Building a Better Retirement: 5 Steps to a Winning RRSP
With 15 per cent of Canadian retirees rating their financial situation as poor, financial expert Gordon Pape takes a look at the keys to a winning RRSP. Photo: ipopba/Getty Images
The Ontario Securities Commission has released an extensive new report on how Canadians are dealing with retirement.
The good news is that most of us are coping well. The study found that 70 per cent of respondents said their standard of living in retirement was as good as, or better, than it was when they were working. That’s an encouraging result and it tells us that the existing retirement savings system is performing reasonably well.
But there are some cracks that need patching. The report says that 15 per cent of retirees and 24 per cent of pre-retirees rate their financial situation as poor. Among retirees, 34 per cent do not own any investment products. That figure is 37 per cent among pre-retirees.
These people obviously need guidance and motivation. Canada is fortunate to have a range of tax-advantaged programs that can be used to build a retirement nest egg. But having them available is one thing. Using them is another.
I’ve written several books on retirement planning over the years. All are out-of-print now, so I thought it would be useful to resurrect some of those ideas, along with some new ones. I’m sure most readers are in the “coping well” category, but some may be looking for direction. And some may have children or grandchildren who could benefit by reading these suggestions. So, let’s get to my five step RRSP plan.
Step 1: Assess where you are
Do you have a retirement savings program of any type already in place? This could include a workplace pension plan, an individual pension plan, an RRSP, and/or a Tax-Free Savings Account (TFSA). If you do, that’s your starting point. Make a broad stroke assessment of how much income it will likely generate at retirement. Then add the income you can expect from Old Age Security and the Canada Pension Plan. (The older you are, the easier this is). If you have a very generous pension plan, you may need to go no further. But most people will need supplementary income in retirement.
Step 2: Establish a reasonable savings routine
Assuming you have no pension plan (only 6.7 million Canadians do), you need to start now. The most effective method is by opening a Registered Retirement Savings Plan (RRSP). I like TFSAs a lot, but I believe an RRSP works better for retirement for three reasons.
- The contribution limit is much higher: 18 per cent of your previous year’s income to a maximum of $30,780. TFSAs only allow $7,000 a year.
- The contributions are tax-deductible, unlike payments to a TFSA.
- Because RRSP withdrawals are taxed, there is a disincentive to taking out money early.
Even people with modest incomes can amass a large retirement nest egg over the years with careful management. A contribution of $100 a month over 35 years, compounding at a rate of eight per cent annually, would be worth almost $230,000 at the end of that time, according to the RRSP calculator on the Get Smarter About Money website, sponsored by the OSC. The eight per cent number is about what the model RRSP portfolio in my Internet Wealth Builder newsletter has generated over more than 10 years.
Increasing the contribution to $200 a month doubles your final total, to almost $459,000. These numbers assume the monthly contributions never increase, which is unlikely.
I’ve heard some people say it sounds like a great idea but where are they supposed to find money to put aside when rising prices make buying food or filling the gas tank a budget squeeze? I didn’t say it was going to be easy, but there are two things that may help.
- Remember, the contributions are tax deductible. That means the federal and provincial governments will pay part of your cost. How much depends on your tax bracket. If your marginal tax rate is 30 per cent, a contribution of $100 a month will be reduced to a net $70.
- Most people receive extra income at some point. It could be a tax refund, a gift from a parent, a lottery win, a raise at work, an inheritance, an insurance settlement, etc. Spend half that money on family or personal needs. Contribute the rest to your retirement plan.
Step 3: Create the right kind of plan
Walk into your local bank and they’ll be delighted to open an RRSP for you, one that invests in their products. In many cases, they will suggest you fill the plan with their low-interest GICs and so-called “high interest” savings accounts (which sometimes offer rates as low as 0.05 per cent). They may also recommend mutual funds (typically their own) which may, or may not, be strong performers.
This is not the way to go.
Your RRSP should allow you to invest in the whole spectrum of securities: GICs, stocks, bonds, ETFs, mutual funds, options, limited partnerships, and more. For that, you need a brokerage account. If you are confident in your own investment skills, use a low-cost account from a discount broker. If you want AI to make the decisions for you, try a company like Wealthsimple. If you need hand holding, use a full-service broker, but it will cost more.
Step 4: Have a clear strategy
The main goal in RRSP management is consistent growth at reasonable risk. The first step to achieve that is asset mix. The worst thing an investor can do is to buy securities willy-nilly, with no specific goal in mind. That’s a ticket to financial ruin. So, before you spend a penny, decide on your asset mix – what percentages of stocks, bonds, and cash do you plan to hold?
A mix of 60 per cent stocks, 35 per cent bonds, and five per cent cash is considered appropriate for a low-risk investor. But it doesn’t always work; 2022 saw normally conservative bonds post big losses. But that’s rare. With interest rates due to decline later this year, 2024 should see a bond market recovery. I think the formula still works over the long term.
Some younger readers may want more growth potential. They can afford the extra risk because they have long time horizons. A stock allocation as high as 75 per cent might be suitable in these situations, assuming investors know what they’re doing. As retirement age approaches, the asset mix should be adjusted to reduce risk.
Step 5: Choose the securities
You’ve put everything in place. Now it’s time to start purchasing the securities for your plan. I’ll discuss how to go about it in a future column.
Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca/subscribe