Every Canadian wants to retire with enough financial security to live the life they want in retirement. With the retirement planning resources out today, and the ease with which Canadians can start investing, the golden years have never felt more within reach.
Even with better technology and readily available knowledge, few Canadians can save for retirement without a solid plan. Retirement, like other major financial milestones, involves numerous steps, and without a clear strategy, you might be left groping your way through the dark.
With that in mind, here’s a guide to help you with your retirement planning.
What is retirement planning?
Retirement planning is the process of figuring out what you want your retirement to look like, how much you’ll need to make it happen, and how you’re going to get there. Retirement planning includes writing out retirement goals, estimating your annual expenses, adding up sources of income, deciding how much you’ll need to save, investing money for the long-term, and choosing the right retirement accounts.
What factors affect your retirement planning?
What factors affect your retirement planning?
The calculations above won’t be realistic for everyone. Some Canadians will spend far less in retirement, especially if they plan to pay off their homes or downsize. Other Canadians plan on travelling, picking up new hobbies, or even buying a vacation home, all of which could require them to save more.
To help you calculate a more accurate magic number for your retirement planning, here are some factors you should consider.
What are your retirement goals?
One of the most difficult parts of retirement planning is figuring out what your life will look like 20, 30, or even 40 years from now. But, in order to plan effectively, you have to begin imagining what kind of retirement you want to live.
Do you want to live closer to your grandkids? Go travelling in an RV? Buy property near the beach, in the mountains, or in a city where the standard of living is lower?
Each of these retirement dreams has a different price tag, and it’ll require you to save more or less money.
How will your spending change in retirement?
After you’ve honed in on a retirement goal, it’s time to examine the expenses that might arise after making that goal a reality.
A good place to start is your current spending habits. Though many expenses will change or disappear entirely (your mortgage, for instance, if you plan to pay off your house), most will carry over, such as groceries, insurance, and utilities. Other expenses you’ll probably face in retirement include:
- Healthcare costs
- Housing costs (rent, mortgage, maintenance, gas, water, and electricity)
- Personal utilities (internet and telephone)
- Living expenses (food, transportation, clothing)
- Entertainment (movies, dining out, subscriptions, memberships)
Once you’ve determined those expenses that will remain after retirement, you’ll want to add new expenses you anticipate paying. These can be based on your retirement goals (an extra $3,000 for travel costs, for instance), or they can be necessary costs you expect you incur (additional healthcare costs).
What income do you expect to have?
Fortunately, when it comes to saving for retirement, you’re not alone. The Canadian government offers several pension plans to retirees, and depending on how long you worked and your income needs, you could greatly enhance your savings. Here are some post-retirement income streams you can add to your retirement planning.
Canada Pension Plan (CCP)
The Canada Pension Plan (CCP) is a government-sponsored pension that distributes monthly payments to retirees who contributed to their CCP during their working years. CCP distributions depend entirely on how much you contributed to the system while you were working. You can start taking distributions as early as age 60 or as late as 70, though the earlier you start receiving payouts, the lower your monthly payments will be.
Old Age Security (OAS)
Like the CCP, Old Age Security (OAS) is a government-sponsored pension. Unlike the CCP, however, OAS doesn’t depend on your contributions. Basically, any Canadian citizen above age 65—or legal residents who have lived in Canada for at least ten years—is eligible for OAS payouts. Similar to CCP, you can choose to defer your OAS payouts to an age above 65, which will raise your monthly payments the longer you wait.
Guaranteed Income Supplement (GIS)
Canadians with low incomes may be eligible for Guaranteed Income Supplement (GIS). In order to receive GIS payments, your income has to be lower than a certain threshold (you can find eligibility tables here), and you have to file your income tax returns every year, even if you don’t expect to owe taxes.
In addition to pension, some Canadians may wish to continue working part-time past the age of retirement. In that case, you can still have a little stream of income coming in, even if the trickle is slower.
Finally, your home can be a source of income, especially if you own it forthright. Downsizing to a smaller house, or moving to an area with a lower standard of living, may allow you to put a portion of your equity toward retirement.
When do you plan on retiring?
Finally, let’s set a benchmark age. At what age would you like to retire? Most Canadians aim to retire around age 65, as that’s when they’re eligible for pensions and retirement account distributions, but you may want to retire sooner (or later) than that.
Of course, this age isn’t set in stone. At this point, you’re simply setting an end goal to give your retirement planning a defined start and finish.
How much money will you need for retirement?
In short, a lot — probably more than you’re expecting.
As we saw above, many factors affect how much you’ll ultimately need to save for retirement, such as your retirement goals, expected living expenses, and your retirement age. For now, if you want to get a rough estimate for your retirement planning, you can use the following methods.
1. The 80% rule
The 80% rule says you should expect to replace around 80% of your pre-retirement income to maintain your current standard of living in retirement. For example, if you make $150,000 now, you’ll need around $120,000 annually when you retire.
2. The 4% rule
The 4% rule states that you can expect to withdraw 4% of your savings for every year of retirement. According to this rule, if you saved $1 million, you could comfortably withdraw $40,000 of your savings per year for the next 25 years. Keep in mind, this doesn’t include your pensions, just the money you’ve saved.
