Straight Talk About Investing.
When you are in your 20s, paying debts and the rent may not leave much money to invest. This is why an automatic transfer is recommended.
Automatic transfers contribute a set dollar amount into your investment from a designated account, so you are investing weekly or monthly, rather than trying to throw a lump sum at the RRSP before the contribution deadline.
Don’t worry if you’re not building up a large RRSP in the early years of your career. Instead, do what you can to increase your income, cut your expenses, and reduce any debt you may have. Remember that reducing debt and saving for retirement are not competing goals: both work together to construct long-term financial health.
Here is an example that explains why investing early is important and how doing so allows you to earn even more money when your interest is compounded and you earn interest on the interest. If you were to invest $4,000 a year starting at 20, and receive an 8% average annual return, by the time you were 60, you would have more than $1 million saved. If you waited until you were 32, you’d have to invest around $10,000 a year for the same result.
In your early thirties, the mortgage, cars and kids are probably weighing you down. There’s no point in clearing out your bank account each month to put money in your RRSP if it means pulling out a high-interest credit card to pay for groceries.
Mortgages at this time are usually considered a higher priority because every time you make an extra payment on your mortgage you reduce the amount owed on the principal. If your mortgage interest rate is 5%, paying it off faster is like getting a guaranteed 5% return.
However, if you are a high-income individual in the top tax bracket, it’s better to maximize on your RRSP room before making additional mortgage payments. Take your tax refund and contribute it back into the RRSP, or even use it to pay down your mortgage to compound your savings.
If you have a pension you might be wondering if you still need an RRSP. For most people the answer to that is “yes”. With no pension, you can contribute up to 18% of your income to an RRSP each year. That amount is reduced if you have a private pension to reflect the fact that you are also contributing to retirement income through your pension at work.
If you stand to collect a very generous pension in retirement, having a large RRSP would result in that money being taxed heavily. If that is the case, use any extra funds to pay down your mortgage and max out your TFSAs.
In your forties, you’re that much closer to retirement so it is very important to review your portfolio, realign your risk, and look at your asset allocation. Most importantly however, is to continue to invest on a regular and consistent basis.
If you haven’t already done so, you may want to consider placing money in mutual funds, which is a diversified way to invest. In these funds, professionals manage the money provided by a pool of investors into areas that are typically considered higher-risk and higher-return, such as stocks and bonds. Because a group of people contribute and the money is placed in a variety of places, it’s considered safer than buying individual stocks or shares.
Opening more than one RRSP account can mean more fees to pay, more statements to read and file, and more complexity to track. A disorganized investment strategy could end up lopsided with too many risky investments or too many conservative ones, or even cause duplications. You could even wind up making over contributions and be forced to pay tax penalties. Having a qualified, trusted financial planner on your team is wise.
You don’t want debt when you retire; make a payment plan that will get you debt free by the time you are ready to retire.
In your fifties, you might want to consider taking advantage of RRSP over-contribution rules, look at consolidation of RRSPs to one account but also review your investment portfolio with more urgency as you are coming closer and closer to retirement.
Market turndowns are more perilous in your 50s than when you were younger. That is why many people begin to further diversify their portfolios into stable products to avoid unwelcome surprises. At this age, you typically want to see about 30% of a portfolio in GICs, which offer a guaranteed rate of return looking to preserve your principal, earning interest at a fixed rate.
As you get closer to your retirement, you want to start building up a buffer. To calculate how much that should be, take the annual retirement income you’ll need and multiply it by three. For example if you think you’ll need to withdraw $20,000 a year, then in the years before you retire, build up a $60,000 buffer in ultra-safe investments.
Retiring with debt can be very dangerous. The more money you owe, the more you will have to withdraw from your RRSPs. The more you withdraw, the higher your taxable income, and the higher your taxable income, the more potential there is for some of your Old Age Security benefits to be clawed back. If you have assets in a TFSA, use some of it to pay down your debt.
Another way is to sell/withdraw enough of your holdings in an unregistered investment portfolio to pay off the debts. If you are dead set on keeping the investments, try this: If you sell some of your holdings, pay off your debt and then re-borrow to buy back the securities after a 30-day period has elapsed. Loans for investment purposes are tax-deductible, unlike regular loans.
You may be wondering what the most tax efficient way to get money out of your RRSP is. Well, the trouble often starts when you turn 65. If you have a good pension and other investments to draw from, you might not dip into your RRSPs at all at first. But when you turn 71, the government forces you to start withdrawals, and if your income is high, more than 40% of that money could go towards taxes. To try and avoid the problem of your income ballooning when you hit 71, consider retiring earlier than you planned and taking the money out of your RRSP early so it’ll get taxed at a lower rate.
When it comes to when you should withdraw from your RRSP, a balanced approach is usually best. Conventional advice rightly recognizes the tax sheltering advantages of keeping money in RRSPs and RRIFs for longer. But if you empty your non-registered accounts first and then take concentrated RRIF withdrawals later, that can produce spikes in taxable income. Because of the progressive tax system which taxes higher income at much higher rates, that can create a big tax hit down the road.
