I’m leaving the world of making money online today as I wanted to share some thoughts about retirement planning and savings. Since 2008, it seems that the whole investment world has changed and companies are using this excuse to make the final move towards less generous retirement benefits for their employees. It is no secret that defined pension plans will soon be extinguished and that Government sponsored pensions will be modified. Regardless if we are looking at a small pension payment or a higher number of years of work before retiring, the whole retirement concept has changed. Freedom 55 doesn’t exist anymore; we can now consider Freedom 75 or something like that.
Can we stop this phenomenon?
Can we make sure that we all have a nice retirement… and that we don’t have to wait until the age of 75 to stop working?
I think there is a solution to this problem: We must force people to save
I think everybody that reads a little bit about personal finance knows about this ultimate savings rule: pay yourself first. What does this mean? It means to consider your savings as important as your mortgage or your car loan payments. In fact, your savings should be your first creditor, the most important one. Before paying your bills, eating or paying your rent/mortgage, you should start saving. Nice theory and those who apply it generally make a very nice living and have plenty of money to enjoy their retirement. This is why I think the Government should apply a “pay yourself first” tax on each pay check.
How about we try to use another well-known personal finance principle: save 10% of your income. Let’s play with number for fun:
Assume you make 50K per year
Saving 10% of your gross income per year would equal to $5,000/year
At a 5% investment return, you will generate the following nest egg in:
20 years: $165,329
25 years: $238,635
30 years: $332,194
35 years: $451,601
40 years: $603,998
As you can see, I’m not talking about astronomical numbers (both in terms of savings and nest egg). Some people will argue that 603K won’t be much in 40 years considering the inflation. Keep in mind that I didn’t increase the salary during 40 years either. Therefore, we can assume that numbers would likely be the same if I increase both the salary of 50K and the savings according to the rate of inflation.
Let’s continue this example and suppose than an individual starts saving at the age of 30 and makes 50K/year. At the age of 65, he will have $451K in his retirement account. If he were to live until the age of 95 (so 30 years), he will be able to withdraw $26,116 per year with an investment return of 4% with a safer portfolio. This is without inflation. If we factor a 2.25% inflation rate, we get $19,477 per year. I don’t know about Government pensions in the States but if you have been working all your life in Canada, you should be able to get a pension of roughly 11K/year today. If you add both numbers, you have $30,477/year in today’s dollar to retire.
If you have managed your budget throughout all these years, you should not have any debt and 30K per year should be more than enough to support your lifestyle.
While my example is quite simple and the math behind my rationale as well, most people don’t save money. They would rather go on vacation, buy a new TV, go out to restaurants… they basically do everything besides saving money for their retirement. And this is why I think we must force them to save.
Instead of leaving people the choice of doing whatever they want with their paycheck; I would setup an automatic withdrawal directly on their pay stub of 10% of their gross income. This amount would not be taxed (in other words, it would be treated as an RRSP contribution for Canadians). This money would be directly sent into an investing account (according to the individual wish). He would be able to manage it as he wishes but would not be able to withdraw from this account until the age of 60.
This would basically force each individual to take care of their own retirement plan. They would build their pension plan over the years. Imagine if your employer would match only 50% of your contribution (as some of them do at the moment). Here are the numbers would you get with the same example:
20 years: $247,994
25 years: $357,953
30 years: $498,291
35 years: $677,402
40 years: $905,998
This would be an easy way to reach $1M in investments before retiring!
Personally, I would be pleased! I would rather be forced to save than be forced to work longer, pay more taxes and support half of the population who didn’t want to save when they were younger!
Comments: 13 Read More
We are in the middle of the RRSP season and I am pretty sure that your financial advisor already called you for your contribution. You don’t have the money to contribute to your RRSP this year? Since it’s very important to prepare for your retirement and we take your financial situation to heart, we are going to offer you an RRSP loan. I Call BS on this one!
Why taking out an RRSP loan is bad for you
There is actually one specific strategy where the RRSP loan is good: when you are about to buy a property. I’ll cover that later on. But for now, get this straight in your mind: RRSP loans are only good for the bank, NOT YOU!