3. The 10x rule
Finally, some financial experts recommend you multiply your annual salary by ten to get your recommended savings goal. For instance, if you made $150,000, according to this rule, you should save $1.5 million to live comfortably in retirement.
The trick with the 10x rule is to use your ending salary, that is, the salary you have before you actually retire. That may seem impossible (after all, who can know what they’ll make when they retire), but a good rule of thumb is to multiply your current salary by 2% for every year you plan on working.
Keep in mind: these rules only give you estimates, and they shouldn’t take the place of a well-thought out retirement plan. To calculate your number, you’ll need to look closely at your spending habits, pension plans, and the life you want to live in retirement.
How can you start saving for retirement?
When you’ve finally calculated how much you’ll need in retirement, you’ll typically have a moment of panic. Your ideal retirement number will often be in the hundred thousands, possibly millions (depending on your age and how much you’ve already saved), which is probably way higher than anything you’ve saved before.
While that number can be daunting, don’t let it discourage you. The key is to save money over a long period of time, rather than all at once, and if you set your finances up right, saving money won’t be a challenge. Here are some things you can do to set your retirement plan up for success.
1. Build a savings goal into your budget
It’s one thing to throw money at retirement accounts in random spurts. It’s quite another to save consistently every month over a long period of time.
In order to guarantee you’re always saving money, build your budget around a specific savings goal, one that ensures you’ll hit your retirement planning goals. Treat this savings goal like a fixed expense. In other words, if your budget doesn’t match up with your income, adjust variable expenses, such as groceries or entertainment, before you touch your savings goal.
Building a saving goal into your budget is more proactive than the more common “leftover” approach: spend money for a month, then put whatever is leftover into savings. This loose approach to saving money almost never works, as the temptation to spend almost always trumps the goal of saving money.
2. Maintain an emergency fund
Most Canadians want to save for retirement. But every time they start, a surprise expense pops up and derails their plans.
That’s where the emergency fund comes in. Maintaining an emergency fund ensures you can always cover unexpected expenses without depending on high-interest debt, such as credit cards and personal loans. It also prevents the temptation to dip in your investment or retirement accounts, which can easily lead to early withdrawal penalties, taxes, and fees.
Though any emergency fund is better than none, most experts agree you’re better off with three to six months of emergency savings. This will help you not only cover big pop-up expenses, such as medical bills, but also stay afloat if you or your spouse lost your jobs.
3. Pay down high-interest debt
If you’re loaded with high-interest debt, work on paying it off first before you start saving for retirement. High-interest debt can become extremely expensive over the long-run. In fact, in some cases, you may pay more on high-interest debt than you would earn on investments over the same period.
While you don’t have to be completely debt-free before you start saving for retirement, you should aim to eliminate high-interest debt as quickly as possible.
4. Set up automatic savings
One method to save consistently is to set up automatic transfers between your chequing and savings accounts. You can schedule to have a certain amount pulled from your chequing on the same day every money — possibly the day you get paid — such that you’re consistently saving money.
If you have direct deposit you could set up automatic savings a different way. Just ask your employer to send a portion of your paycheque to a separate savings account. In this way, you eliminate the temptation to spend money that you really should have saved.
How can you invest for retirement?
Investing money is one of the most powerful ways to build a hefty nest egg. With the power of both compound interest and time, you can outpace inflation and amass huge amounts of wealth, especially if you don’t day trade or pull-out of the market when the going gets rough.
Just as an example, if you invested $10,000 per year for the next 10 years, and if we assumed a modest 8% return, you’d have $156,455 at the end of 10 years. Invest the same amount with the same rate of return for 20 years, and you’d sit on a $495,229 egg. And after 30 years of investing $10,000? Well, in that case, you’d be a millionaire with $1.2 million.
Just to drive the point home: of that $1.2 million, $300,000 is money you earned and invested. The other $900,000 is money you accumulated.
Of course, investing for retirement has its risks. The market will likely rise and fall, and you may lose a lot before you earn a lot more. Your investment choices, too, determine how much your money grows, and if you want to be a savvy stock investor, you’ll have to know some basic principles before you start capitalizing on growth.
To help you build investing into your retirement planning, here are some basic principles you should know.
1. Invest in stocks
Stocks have proven to be the best way for average people to build extraordinary wealth over the long-term. As a stockholder, you own a piece of a business, and as that business becomes profitable, you benefit from its growth, whether in increased share prices or dividend payouts.
2. Invest for the long-term
Day trading — buying low and selling high — is a tempting strategy. After all, is it really that difficult to buy stocks when the prices are down and sell them when the values go up?
Yes. It is difficult. The reality is, day traders often lose loads of money. The odds of you guessing the market’s movements are ridiculously low, and even if you did guess right, who’s to say you’ll guess right the next time?
Instead of gambling on market trends, a better strategy (especially for retirement planning) is to “set it and forget it.” Patience will go a long way in helping you accrue significant gains. So long as you stay invested, and don’t cash out during market corrections or crashes, you’ll capitalize on long-term growth, and you’ll eliminate the risk of buying too rashly or selling too soon.
