When is the best time to do retirement planning? My word to my adult children: with the first dollar you invest in retirement savings plan. Fortunately there are such good tax efficient vehicles to choose from today. Really there is no excuse for not taking control of your future.
Make no mistake, failing to launch financially while you are young has lifetime repercussions. If you are wondering why you should care about retirement—so far away from now—consider this: you are not entitled to any guarantees on public pension benefit levels many years from now. However, you are in a position today to guarantee your own future lifestyle, by being financially astute.
Here are the issues:
First, compounding time. The later you start to save the more you will have to save. Use any compounding calculator to prove it to yourself. Let’s say you invest $100 a week each and every week for 40 years at a 3% interest rate. You’ll save over $335,000 on an after tax basis*. But if you cut your savings time in half—starting at age 45 for example instead of age 25—you’ll accumulate only $131,000. That’s 61% or $204,000 less. That difference can buy a lot of lifestyle in your retirement.
Second: Rate of Return. It makes a big difference whether you earn 3% or 6% on your invested dollars, so make sure you have the right investment products with the least costly fees attached to them. Doubling your interest rate from 3% to 6% in the example above produces $569,000 in savings after tax, in the same 40 year period; yes that’s $234,000 more.
Third: Tax Efficiency is Most Important. Tax efficiency and deferral can add many points to your rate of return. You need to pay attention to this. When you invest a hundred dollars into a TFSA, for example, instead of a non-registered account, your $100 per week (at the 3% interest rate for 40 years) turns into $398,000; that’s $62,000 more just be putting the money into a tax sheltered account. However, with double the interest rate, you’ll have over $829,000 in your TFSA account over 40 years; that’s $260,000 more than if you saved your money in a non-registered account.
So remember, if you are at least 18 years of age, you can invest $5000 each year (that’s $96 15 each week) in a TFSA each and every year. You should do so to take advantage of the powerful compounding time, and try to get the best rate of return you can every year.
Where does the RRSP come in? To contribute to a Registered Retirement Savings Plan, you must have earned income from employment or self-employment last year, and you must be under age 72. If this fits, you can invest 18% of that earned income in an RRSP. Remember, the RRSP investment differs from the TFSA in that you will receive a tax deduction for your RRSP contribution; (this is not so with the TFSA, which uses after-tax money). However, upon withdrawal of your RRSP later, you will pay tax on both principal and earnings, unless you use the money to buy a home or go back to school.
With the RRSP, however, you do get the power of a pre-tax deposit, compounding on a tax deferred basis over time, and often the allowed deposit is higher. Used in combination with the TFSA, these two tax-preferred investment vehicles could make you a millionaire.
If this is all Greek to you, consider taking a basic tax efficient investing course. We have an excellent computer-based one available 24/7 by e-learning at the Knowledge Bureau. That knowledge will really pay off for you handsomely.
It’s Your Money, Your Life. If you are 20 or 30-something, still living at home, and not saving a penny for retirement, you are making a choice in the quality of your lifestyle later in life. If you feel you are entitled to a comfortable retirement, make a commitment to learning, earning and saving now. You’re entitled to your choices, after all. Learning more about your retirement savings and withdrawal options, with the first dollar you invest, will make you rich later in life.
Evelyn Jacks is President of the national financial education institute, Knowledge Bureau and best-selling author of 46 books on tax preparation, planning and wealth management, including Essential Tax Facts. Take a free trial of the Real Wealth Management course to think with focus on how to take better control.
*Assumes a combined federal and provincial marginal tax rate of 25%. All calculations performed using The Knowledge Bureau’s Retirement Savings Calculator.