Retirement. For some, it feels like a lifetime away. For others, it is right around the corner. But in all instances, careful planning and dedication are needed to make sure that there is enough money on hand come that last day of work. For such planning, a financial advisor and some knowhow on retirement savings are absolutely necessary.
The building blocks of almost every retirement savings plan in Canada are the Tax-Free Savings Account (TFSA) and the Registered Retirement Savings Plan (RRSP). Both operate differently but have one thing in common: they grow and compound interest-free. This makes them powerful tools to use in any retirement savings plan.
“TFSAs and RRSPs are really important tools for retirement savings,” says Tim Weber, consultant for Investor’s Group. “Basically, an RRSP lets you deduct your contributions from your income, but you are taxed when you start withdrawing. TFSAs are the opposite: contributions aren’t deducted from your income, but you aren’t taxed on withdrawals.”
Contributions are handled differently as well. For RRSPs in 2018, you can contribute 18 per cent of the earned income you reported on your tax return in the previous year, up to a maximum of $26,230. For a brand new TFSA in 2018, you can contribute up to $57,500 today. After that, you can put in a maximum of $5,500 every year.
The TFSA has become an increasingly popular way for Canadians to save money. Andy Husband, financial advisor with AMH Financial, says more and more Canadians are putting money into these accounts. “According to recent data provided by Canada Revenue Agency (CRA), there was about $233 billion held in TFSAs at the end of 2016,” he says. “About 13.5 million Canadians held at least one TFSA and there were about 18 million TFSAs held by the end of 2016. This would indicate that TFSAs have become a very popular vehicle for Canadians.”
The main reason for this, according to Husband, is the flexibility. Not only can you withdraw the money at any time, but TFSAs can be used for more than just your retirement.
“It’s important to remember that TFSAs were not designed as a retirement savings vehicle,” says Davis Graham, portfolio manager and investment advisor with CIBC Wood Gundy. “They were designed for people to save up for the big purchases, which is why they are so handy for younger people.”
That flexibility is one of the major reasons why TFSAs make sense for people in younger demographics, especially new graduates and people in their 20s. Husband notes, “Generally speaking, for most younger people, retirement is a long way off and their needs are more short-term, i.e. buying a house, buying a car, going on vacations [and] getting married,” he says. “A TFSA would work better for them because of its flexibility.”
Ideally, one could maximize the money they put into both their RRSP and TFSA, but this isn’t necessarily possible for many people. Instead, sometimes one is more beneficial than the other. In general, it’s better to maximize your TFSA when you aren’t earning more than you will during your retirement to take full advantage of the tax savings. If you are in a higher tax bracket than what you anticipate for your retirement earnings, the usual advice is to put money into your RRSP.
“For the person closer to retirement, obviously they are wanting to accumulate retirement savings,” says Husband. “They should pile as much into an RRSP as they can.”
This rule, of course, depends on a number of different factors and can change depending on many more. Your marital status, age, income, citizenship and potential inheritances can mean a completely different retirement plan. Americans, for example, cannot benefit from TFSAs but can benefit from RRSPs.
For those who will probably earn more in retirement, Graham recommends a different plan. “There are people out there who will likely make more money in their retirement than during their working years because of inheritances,” says Graham. “For them, I recommend other investment strategies for their retirement because RRSPs don’t offer the same sort of advantages.”
For young people, like recent grads, people in their 20s and those just starting to save for retirement, there are plenty of tactics, advice and plans. However, the start of any savings plan is to avoid credit card debt and build yourself a healthy savings account for future unexpected expenditures.
“There aren’t many hard and fast rules when it comes to investing, but there are two I always tell people: avoid credit card debt and save at least three months’ salary for a rainy day fund,” says Weber. “That’s for if you lose your job or your house needs a new roof. You need to have a fund that you can access that’s separate from your retirement plans.”
Making the right contributions with an eye to your tax bracket is important, but Husband also recommends taking your annual tax return and making that money work for you in the future. “Unfortunately, most people think a tax refund is a bonus from the government and they just take it and spend it, when in reality it is a refund of your over-contributions,” he says. “A sound retirement strategy would be to contribute any tax refund to an RRSP to help contribute towards a higher retirement income.”
Graham doesn’t recommend any major risks for young people starting their retirement savings. Instead, he says slow and steady wins the race. “I like to be very safe with people’s money when they are young,” says Graham. “I recommend GICs for them. The growth is slow but guaranteed. There is nothing more discouraging for a young person than making their first investment right before an economic drop, like the one we may see soon, and losing money right off the bat.”
For many, retirement seems like it is a long way away, but it can come up much quicker than you imagine. To prepare, it is best to start thinking about it early and understand what strategy is best for your current and future circumstances. While it may be too early to start making large contributions, it is never too soon to sit down with a professional and think about the future. With powerful saving tools like the TFSA and RRSP available, your retirement could be more comfortable and come sooner than you ever imagined.