more of your savings on contingencies than you had originally budgeted for
Here are some strategies to supplement your retirement income, and financially secure your golden years:
- Continue working: Consider putting in a few more years in the workforce, either on a full time or part-time basis. Staying employed will not only add to your income, but it may also boost your employer-based pension fund. If your investments have taken a downturn, the delayed retirement would give them some time to bounce back. Moreover, your CPP benefit will increase by 6 percent for each year you delay retirement, until the age of 70.
- Increase your savings: If you have several years before retirement, investing a little extra money each month will go a long way in getting you closer to your retirement planning goals. Of course, the further you are from retirement, the more effective this may be.
- Cut your debt as much as possible: Large amounts of debt can hurt any budget, especially if you do not have a steady income stream in retirement. Make sure that your retirement planning strategy helps you cut the burdensome debt (like credit cards or a conventional mortgage) before you stop working.
- Monitor and modify your investments: While you may have been able to weather the economic ups and downs earlier in your career, the closer you get to retirement, the more conservative investments you may want to make. Don’t hesitate to make the necessary adjustments and modify your portfolio to suit your current life stage.
- Consider a reverse mortgage: By the time you reach your retirement years, you may have built up a significant amount of equity in your property or may even own your home outright. While emotional attachments, moving expenses, or difficulties in finding other suitable accommodation may prevent you from selling your most valuable asset, you may actually be able to use it to your advantage through a reverse mortgage.
- If you are over 55 years of age and are a Canadian homeowner, you can cash in up to 55% of your home’s appraised value, tax-free, in the form of a reverse mortgage
- You can continue to stay in your home and retain its full ownership
- There are no monthly repayments (not even interest)! Your loan becomes payable only when you move, or sell your home, or pass on.
Imagine the longer, fuller retirement that you can enjoy with this additional income that can finance your golden years!
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