3. Build a diversified portfolio
When it comes to investing for retirement don’t stop at one stock. Don’t even stop at a handful of stocks. Don’t even stop at stocks. To have a truly diversified portfolio, you should aim to invest in 10 – 15 different stocks, as well as invest in numerous asset classes, such as bonds and real estate.
The more companies, industries, and assets you invest in, the less likely a market crash will crack your nest egg.
Diversification is important no matter how much you’re investing, but it becomes increasingly more important as you invest higher sums. Entrusting your money to one or a handful of stocks could be disastrous, as it all takes is one big market dip to deplete your savings.
If you don’t have a lot of money to invest with, you could diversify simply by buying into a fund, such as an index fund, ETF, or mutual fund. Each of these will help spread your money across numerous companies without requiring you to handpick those companies yourself.
4. Adjust your asset allocation as your age
Asset allocation is simply the practice of balancing your investment portfolio’s risk level by investing percentages of your money in stocks, bonds, and cash (stocks have the highest risk, followed by bonds, then cash). As you get older, the risk of a market correction crushing your nest egg gets higher, and for your financial and emotional well-being you’re better off adjusting your allocation to a lower risk level.
One rule of thumb is to subtract your current age from 110 and invest that percentage in stocks. For example, if you’re 60, then, according to this rule, you should have only 50% invested in stocks.
5. Lookout for investment fees
Pay close attention to what you’re paying to invest with certain brokerages. In this day and age, with the impressive development of robo-advising and discount brokerages, you don’t need to pay large sums to invest your money.
Even small sums, such as expense ratios and administration can eat away at your returns. Compare costs for online brokerages and always evaluate costs with the actual services provided.
6. Invest in only what you understand
If you can’t explain why you’re investing in something, how you’ll make money from it, and how it actually works, don’t risk investing your money in it. You should know the ins and outs of an investment, including the risks, or else it’s not worth your retirement money.
What investment accounts should you use?
Investing money is crucial, but where you invest that money is just as important to your retirement planning. The Canadian government sponsors some lucrative retirement accounts, ones that will help your money grow without tax liabilities. If you want to pay less in taxes, you’ll do well to invest your money in the following accounts.
Please note, this information is provided for educational use only, and is not retirement advice. For personalized information about your situation, please consult a financial advisor.
Registered Retirement Savings Plan (RRSP)
The Registered Retirement Savings Plan (RRSP) is a tax-sheltered savings account that houses certain investments. Basically, as long as you’re earning income and you’re under age 69, you can open an RRSP.
The tax benefits on RRSPs are remarkable. For one, any contributions you make into an RRSP grow tax-free. So, if the investments inside your RRSP perform well, you won’t have to pay taxes on your earnings. Additionally, any RRSP contributions are automatically deducted from your taxable income, which can help you reduce how much you pay in taxes every year.
RRSPs do have some restrictions, however. For one, your annual contributions cannot exceed 18% of your previous year’s income, up to a maximum of $27,830. Any unused contribution space, however, will be rolled over to the next year.
Finally, you will pay taxes on RRSP withdrawals in retirement. That’s because your RRSP contributions are pre-tax, meaning money the CRA hasn’t collected taxes on. When you start making withdrawals in retirement, the CRA will tax them as ordinary income.
Group Registered Retirement Savings Plan
A Group Registered Retirement Savings Plan is similar to a RRSP, except it’s sponsored by your employer. Often, your employer will match your contributions (up to a certain amount, usually three to five percent), and contributions are taken directly from your paycheck.
If your employer offers a match, always take the match! You don’t want to leave money sitting on the table.
Tax-Free Savings Account (TFSA)
The Tax-Free Savings Account (TFSA) is another tax-advantaged retirement account. Like the RRSP, money invested in a TFSA grows tax-free. But, unlike the RRSP, TFSA withdrawals aren’t taxed. That’s because you invest after-tax dollars into your TFSA: you’ve already paid taxes, so the CRA won’t make you pay them again, no matter how much your underlying investments earn.
Like RRSP, TFSAs have contribution limits. For 2021, the annual contribution limit is $6,000. Additionally, TFSAs have a total contribution limit, which is currently set at $75,500. That means if you open a TFSA today, you can contribute a grand total of $75,500 over the entire life of the account.
Please note, this information is provided for educational use only, and is not tax advice. For tax information that is personalized to your situation, please consult a tax advisor.
Retirement planning starts today
Every Canadian should start saving for their retirement as soon as they can. Your money will never have as much growth potential as it does today, and the younger you start investing, the more earning potential you’ll have.
If retirement planning still feels elusive, you can always seek help from a certified financial planner. These financial experts can help you make retirement plans, hit savings goals, and possibly even help you manage your investments.
If you’re ready to invest better, Motley Fool Stock Advisor Canada can help. You don’t need a broker or a degree in Finance to grow your wealth. You just need a few minutes a month, and some great stock recommendations – and that’s what we’re here for. Best of all, when you join Stock Advisor Canada today, you’ll receive immediate access to our latest stock picks.