It’s RRSP season, and that means that many of us are trying to pack our retirement accounts as much as possible right now. But it’s also a good time to look at your goals big picture to ensure you’re on the right path with that savings.
For me, while I’m putting in money into my registered retirement savings plans (RRSPs), I spend some time daydreaming about the day I’d retire, and my post-retirement life. Drinking cocktails on a beach is mostly what I think about. I also think about how much I might need to retire. At present, I aspire to a $1 million RRSP. If that is something you think about as well, you’re probably wondering how to get there.
It seems impossible, especially if you’re hoping to save $1 million by holding it in cash somewhere. Instead, make the goal more manageable, by deciding to save the $1 million in 30, or 40, or if you’re lucky enough to start young, 50 years.
A quick note before we get into that though. If your tax bracket is low, a tax-free savings account, or a TFSA, might be a better bet than an RRSP.
“The reason is your contributions will save you tax, but your withdrawals will be taxable. The higher the tax bracket today and the lower your tax bracket in the future, the more advantageous,” says certified financial planner Jason Heath, who is Managing Director of Objective Financial Partners.
How Much Can You Save?
The most you can contribute to an RRSP in 2022 is 18% of your earned income, up to a maximum of $30,870. That seems like a lot, especially if your salary is not very high. However, the good news is that you don't have to save anywhere near that much per year if you’re just starting out. The earlier you start investing, the longer your investment will compound (your money will grow exponentially). Heath recommends you try to invest as aggressively as you can be based on your risk tolerance if you have a long-time horizon so you can maximize your long-term returns.
“If someone wanted to save $1 million in today’s dollars by age 65, assuming 2% annual inflation, the earlier they started the easier it would be to do so. A 25-year-old would need to save about $1,157 per month assuming a 6% annual return. That may require an aggressive low-cost portfolio. At 35, the monthly savings required would be about $1,859. And at 45, it is about $3,277 per month. The point is the longer you wait, the less you benefit from the compounding effects of investing,” says Heath.
If you’re not comfortable with a 6% return, you could choose a more conservative estimate of 5%, or 5,5%, but in that case, you will need to save more each month.
You might have another major tool in your arsenal, though, an employer match. Many employers in Canada offer an RRSP match. Let's say, for example, your employer matches the first 5% of your RRSP contribution. That means that if you save at least 5% of your paycheck ($3,000 if your base salary is $60,000), your employer will give you another $3,000. This means you’ll only need to save $3,000 less per year to get into the ballpark you want to be in. Heath adds that if you have any sort of employer matching contribution for a group RRSP or defined contribution pension plan, this is free money that you should try to maximize.
Is $1 Million Enough?
Unfortunately, the answer here is, ‘It depends.’ It's a considerable amount of money and it's a lot more than many people have when it comes time to retire. But if you have many decades until retirement, inflation takes a toll and you might find that a million dollars just isn't a whole lot of money.
“$1 million may be more than enough to retire for some and nowhere close to enough for others. There are many factors at play. If someone retires at 40, that million may not be sufficient compared to someone retiring at 70. Life expectancy is also important. Some healthy retirees with longevity in their family may live well into their 90s. Others may not expect as many years of retirement so may not need as much saved,” Heath says,
Plus, you might have some other sources of income, such as pensions.
“If someone has $1 million saved and a defined benefit pension that will pay them a monthly income, they are in a better position than a pension-less retiree. Other factors to consider are any debt carried into retirement, a planned home downsize, or an expected inheritance. And of course, investment risk tolerance. An investor with an all-stock portfolio will likely need to save less than a GIC investor,” Heath points out.
Also remember that in general, the goal of retirement is to maintain your current lifestyle, plus or minus some expenses – usually new retirees like to spend more on things such as travel, before scaling back. Many people focus on replacing 80% of their pre-retirement paycheck. Additionally, in Canada, we are fortunate to have government support in the form of CPP/QPP or OAS. Finally, you might still continue working in retirement, as a consultant, or even in the gig economy. Considering all these aspects, you might need to rework whether the $1 million is the number that s right for you.
Does a House Count?
One major bonus for recent retirees in Canada has been the bumper rise in home prices. This benefit may not extend to those who hope to retire 40 years from now.
“The housing market plays into retirement savings in a couple of ways. Young people who overcommit to real estate may not have the leftover cash flow to save for retirement. That means their house may become their primary investment. The problem with this approach is you will always need somewhere to live. Unless you expect to significantly downsize in retirement or move to a lower-cost city, borrowing against a home in retirement may be the only way a home plays into retirement planning. For many people approaching retirement, a downsize may accelerate retirement. For seniors in a position to downsize, the recent increase in home prices may pad their retirement or allow them to consider other options like a condo down south or helping their kids or grandkids financially,” Heath says.
Keep an Eye on Fees
As always, remember that fees matter.
“In dollar terms, a $1000 invested in the index in 1998 results in a portfolio value of $4,500 after 20 years if there were no fees, but only $3000 if a fee of 2% was charged. Put in percentage terms, after 10 years, the impact of a 2% fee results in a difference of 18% less wealth when compared to no fees. After 20 years, that gap balloons to 33% So you need to be diligent in monitoring the fees you’re being charged because the fees you pay are detrimental to the amount of wealth you will end up with,” warns Ian Tam, Morningstar Canada’s director of investment research.
The point is, saving a considerable amount for your retirement isn't impossible. It can be difficult, of course -- especially in the early stages of a career when incomes tend to be lower. Though for some it may be out of reach, for others it may be more achievable than they thought.