Why? Fundamental mathematics will show you why J
Let’s say you take out a $10,000 RRSP loan with an amortization of 5 years. For the sake of calculation, let’s assume your RRSP loan is at a very good rate of 6.5% for 5 years (fixed rate). If you pay monthly, your RRSP loan payment will equal to $195.66.
If you invest this money and make a 6% yield, you will have $13,382 in your investment account after 5 years. However, if you setup a periodic investment of $195.66 per month during 5 years and make the same 6%… you will end-up with $13,651. I agree that this is not a huge difference, but if you take out an RRSP loan every 5 years instead of investing regularly during the next 25 years, then you get:
RRSP loan every 5 years: $130,246
Periodic investment: $135,591
There is more about the RRSP loan:
If you take out a 10K RRSP loan, you will invest this money in one shot. Over the long run, it won’t make a big difference but you might bit your nails at first if you start investing right before a crash. Just think of people who did this strategy back in 2008! If you make preauthorized investments, you will be able to average the cost of your investments which will smooth out any dip in the market.
The last point is the amount of RRSP contribution vs your marginal tax rate. If you are right over a tax bracket and take a big loan of 10K, you will get a smaller tax return than if you add your 5 years of smaller contributions. You must take a look at your marginal tax rate to know if this advice is good for you or not.
RRSP loans can be good if…
If you plan to buy your first house this summer and you are thinking of using the HBP. You can take an RRSP loan, get a bigger tax return and withdraw your investment to pay off your loan under the HBP. Then, you won’t have an RRSP loan anymore but you will have benefitted from a tax return to boost your cash down. This could be an interesting strategy (just remember that you must keep your investment within the RRSP account for at least 90 days before withdrawing them under the HBP!).
If you take an RRSP loan over a short period of time (12 to 24 months), then it will be worth it. Chances are that the interest paid on the loan will be minimal and if you are lucky enough, you will benefit from a gain on the stock market.
You want a clear answer on RRSP loans? Ask your advisor!
If after reading this column you are confused about whether or not you should take a RRSP loan, ask your financial advisor to make both calculations:
A) What is going to happen to my investment over the next X years if I take a loan?
B) How much would I get if I take the payment loan amount and invest on a monthly basis with it?
Remember, people may lie… numbers don’t 😉Comments: 6 Read More
All right, you have one week left and you haven’t made your RRSP contribution for 2009 yet. You need to make your RRSP contribution before the deadline: March 1, 2010. So you have 6 business days left, not much time to do it. Chances are that your financial advisor’s agenda is already full ;-). So here’s a 2 minute guide to last minute RRSP contributions.
Before meeting with your financial advisor, get your paperwork in order. Check the following items before making your RRSP contributions:
– Your 2008 Notice of Assessment will tell you how much you can contribute (18% of your declared income minus any pension plan adjustment)
– Calculate if you are already on a systematic investment plan to contribute to your RRSP
– You are allowed to go $2,000 over your maximum RRSP contribution limit. However, since you won’t get a tax return for this extra 2K, don’t use it… it’s useless!
– Consider your marginal tax rate (you can use the Free RRSP tax return calculator in this article). This will help you determine your tax return according to your RRSP contribution.
When meeting with your financial advisor, he will obviously direct you towards one product or another. Here’s how it should be done if you want to make a good investment decision for your RRSP contribution:
#1 Revise your investor profile: You should complete or review an investor profile questionnaire. This is the very first step to determine which investment solutions are the best for you.
#2 Ask for at least 2 options: In order to be able to compare and understand what you are investing in, ask your financial advisor for 2 investment options for your RRSP. Ask him to compare both and to tell you which one he prefers and why. By looking at comparables, you will be in a better position to know what you are doing. Don’t forget to ask him if he gets a bigger monetary compensation for one product or another. Hint: he has to tell you so, if he tries to deviate from your questions, remind him that he has to provide you with a clear answer (he doesn’t have to tell you how much he makes, but he must declare if he is in a position with a conflict of interest).
