Financial planning for your future is more than just a good idea, it's a necessity. Whether you decide to retire early or you work well into your senior years, you want to know that you and your family will have enough money to live comfortably as you get older.
Reaching that goal requires careful planning to determine how much money you will need and where that money will come from.
Marie DeLauretis, a Calgary-based certified financial planner, says the process of setting goals allows you to establish a starting point and pivots you in the direction of where you ultimately want to be in retirement. “There will always be bumps in the road such as job loss, health issues, and other goals that may take priority,” she says, stressing that “with a well-considered plan, you are more prepared to handle life.”
Here are some of key questions to ask yourself when assessing your retirement readiness:
How Much Money Do I Need in Retirement?
Once retirement goals are set, the next step is to get a rough estimate of how much you will need to fund a comfortable retirement. While that number will be different for each person, financial experts point to a rule of thumb as a starting point. It’s called the income replacement ratio, which means the amount of income you'll need in retirement as a percentage of your current income.
Typically, the income replacement ratio is 70%. “You will need to have accumulated in your retirement account enough funds to provide an income equivalent of 70% of your pre-retirement income for the number years you expect to live,” says DeLauretis.
There’s also the 25x Rule. That is, take the amount you want to spend each year in retirement and multiply it by 25. However, one must have some idea as to how much they want to spend and what they plan to do in retirement.
“Your number can vary greatly depending on your personal goals, your health and how long you expect to live, whether you will be single or with a spouse/partner and when you will actually retire,” says DeLauretis.
Where Will the Money Come From?
Once you have a general sense of how much you will need to retire comfortably, think about where that money will come from.
Here are some sources of retirement income to consider:
Canada Pension Plan (CPP):CPP is a monthly, taxable benefit that replaces part of your income when you retire. “One can receive CPP as early as age 60 with a reduced pension and as late as age 70 with a premium added or at an increased monthly amount,” says DeLauretis.
Old Age Security (OAS): OAS is a pension benefit paid monthly to most Canadians aged 65 or older. OAS payments are not dependent on one having worked, but one must meet some pre-requisites including they must be 65 or older, a Canadian citizen or legal resident at time of application, and have lived in Canada for at least 10 years after the age of 18.
“If deferring OAS, one would receive an additional 0.6% per month for every month they defer, up to a maximum of 36% increase if deferring till age 70,” notes DeLauretis.
Guaranteed Income Supplement (GIS): It is a non-taxable monthly payment provided to low-income Old Age Security (OAS) pensioners. One cannot receive GIS if not receiving OAS. DeLauretis cautions, however, that “those in a higher income bracket would not qualify for GIS [and] would benefit from delaying CPP and OAS in order to draw down another taxable income source such as RRSP/RRIF.”
Investment portfolios: Canadians can save and invest for retirement in many tax-advantaged registered accounts, including RRSPs, RRIFs, and TFSAs, and taxable non-registered accounts.
“It is important to determine which ones to draw on, and when to draw, to minimize taxes and maximize cash flow,” she notes.
Annuities, rental income, and insurance policies are other sources that could generate retirement cashflow.
RRSPs vs. TFSAs
A registered retirement savings plan (RRSP) is an account for holding savings and investment assets for retirement. Investments held in RRSPs grow tax-deferred, which means investors don’t have to pay tax on any profits made within an RRSP account until the funds are withdrawn.
Moreover, the amount of deductible RRSP contributions you make reduces your taxable income thereby reducing your income tax bill.
Tax-free savings account, or TFSA, was introduced by the Federal Government in 2009. It’s a savings vessel that allows contributions to grow tax-free. Its annual contribution limit for 2023 is $6,500 and any withdrawals made from the account or investment income earned within it are also tax-free.
Suitability of either depends largely on available contribution room, age of the account holder, taxable income, tax considerations and retirement goals.For those in a very low-income bracket, and with low tax liability, “perhaps the TFSA is the best vehicle to invest in if the individual has the room,” says DeLauretis.
Conversely, one could also argue that individuals in a low income tax bracket, “should contribute to the RRSP and simply carry forward that contribution to higher income earning years, to save on tax payable then,” she says.
It is generally agreed that RRSP contributions provide the most tax benefits even considering the drawdown years. “In some cases, contributing to your RRSP to reduce taxable income and net income allows you to qualify for other government benefits and tax credits,” argues DeLauretis.
For investors who have maxed out their RRSP contributions for the year, a TFSA is a great way to complement their retirement savings tax-free.
How Much Money Should I Put in My RRSP Annually?
More than half of Canadians do not contribute to RRSPs, according to an Edward Jones survey. The most cited reasons include financial constraints due to the COVID-19 pandemic and prioritizing paying down mortgages, the study finds.
“Every little bit of saving helps and will make it easier, if you start early enough,” says DeLauretis. “Harness the power of compound interest where planning and saving a little now on a regular basis can let money work for you over the years.”
Your savings may grow slowly at first but then starts to balloon as you get older, even if you put in the same amount of money. “Every year you delay means you’ll need to save more money and perhaps take on more investment risk in order to reach your goals,” she notes. However, those earning a high income should maximize their RRSP contribution room annually, she says. That way, they can receive the tax deduction to minimize taxes payable and enjoy tax-deferred growth on their investments.
Another key component of long-term financial planning is managing and minimizing debt.
Canadians are retiring with more debt than ever before. The household debt-to-disposable income ratio is near an all-time high of 183.99, according to most recent Statistics Canada data. Retirement experts argue, though, that retirement savings need not be sacrificed to be debt-free sooner. There is no silver bullet approach to the saving versus debt repayment dilemma.
There are many different options available as you approach—and plan for—your retirement. It’s important that you choose the one that works best for your own financial situation. The key is to start thinking early about saving for retirement.
