How to save for retirement (Part 2)July 31, 2014
By Sheryl Smolkin
See Part 1 .
Every family has multiple financial priorities. If you have small children and a big mortgage it is often daunting to think about saving for anything more than a family night out at a local fast food restaurant.
But one way to manage your money is to pay yourself first by allocating specific amounts to savings and having these amounts moved into different jars (or accounts) as soon as your paycheque is deposited into your account.
In Part 2 of the series “how to save for retirement” we will focus on several of the tax-assisted or tax–deferred savings plans available to you and some tips for using them effectively.
- Government benefits: Every working Canadian must pay into the Canada Pension Plan or the Quebec Pension Plan until age 65. In addition, Old Age Security is payable to Canadians or legal residents living in Canada who lived in the country at least 10 years before age 65 and Canadians or legal residents living outside Canada who lived in the country at least 20 years before age 65. Lower income OAS recipients may also be eligible for the Guaranteed income Supplement (GIS). But changes to government benefit programs mean you can take benefits later or in some cases earlier (with a penalty). When developing a retirement savings plan you should understand how these programs work and the benefits you can expect to receive. You also need to decide when it makes the most financial sense for you to start collecting CPP and OAS.
- Saskatchewan Pension Plan: The Saskatchewan Pension Plan is a defined contribution pension plan open to all Canadians with registered retirement savings plan (RRSP) room. You can contribute up to $2,500/year or transfer in up to $10,000/year from another unlocked RRSP. Low fees (one percent/year on average) and consistent returns (average of 8.13% over 28 years since inception) make SPP an excellent investment. The program is very flexible because how much you contribute and when is up to you. Funds are locked in until your selected retirement date, between ages 55 and 71.
- Registered Retirement Savings Plan: In 2014 you can contribute 18% of your previous year’s income to a maximum of $24,270 to your RRSP minus specified amounts contributed to other registered savings accounts. Unused contribution room can be carried forward. You can find your RRSP limit on line (A) of the RRSP Deduction Limit Statement, on your latest notice of assessment or notice of reassessment from the Canada Revenue Agency.
- RRSP withdrawals: One weakness of an RRSP as a retirement savings vehicle is that you can withdraw money at any time. If you do withdraw RRSP funds you will pay tax on withdrawals at your normal tax rate, the contribution room is lost and you lose the benefit of future tax-free compounding. However, the Home Buyers’ Plan and the Lifelong Learning Plan permit you to withdraw amounts from your RRSP in specific circumstances without triggering a tax bill and require you to repay the money, usually over 15 years.
- Tax deductible: Contributions to SPP, RRSPs and other registered pension plans are tax deductible. If you participate in one or more of these plans and have not already arranged to have less tax taken off at source, you may get a hefty income tax return. There are lots of ways to spend this windfall including taking a vacation or paying down debt. However, in his book The Smart Debt Coach, author Talbot Stevens says reinvesting your tax returns into an RRSP is the best way to get the full benefit of compounding in the plan.
- Deferring tax deduction: There is no minimum age for an RRSP. In order to make contributions to an RRSP account, a minor needs to have earned income the previous year and have filed an income tax return. If a thrifty young person or anyone with a low income makes RRSP contributions, deferring taking the tax deduction until they are in a higher tax bracket means they will get a bigger bank for their savings bucks. The last RRSP contribution a taxpayer can make is in the year they turn 71.
- Tax Free Savings Account: A Tax Free Savings Account (TFSA) allows you to currently save $5,500 a year. Contributions are not tax deductible, but investment earnings accrue tax free in the account. If you withdraw money, you can re-contribute the amount to the account in the next or subsequent years without any penalty. You can only begin making contributions at age 18 but there is no upper age when you have to stop contributing. How do you decide if a TFSA or an RRSP is best for you? Gordon Pape says TFSAs are better for short-term savings goals and if you don’t want to undermine possible eligibility for government benefits like the GIS. But if your income will be lower in retirement he suggests saving in an RRSP.
- Automatic withdrawal: Whether you participate in a company pension plan, SPP, RRSP, TFSA or a combination of all or some of the above, set up automatic withdrawal so a specified percentage of your income is moved into these accounts every payday. David Chilton made “pay yourself first” a popular mantra in The Wealthy Barber, first published in 1989. If savings are skimmed off the top, you will learn to live on less while you get on with the business of day-to- day living. And when you do retire, you will have a significant part of the nest egg you need to live on.