#3 Don’t forget to talk about fees: It is one thing to do a last minute RRSP contribution, it’s another to get creamed by high management fees or redemption fees. Ask how much the product costs and why those fees are applied to the specific investment products. It is important to know if there is a fee to open the account, to make transactions (buying or selling) or if its management fees are based on a percentage of the amount invested.
#4 Ask for your RRSP contribution receipt: While you won’t receive your official RRSP contribution slip on the spot, ask for a copy of the document you have signed and when you can expect to receive your RRSP contribution receipt by mail. You must include it in your Tax declaration in order to receive your tax return.
#5 Don’t forget your HBP reimbursement: Making an RRSP contribution isn’t automatically applied to the reimbursement of your Home Buyer’s Plan. So if you must reimburse a part of your RRSP withdrawal this year, remember that this amount won’t generate a tax return. So if you are already calculating your tax return, review your calculation according to the amount reimbursed.
That’s it! You are set to make your RRSP contribution within the next 5 minutes ;-). However, if you can’t get a hold of your financial advisor for a good 45 minutes, you are better off making a temporary RRSP contribution (just to get your RRSP slip) and revise your investment strategy in March. Make sure to book a second appointment in March right away though!
If you have last minute RRSP questions, please comment below and I’ll answer them as fast as I can !Comments: 13 Read More
We are nearing the end of the RRSP rumble and you only have 2 weeks left to make your RRSP contribution for the 2009 tax year. But before you run like a crazy horse to the bank and ask for their best rate on a 5 year certificate of deposit, let me give you a few tips to investing inside your RRSP:
It is true that you only have 2 weeks left and most financial advisors will be pretty busy during this rush. However, if you don’t have much time to give to your retirement planning, you won’t have much money with which to retire when you are 65! In the worst case scenario, call your banker and ask for an RRSP contribution that is not “locked”. He will deposit your money in an “RRSP cash account” that you will need to invest wisely later on, in the meantime you can get your tax receipt for 2009 right away. However, during the same phone call, I strongly suggest you schedule an appointment in March. You don’t want this money to stay in limbo forever!
Since I have already produced a series on how to find a good financial advisor, I’ll let you read it (start with part 1 here). It is very important to deal with someone you trust and that is available.
Famous investor Warren Buffett once said that he doesn’t invest money in something he doesn’t understand (techno’s during it’s bubble, ABCP, etc 😉 ). Well you should do the very same thing! Ask how your money will be managed, how much you will pay in fees, if there are transaction fees and how you can read your investment returns. If your financial advisor sounds evasive, leave him or change the product but don’t waste your time 😉
Some people have the bad habit of pickings funds here and there according to their mood. Do you know that 90% of your investment yield is correlated to your asset allocation and not to market timing or the selection of investment products? Make sure that your asset allocation covers several asset classes and that it is linked to your investor profile.
Then again, if you don’t ask questions and you don’t look at your asset allocation, you may fall into the flavour of the month. Some products will be “pushed” by some financial advisors. They may be good for you, they may not be. Therefore, ask how this investment product fits within your retirement plan?
It is always tempting to follow the herd and invest in the “hot industry” of the moment. Some people are very attracted to Canadian banks or to commodities (gold, oil, etc.). I am not say that you shouldn’t have financials or commodities in your RRSPs, but I seriously think that you should consider your asset allocation first!
If you have 100K or more, don’t bother having more than 5-7 funds. Over this amount of funds, you are over diversified or you are just paying MERs for nothing. If you have a small amount to invest (a few thousand), your best bet is to take a package of mutual funds since they are balanced according to your investor profile and you don’t have to mess around with 10 mutual funds. Too much diversification is called diworsification 😉
I think you should not invest the equity portion exclusively into the Canadian market. It would be a great idea to look at the US and global markets. However, if you do so, ask if your investments will be hedged against currency fluctuations. For example, someone who invested in US dollars from 2003 to 2007 didn’t make much once converted into CDN dollars. While the US market jumped by more than 30%, our dollar also jumped with the very same proportion compared to the US dollar. What you made with the right hand, you lost it with the left one.
