Saving for retirement is about planning ahead so you can have a high quality standard of living when you retire. Here are some of the most common questions people ask when thinking about their retirement journey -
- When should I start saving for retirement?
- What's the best way to save for retirement?
- How much will I need in retirement?
When should I start saving for retirement?
It’s never too soon to start saving for retirement. Every single year you put money aside, you’ll benefit from the effects of compound interest.
- You contribute $100 to your retirement today
- Over the next 40 years, you get an average annual return of 6%
- With no additional contributions, your initial $100 is now worth more than $1,000
Even if you don’t have 40 years before you retire, the best thing you can do is start saving now and give your money as much time as possible to grow.
What’s the best way to save for retirement?
If you’re thinking about putting money aside for your retirement, you might consider opening a registered retirement savings plan (RRSP) or a tax-free savings account (TFSA).
Open an RRSP
The government of Canada created the RRSP, or registered retirement savings plan account, to help Canadians save for retirement.
Every year, Canadians are allowed to contribute up to 18% of their income into an RRSP, up to an annual contribution limit set by the government.
The money you contribute to an RRSP is tax-deductible. This means you can subtract the amount you contribute from your income and pay less in income taxes each year.
- You earn a $50,000 salary and contribute the maximum amount of your income (18%) to your RRSP
- 18% of $50,000 is $9,000
- Your taxable income for the year drops from $50,000 to $41,000, so you only pay tax on $41,000 this year
Some employers offer RRSP matching, where they will match your contributions up to a certain amount. Make sure to take advantage of this program – it’s free money.
- You earn a $50,000 salary and your employer offers a ‘5% match’ program
- 5% of a $50,000 salary is $2,500
- If you contribute $2,500 to your RRSP each year, your employer will match your contributions with another $2,500
- You’ll add $5,000 in total per year to your retirement savings
Besides saving for retirement, you can also use funds from your RRSP to buy a home or even fund your education.
Open a TFSA
The tax-free savings account (TFSA) is designed to help you save and invest money without paying tax on the gains.
Although it is called a ‘savings’ account, a better name for it would be an ‘investment’ account since you can invest money in all kinds of investment products from within a TFSA. Like a RRSP, there is a limited amount you’re allowed to contribute each year to your TFSA.
Unlike a RRSP, the money you contribute to a TFSA is after-tax income. You’ve already paid income tax on these contributions, and they won’t be subject to any further income tax. Any gains you generate from your contributions to a TFSA are tax-free.
How much will I need in retirement?
You can calculate how much you need to save for retirement by:
- estimating your annual expenses
- working backwards to see how much you’ll need to withdraw from your investment accounts each year during 25 years of retirement (i.e. from 65 to 90 years old)
- You think you'll have around $50,000 of expenses each year when you retire at 65. To cover these expenses, you’ll need a retirement income of around $66,000 per year before tax.
- Your income comes from government benefits, any other sources of income you may have, and withdrawals from your retirement account. In this example, your income is $15,000 per year from Old Age Security (OAS) and the Canadian Pension Plan (CPP).
- To make up the difference between your income (government benefits) and your expenses, you need to withdraw roughly $51,000 from your investment accounts each year. (i.e. $66,000 before-tax income = $15,000 benefits + $51,000 withdrawals.)
If you make $51,000 in withdrawals from your investment accounts for 25 years of retirement, you’d need to save roughly $1,275,000 in your retirement accounts.
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