HOW MUCH MONEY WILL YOU NEED TO RETIRE COMFORTABLY?
By Charles W. Moore
© 1998 Charles W. Moore
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Seventy percent of Canadian RRSP holders have less than $50,000 accumulated in their
plans, according to a recent bank survey. Even worse, between 1991 and 1995, 48 percent
of Canadian income tax filers between the ages of 25 and 64 didn't contribute to
an RRSP at all.
These are alarming statistics, given that the big baby-boom generation will start
retiring in twelve years, and with the Canada Pension Plan's future still very much
in doubt--despite Finance Minister Paul Martin's recent massive premium hikes.
As Reform MP Allan Kerpan recently pointed out in the House of Commons, $1 contributed
to the CPP fund today will reap "a whopping return of $1.80 after only 30 years of
uncertainty in a plan that is already $500 billion in debt. Wow."
The same dollar invested in an extremely conservative bond mutual fund yielding an
aveage of 5% would turn into at least $4 in 30 years. Plus the money would be safe
or secure in a bank or credit union rather than in the hands of the government. However,
with a 30 year time horizon, the wisest place to put the dollar would be in an equity
mutual fund or a blue chip stock, where an average return of 10 to 12 percent could
be expected based on historical performance. The Canada Pension Plan is simply a
bad, bad deal for Canadians through which the federal government is swindling them
out of the financial comfort in their retirement years that they could easily achieve
through replacing the CPP with a mandatory RRSP.
Most people grossly underestimate the amount of savings they will need in order to
retire comfortably at age 65, even if the CPP survives. Studies indicate that the
average RRSP-holder thinks a nest-egg of $250,000 would be an adequate retirement
savings goal.
Not even close--unless you plan to live an extremely frugal existence in your sunset
years. In fact if you're a baby-boomer you will need roughly four times that amount
plus the CPP in order to live what most Canadians regard as a comfortable, middle-class
lifestyle for 20 years of retirement--a not unlikely prospect with today's life expectancies.
Most of us baby-boomers have a whole lot of catching up to do, and precious little
time left to do it in. For example, if you're 50, get paid twice a month, and plan
to retire at 65, you have just 360 paychecks left to come. The only hope most boomers
have of saving the retirement capital they need is to invest, and the first priority
of intelligent investing for Canadians is to max out our RRSPs.
In fact it is well worth considering an RRSP loan--offered at prime or slightly above
by most Canadian financial institutions--to take advantage of any unused RRSP eligibility
you have coming. You probably have plenty. Canadian taxpayers invested just 13 percent
of the total allowable last year, and only 11 percent used their full contribution
limit in 1995.
As RRSP loan works like this. For example, a person in the 40% income tax bracket,
borrowing $1,000 for an RRSP contribution at 6% interest over twelve months would
have monthly payments of $86.07. The income tax refund resulting would be $400 0r
$1,000 x 40%. Total interest on the loan would be $32.80, so your net saving even
if your investment return was nil would be $367.20. Of course, your investment will
usually have a return of from 3% - 4% (GICS) to as high as 10% to 20% or more with
an equity mutual fund. Individual circumastances will vary, but this example illustrates
how borrowing money to save money actually works due to the tax advantages of contributing
to a RRSP.
What to invest in? Forget about bank savings accounts and GICs. With interest rates
stuck in the low single digits for the foreseeable future, you won't make significant
progress toward your retirement goal with that sort of supposedly "safe" investment.
The real danger is running out of money with years left to live. If you are absolutely
capital-risk averse, consider strip bonds as a more attractive guaranteed investment
with a higher rate of return than GICs, and cashable at any time. There are also
hybrid GICs linked to stock market performance, which are preferable to plain GICs.
However, for most small investors saving for retirement, it's tough to beat a diversified
portfolio of mutual funds. Financial advisors, banks, and fund management companies
will be delighted to advise you on allocating your mutual fund portfolio among different
fund categories to best reflect your personal needs and investment objectives.
Here are a few more RRSP tips:
1. If you have investments both inside and outside a RRSP, concentrate ones that generate
income (interest, dividends) in the tax-sheltered RRSP.
2. Use your full 20 percent allowable RRSP foreign content eligibility. Over 97 percent
of the world's financial markets are outside Canada. Foreign investment taps you
into that action and increases diversification.
3. Pertaining to equity mutual funds especially, take a mid-to-long term perspective
and try to ignore stock market volatility. Historically, equities have outperformed
all other investment classes by a wide margin over any 10 year interval in the past
70 years.
4. Don't wait until "RRSP season" to top up your annual contribution. If you can,
invest as early as possible to maximize the tax-shelter advantage. Second best is
a regular monthly purchase plan, but better late than never.
The cut-off date for making 1997 tax-year deductible Registered Retirement Savings
Plan contributions is March 2.
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