You can’t stand the market anymore and you are only looking for secured investments in your RRSP? This is fine but be careful of locking your money for a 5 years term at 3%. If inflation comes back (and it will!), you will get hit by a train and you won’t make money for 5 years. If you go with bonds and certificates of deposit, you are better off with a bond ladder to mitigate your interest rate risk.
image source: ansikComments: 0 Read More
I had recently written a post about common RRSP Facts and FAQs. Since we are entering the biggest RRSP month of the year (deadline to contribute for tax year 2009 is March 1st 2010), I thought of taking a look at some RRSP strategies and RRSP basics.
No, this wasn’t an evil invention by mutual funds’ companies or Canadian banks ;-). The Government created the RRSP to give everyone the chance to build a comfortable retirement. An RRSP account allows investments to grow tax free while reducing your tax exposure according to the RRSP contribution of the individual. At retirement, when your marginal tax rate could be at its lowest, RRSP withdrawals become taxable.
Some say that you should put all your fixed income into your RRSP for tax optimization. Some other say that since you have several years before your first withdrawals, you should invest in an aggressive portfolio and let the stock markets work its magic. I’d say that you should always consider your investor profile and invest according the asset allocation you have chosen.
If you are looking into a retirement perspective, investing in your RRSP or your TFSA will create about the same results. While the RRSP gives you’re the opportunity to get your tax return right away, you won’t be taxed on your TFSA withdrawals at retirement. Personally, I would stick with the RRSP’s for retirement and use my TFSA for other projects.
Depending on your financial situations, you may find some interesting RRSP investment strategies that can help you save a lot of money:
A long time ago, I wrote about the double dip strategy. This RRSP strategy consists of reinvesting your tax return into your RRSP every year. Therefore, if your marginal tax rate is 40% and you contribute $10,000 to your RRSP, you should save $4,000 in taxes. Use this very same amount to contribute again to your RRSP and you will get an additional $1,600. So with a 10K contribution, you generate a tax return of 5,6K which is 56% taxes saved. Not bad, huh?
Several financial advisors will recommend that you take an RRSP loan if you don’t have the money to contribute to your RRSP. While this technique will allow you to receive a bigger tax return right away, you should think twice before taking an RRSP loan. Why? Simply because if you can’t pay this loan back within 12 to 24 months, you are paying too much in interest and you would be better off with a systematic investment. You won’t get a huge tax return if you invest $400 per month into your RRSP but you will end-up with a better return over 5 years than taking a RRSP loan with similar payments.
This is a very interesting strategy as it is used to boost your cash down for first home buyers. If you have a marginal tax rate of 40% and you have 20K RRSP unused contributions, you can take a 20K RRSP loan before buying the house. Under the HBP, you are allowed to withdraw your RRSP investments to buy a property tax free (as long as the money had stayed in your RRSP account at least 90 days). So you withdraw your 20K and payback the loan. Why do this? Because the 20K contribution will generate a 8K tax return the very same year. Therefor, you will have 17 years (15 years + 2 years of grace period) to put back the 20K in your RRSP account and you will benefit from an additional 8K right away to purchase your property. More info can be found in Million Dollar Journey’s post about HBP plan.
This investing strategies is relevant only for investors who have a significant amount of money invested in both registered and non-registered accounts. The strategy is fairly simple but it is too often forgotten. Using your track investment apps, you should be able to determine your global asset allocation. Then, you simply have to maximize the amount or fixed income in your RRSP and increase your equity portion in your non registered account. For example, if you have a overall balanced portfolio (50% fixed income / 50% equity), you should show a conservative portfolio in your RRSP (75% fixed / 25% equity) and an aggressive investment strategy in your non-registered account (25% fixed / 75% equity)(assuming that both accounts represent 50% of your total investment). If you are not sure about how to do it, you can use bank investment services.
For young (and not so young) investors, the bi-weekly RRSP contribution is definitely the best investment strategy you can put in place. While you won’t even notice that your RRSP contributions are made, you will build a strong portfolio and absorb market fluctuations. So if I have one advice for 2010; this would be it!Comments: 4 Read More
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