It’s sometimes said that you need at least a $1 million retirement fund to maintain the kind of lifestyle you want after age 65. But starting at, say, age 40, can that even be done? The good news is that it is possible to build a million-dollar retirement fund. But there five important principles you have to follow.
1. Forget about “saving”
First things first. You absolutely cannot “save” your way to a million-dollar retirement. Understanding this is one of the first steps to financial literacy – which is appropriate, as November is Financial Literacy Month in Canada. Here’s why.
Have you checked the interest rate paid on money sitting in a standard, plain-vanilla deposit account at your local financial institution? A recent survey of the market showed that the highest rate paid was around 2.4%, while the lowest was, believe it or not, 0.03%! Believe me, with this kind of return, you will not be able to “save” a million dollars – even over 20 years. In fact, with inflation and taxes, you’ll actually lose money. At a 2.4% annual rate, a $100,000 savings account will shrink to $88,000 in 20 years, after inflation and taxes. For those people, especially women, looking for the path to financial independence, that’s more like the road to ruin.
2. Make a plan
To get on the road to financial success, you have to get off the road to ruin. You don’t know where you are now. You need a plan of some kind, even if it’s on the back of the proverbial envelope. You need to know what you own, what you owe, what you really earn (after taxes), what you spend, and how much you have left at the end of the month. Then you need to decide where you want to be financially when you retire, in 20, 25, or 30 years. Next, you need to decide on a strategy – that’s the tool that will let you achieve your long-term goal. If that sounds like a lot of work, it is. Here’s where a financial planner can help. If you’re in any doubt about the time and effort needed, think about that shrinking savings account!
3. Control your spending
Unrestrained spending is the biggest challenge to getting your personal finances in order. If you spend everything you earn – or more – every month, and you carry credit card balances from month to month, you’re already behind the eight-ball before you’ve even started. But getting control is easier than you think, if you start with small steps. For example, if you’re a lunch buyer rather than a brown-bagger, you’re paying an average of about $9 or $10 a day. Eating lunch out three times a week adds up to $1,500 per year. Tack on $30 a week for those irresistible lattés and you’re down another $1,560 a year. That’s about $255 a month, or about $3,060 per year altogether…at a minimum. So if you give up the lattés for a year, brown bag it more often, and save that $255 per month for 19 months, you’ll have saved up over $5,000! If you put your $5,000 into a high-performance investment fund earning, say, an average annual 9.5% and continue to contribute $255 per month for 25 years, that money will have turned into $366,577! But it can be more, much more.
4. Use registered plans
You can be a millionaire by the time you retire, and not just by cutting down on the lattes. Start on that road to a million right now, by opening and contributing to a Registered Retirement Savings Plan – an RRSP. It’s the single best tax deferral vehicle available to Canadians. The current annual contribution limit for RRSPs is the lesser of 18% of your previous year’s earned income, or $26,230. An RRSP can hold just about every type of investment available, and investments grow inside the plan, free of tax of any kind. In addition to that, you get to deduct your annual contribution from your income, further reducing your annual tax bill. If you get a tax refund as a result, you can contribute that to your RRSP too, increasing your tax deduction even more. The second-best vehicle is a Tax-Free Savings Account. You can contribute as much as $5,500 per year with no income test needed, and investments grow tax free in the plan and withdrawals are completely tax free. But you don’t get a tax deduction.
So how do you combine these two plans to make a million? If you start contributing just $770 a month to an RRSP at age 40, and target an 8.5% average annual compounded return, your RRSP will be worth $794,000 by the time you reach 65. Then, if you contribute your annual tax refund from your RRSP contributions, say, $3,228 (the approximate average refund from a $9,240 annual RRSP contribution at the top marginal tax rate), into a Tax-Free Savings Account earning the same return, you’ll have an additional $254,000 at age 65. Put it together, and you’ll have over a million bucks!
I can hear the question now: “But where do I get that 8.5% annualized return?” You might be surprised to learn that according to Fundata, Canada’s leading fund performance data provider, there are 100 investment funds that have a historical 20-year annualized return of 8.5% or more, with the highest coming in at a whopping 15.8% average annual return.
The 20-year annualized returns for the top 10 funds in the Canadian Equity Balanced category ranges between 6% and 8%; conservative Canadian Fixed Income returns range between 4.4% and 6.5%, and returns for the aggressive growth Canadian Small/Mid-Cap Equity portfolios range between 9.5% and 14.7%.
5. Get free money from your employer
Most people don’t pay enough attention to pension planning. It sounds dull. It’s a long way off. It’s for “old” people. But guess what? It’s what’s going to make you rich. So pay attention! Your RRSP is just one part of the retirement planning mix. Check with your employer to see if they offer a Defined Contribution Pension Plan (DCPP). Contributions can be made by your employer, by the employee, or some combination of both.
Take advantage of this, especially if your employer contributes all or part of it. It’s free money! Much like an RRSP, contributions are tax deductible, and investments grow on a tax-deferred basis in the plan. Unlike an RRSP, funds are locked in until you retire. The 2018 annual contribution limit for DCPPs is the lesser of 18% of your current year’s earned income, or $26,500. This amount will increase in 2019. Your RRSP maximum contribution will be reduced if you also have a DCPP.
Getting all these moving parts to work properly can be challenging. A Certified Financial Planner can really help you makes sense of it all, and get you on the road to that $1 million retirement.
Courtesy Fundata Canada Inc. © 2018. Robyn Thompson, CFP, CIM, FCSI, is president of Castlemark Wealth Management. This article is not intended as personalized advice. Securities mentioned are not guaranteed and carry risk of loss. No promise of performance is made or implied.
