You’ve decided you need to save for retirement by contributing to a registered retirement savings plan (RRSP) or your company pension plan. The question is, how much will you need and how much should you save? Unfortunately there isn’t one simple answer.
“The older you are when you start your retirement savings plan, the higher the percentage of income you have to put aside, because you’ve lost years of compounding,” says Gordon Pape, author of RRSPs: The Ultimate Wealth Builder. “A 25-year-old might only need to save 8% - 10% of income each year. However a 45-year-old might have to save as much as 25%.”
For 2014, you can save up to 18% of your earned income in an RRSP (to a maximum of $24,270) or an employer-sponsored defined contribution (DC) plan (to a maximum of $24,930). You’ll get a tax deduction for your contributions, and your investments will grow on a tax-deferred basis. If you are a member of a defined benefit plan, your RRSP contribution room will be reduced. Unused RRSP contribution room can be carried forward to future years.
“I strongly encourage people to max out their RRSP contributions every year. This can be an enormous challenge, but in future, you will be glad that you did,” says Bruce Sellery, author of The Moolala Guide to Rockin’ Your RRSP.
Your financial advisor can help you determine how much you need for retirement and how much you have to save. But you can start by asking yourself the following questions.
- When did you start saving? The longer you save, the more you will have in your nest egg. Investment income will also build your account balance over time.
- When do you plan to retire? Thinking of retiring at 60 instead of 65? You’ll need to save more because you are losing five prime contribution years and your savings will have to last longer.
- What’s your life expectancy? No one can predict his or her date of death. However, if all your relatives lived to age 95 and you are in good health, it is wise to factor this potential longevity into your retirement planning.
- What are your plans for retirement? How will you spend your retirement? A modest retirement may only require 50% of your pre-retirement income. But if you are planning an active retirement including frequent, exotic travel, you may need up to 70% or more of your previous earnings. Consider various retirement income options.
- Do you have a workplace pension? If your employers sponsors a group RRSP or DC plan and matches your contributions, this annual tax-deferred bonus will reduce the amount you have to save on your own.
- How much will you earn on your investments? To calculate how much you need to reach your retirement savings goals, you will need to assume a rate of return on your investments. Your financial advisor can help you select a realistic number for your investment projections.
- What other assets do you have? You may have assets such as a Tax Free Savings Account, other unregistered savings or real estate. You might own a business. Depending on the value of these assets, you may not need to save as much in a workplace pension or RRSP.
- Will you make early withdrawals from your RRSP? When you withdraw money from your RRSP, you pay tax on the withdrawal at your marginal rate. You also lose the contribution room and the benefit of compound interest over time. Emergency funds should be saved in your TFSA where contribution room is restored in the next year.
- What balance are you aiming for at death? Do you want to spend all of your money when you are alive, or leave a legacy for your children or your favourite charity?
If you are early in your career, it may seem impossible to predict how much you will earn in the future and what you will need to retire 30 years down the road. You also may also have other financial priorities, such as saving for a house or your children’s education.
That’s why you should review your retirement savings plan with your financial advisor at least once every three years, or in connection with a major life event such as the birth of a child, a divorce or the loss of a spouse.