While figuring out precisely the optimal balanced withdrawal strategy is no doubt complicated, you can still derive a lot of benefits from a few simple actions. You can get a rough sense of the potential tax spike down the road by projecting out the value of your RRSPs and then applying mandated RRIF withdrawal rates to see what that will do to future income. Combine that with other estimated income and you’ll get a rough sense of what tax bracket you might land in. From that you can assess potential tax spikes and the benefit of avoiding them.
A key tax bump for affluent seniors to keep an eye on is the Old Age Security (OAS) clawback on taxable incomes greater than $70,954*. Above that threshold, seniors give up 15 cents of OAS for every dollar of income until the OAS is entirely eaten up. Smoothing out income to stay just under $71,000 will help you collect your full OAS entitlement every year. Another major tax bump occurs at $43,561*, which is the start of the second federal tax bracket. Incomes above that threshold are taxed at a marginal tax rate that is seven percentage points higher than just below it.
When you are ready to retire, most people decide to change the composition of their investments, now that income and safety are priorities, rather than growth. This can mean adding an annuity, which guarantees a set monthly payment for a set period of time (often for life). Other options included bonds, dividend-paying stocks and even income trusts.
You can also choose at what point you want to start receiving your Canada Pension Plan (CPP). They normally start at age 65, but you can choose to start them earlier or later. If you choose to start them early at age 60, you’ll receive smaller payments. If you wait until 70, you will receive larger payments.
The rules change when converting your RRSP into a Registered Retirement Income Fund (RRIF). You won’t be able to put any more money in, and you are forced to start taking money out. Your financial institution will send you a notice telling you the minimum amount you need to take out each year.
For couples, the tax hit from RRSP/RRIF withdrawals is compounded if one spouse dies well before the other because these investments are then combined for the benefit of the surviving spouse (if that person is the designated beneficiary). Typically that doubles the survivor’s required RRIF withdrawals, which often bump them up into a higher tax bracket.
*as per 2013 regulations
How To Calculate Yearly Minimum Withdrawals:
The Canada Pension Plan (CPP) ensures a basic income for retired workers. If you have paid into the CPP, you are entitled to receive a monthly pension payment as early as age 60 or as late as age 70. CPP is based on how much, and for how long, you contributed to the plan and the age at which you choose to start your Canada pension payments. Should you choose to start your Canada pension payments earlier than age 65, your monthly CPP payment will be reduced by 0.6% per month for every month before 65. If you choose to delay retirement, your monthly CPP payment will be increased by 0.7% per month for every month after age 65 up to age 70.
Your designation of beneficiary by means of a designation form will not be revoked or changed automatically by any future marriage or divorce. Should you wish to change your beneficiary in the event of a future marriage or divorce, you will have to do so by means of a new designation.
The rate at which an individual is taxed. Tax brackets are set based on income levels; individuals with lower income levels are taxed at a lower rate than individuals with higher income levels. Tax brackets serve as cutoff points for given income tax rates; therefore, if an individual’s annual taxable income exceeds the cutoff point, that person is taxed according to the next tax bracket.
An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money managers, who invest the fund’s capital and attempt to produce capital gains and income for the fund’s investors. A mutual fund’s portfolio is structured and maintained to match the investment objectives stated in its prospectus. An investment in mutual funds is not guaranteed by the Credit Union Deposit Insurance Company (CUDIC), any other deposit agency or the credit union/affiliate. An investment in mutual funds is subject to fluctuations in market value and a mutual fund’s past performance may not be repeated. Mutual funds are sold by prospectus only through a licensed salesperson.
TFSA or RRSP? It’s not always an either/or choice. TFSAs and RRSPs can be used together to build a savings plan that’s right for you. We recommend speaking with a credit union investment advisor, who can review your current and projected financial circumstances and help you build a personalized retirement savings plan. When building your retirement plan, you will want to consider:
Will you want, or need, to use a portion of the savings before retirement?
If so, investing funds in a TFSA account is a good option. Funds withdrawn from a TFSA will not be taxed and you do not lose your contribution room. You can re-contribute the amount withdrawn in a future year. If funds were held in an RRSP and withdrawn, they are taxable at your marginal tax rate for the year.
Do you want to build savings as quickly as possible?
The TFSA contribution limit ($6,000 in 2021) is not determined by income but rather is the same for all who qualify for a TFSA. The contribution maximum for an RRSP is based on income and therefore varies per person. For the 2020 taxation year, the maximum RRSP contribution is 18% of your 2020 earned income to a maximum of $27,830. This means, depending on your income, you may have greater contribution room in an RRSP than in a TFSA, allowing you to accumulate savings faster.
Will your marginal tax rate in the future be higher or lower than it is today?
If you expect your marginal tax rate to be lower in the future, then an RRSP may be a better savings option. If you expect your tax rate to be higher when you are in your retirement years, then investing in a TFSA may be the better choice. In some situations, moving funds from your TFSA to your RRSP makes sense.