Saving for retirement might not be the first thing on your mind, especially if money is tight. Unfortunately, that’s a short-sighted view. With life expectancy rising, Canadians can expect longer retirements, and the longer you spend not working, the more savings you need to finance it. Starting now and saving a substantial portion of your income can make all the difference between happy, financially comfortable golden years and a decade of penury. Even if you’re still thirty or forty years from retirement, this advice applies to you. The earlier you start saving for retirement, the more money you’ll have to play with when you stop working.
How Much Do I Need To Save?
That partly depends on what you plan to do with your retirement. A retirement spent touring Italian vineyards is naturally going to be more expensive than a retirement spent watching cable television. There are retirement lifestyle calculators online, like this one, that will give you an idea of how expensive your intended post-work lifestyle will be. The Canadian government provides a calculator to find out how much your retirement income will be. Do some self-reflection to figure out how much of an income you’d like to have per year after retirement.
The amount that you need to save can be reduced by working after retirement, or at least by tailing off work slowly instead of simply hanging up your boots by working part-time or consulting. Working beyond 65 will increase the size of your state pension when you do start taking it. While employers can sometimes be unwilling to keep older people in work, this is changing, and by retirement age you’ll have decades of skills and experience to draw upon. If traditional employment doesn’t appeal, you may be able to work in a self-employed or consulting capacity, giving you more flexibility. Taking this option is becoming increasingly popular in Canada, often because people have misjudged the costs of retirement. Treat this information as a reason to start saving now, because you won’t be able to work indefinitely after retirement.
Savings accounts and GICs are good enough for regular savings, but when you’re saving for retirement, you have some additional options. The two major ones are the Registered Retirement Savings Plan (RRSP) and the Tax Free Savings Account (TFSA), and a lot of ink has been spilled arguing over which one is better.
The RRSP allows you to save up to 18% of your previous year’s earned income or the year’s contribution limit, whichever is lower (unless you’re earning six figures, you won’t reach the contribution limit), and contributions are tax-deductible. However, any withdrawals are treated as taxable income for the year, which will also affect your eligibility for some government benefits, and you’re required to convert your RRSP after age 71. TFSAs give more flexibility: withdrawals are tax-free instead of tax-deferred. You also aren’t required to be working to contribute to a TFSA, unlike RRSPs for which you must be in work. However, your TFSA can’t grow as large as your RRSP, because the annual cap on contributions is $5500. Your unused contribution per year carries forward in both cases.
So, which one should you use? If you have the income to support it, there’s nothing preventing you from using both, and the RRSP’s reduction of taxable income can be very useful. Beyond that, it depends on your income and on what you want out of your savings. If your account isn’t being used strictly for retirement income, the TFSA might be the better option because withdrawals aren’t penalised. The RRSP can allow for tax-free withdrawals (under certain restrictions) to fund home-buying or construction, or education, but generally withdrawing money from it is a bad idea because it counts as taxable income.
If you plan to keep the account strictly for retirement savings, things get more complicated. In fact, the withdrawal penalties on an RRSP might help you to be disciplined with your retirement fund. The usual advice given is that lower earners should choose the TFSA, because the tax reductions of the RRSP won’t be as significant, while higher earners should enjoy the taxable income reduction provided by the RRSP. If you’re likely to use government assistance such as the Guaranteed Income Supplement in old age, RRSP withdrawals can disqualify you. If you earn over $50000 per year, the RRSP is probably the better option. However, getting the most out of your RRSP also requires discipline; namely, you have to be prepared to use the tax reduction on productive investments instead of spending it on sundries. While that’s a good rule of thumb, consider talking to a financial advisor who will be able to give advice based on your individual financial situation.