- Automatic escalation: To find out how much you need to save for retirement, you need a financial plan. But in a recent column in the Globe and Mail, personal finance expert Preet Banerjee suggests that in the absence of a plan, the rule of thumb should be at least 10% or as much as you can save. In other words, you are not going to have enough if you keep saving a flat dollar amount each year. But if you select a percentage of income and ensure you increase your contributions every time you get a raise, it is more likely that you will reach your retirement savings goal.
- Consider insurance: Nobody expects to become disabled or die young, but it happens more often than you think. Regardless of how much you are saving for retirement, an unexpected loss of income can derail all of your short and long term goals. You may have some life insurance, disability insurance and maybe even critical illness insurance at work. Review your coverage with a financial advisor to determine if you need more individual coverage or if you can afford to self-fund the risk.
In Part 3 of this series we will focus on some basic investment principles that will help you grow your retirement savings.
Book Review: THE SMART DEBT COACHJune 12, 2014
By Sheryl Smolkin
Talbot Stevens is so confident that his book “The Smart Debt Coach” can save you money, that he is offering a free refund to anyone who doesn’t think they can save at least $1,000 by applying the basic principles he discusses.
The book is written in the style of a “self-help novel” like David Chilton’s The Wealthy Barber and Jon Chevreau’s Findependence Day. The main characters are Joe, Michelle, their friend Kim (physician and single mom) and financial advisor Bruce.
When Joe’s sister Lisa asks his family to join them on a Caribbean holiday, they are reluctant to do so because it will mean further maxing out their credit cards. Then Joe realizes Lisa saved the money in advance for the trip and he wants to learn more about how she accomplished this on a lower family income.
She explains that on the advice of their parents (which Joe ignored at the time) for over 10 years she and her husband have been working with Brian, a financial advisor. Since his death they continue to get similar advice from his nephew Bruce.
It turns out that Bruce (a widower) is the parent of one of the kids on the hockey team that John and Michelle’s son plays on. Kim (divorced) is also a hockey mom. While watching the games week after week, they quiz Bruce on basic financial concepts and eventually John and Michelle retain him privately.
And so their journey to a better financial future begins.
Bruce goes through a goal setting exercise to help them establish priorities and negotiates a contract which clearly sets out the responsibilities of both the financial coach (Bruce) and the clients (Joe and Michelle).
One of the first strategies Joe and Michelle learn about is “Debt Swapping.” Essentially this means if you have high interest credit card debt plus unregistered investments, you can cash in your investments, pay off the debt and then borrow at a lower rate to re-populate your investment account.
This is a win-win because they will pay less interest on the investment loan and they can write off the interest expense against any investment income.
But based on the maxim that “a penny saved is a penny earned,” Bruce also illustrates how avoiding credit card debt and other unnecessary expenses represents real money in their pockets. Furthermore, their advisor demonstrates they are not getting the full benefit of their RRSP contributions if they spend their tax return instead of topping up RRSP accounts.
Like the wealthy barber, Bruce encourages John and Michelle to “pay themselves first” by setting up automatic withdrawal of monthly RRSP contributions and increasing contributions every year by a specified percentage. He says that in most cases saving 8% of income and inflating deposits yearly by 3% produces a larger retirement fund than saving 10% without ever ramping up savings.
He also motivates them to be more frugal in other areas and buy a slightly used truck instead of a new one to reduce monthly car payments. Some more complicated strategies recommended later in the book include taking out short-term loans to top up RRSP contributions and using a second tax refund from RRSP top ups to fund registered educational savings plans for their children.
In addition there are chapters on other smart debt strategies, a common sense way to beat the market and how being a landlord can pay dividends.
However, by the time I read about 80 pages I found myself skimming to try and pick out the relevant financial information without having to wade through the somewhat contrived story. I was also disappointed that there was not a point form checklist of the basic ideas I could use for future reference.
The book is extremely readable and the advice is good. While it is far from a romance novel I was not surprised that after all those hockey games (spoiler alert), Bruce and Kim are a couple by the end of the book.
Unless you are already doing everything Stevens suggest (and few of us are) it is unlikely that you will be able to honestly collect on his money back guarantee for the book. Even if you don’t read it cover to cover, you will discover some new strategies you can use to map your own road to a healthy financial future.
You can purchase The Smart Debt Coach for $15.67 on the Chapters Indigo website.