It鈥檚 sometimes said that you need at least a $1 million retirement fund to maintain the kind of lifestyle you want after age 65. But starting at, say, age 40, can that even be done? The good news is that it is possible to build a million-dollar retirement fund. But there five important principles you have to follow.
1. Forget about 鈥渟aving鈥�
First things first. You absolutely cannot 鈥渟ave鈥� your way to a million-dollar retirement. Understanding this is one of the first steps to financial literacy 鈥� which is appropriate, as November is Financial Literacy Month in Canada. Here鈥檚 why.
Have you checked the interest rate paid on money sitting in a standard, plain-vanilla deposit account at your local financial institution? A recent survey of the market showed that the highest rate paid was around 2.4%, while the lowest was, believe it or not, 0.03%! Believe me, with this kind of return, you will not be able to 鈥渟ave鈥� a million dollars 鈥� even over 20 years. In fact, with inflation and taxes, you鈥檒l actually lose money. At a 2.4% annual rate, a $100,000 savings account will shrink to $88,000 in 20 years, after inflation and taxes. For those people, especially women, looking for the path to financial independence, that鈥檚 more like the road to ruin.
2. Make a plan
To get on the road to financial success, you have to get off the road to ruin. You don鈥檛 know where you are now. You need a plan of some kind, even if it鈥檚 on the back of the proverbial envelope. You need to know what you own, what you owe, what you really earn (after taxes), what you spend, and how much you have left at the end of the month. Then you need to decide where you want to be financially when you retire, in 20, 25, or 30 years. Next, you need to decide on a strategy 鈥� that鈥檚 the tool that will let you achieve your long-term goal. If that sounds like a lot of work, it is. Here鈥檚 where a financial planner can help. If you鈥檙e in any doubt about the time and effort needed, think about that shrinking savings account!
3. Control your spending
Unrestrained spending is the biggest challenge to getting your personal finances in order. If you spend everything you earn 鈥� or more 鈥� every month, and you carry credit card balances from month to month, you鈥檙e already behind the eight-ball before you鈥檝e even started. But getting control is easier than you think, if you start with small steps. For example, if you鈥檙e a lunch buyer rather than a brown-bagger, you鈥檙e paying an average of about $9 or $10 a day. Eating lunch out three times a week adds up to $1,500 per year. Tack on $30 a week for those irresistible latt茅s and you鈥檙e down another $1,560 a year. That鈥檚 about $255 a month, or about $3,060 per year altogether鈥t a minimum. So if you give up the latt茅s for a year, brown bag it more often, and save that $255 per month for 19 months, you鈥檒l have saved up over $5,000! If you put your $5,000 into a high-performance investment fund earning, say, an average annual 9.5% and continue to contribute $255 per month for 25 years, that money will have turned into $366,577! But it can be more, much more.
4. Use registered plans
You can be a millionaire by the time you retire, and not just by cutting down on the lattes. Start on that road to a million right now, by opening and contributing to a Registered Retirement Savings Plan 鈥� an RRSP. It鈥檚 the single best tax deferral vehicle available to Canadians. The current annual contribution limit for RRSPs is the lesser of 18% of your previous year鈥檚 earned income, or $26,230. An RRSP can hold just about every type of investment available, and investments grow inside the plan, free of tax of any kind. In addition to that, you get to deduct your annual contribution from your income, further reducing your annual tax bill. If you get a tax refund as a result, you can contribute that to your RRSP too, increasing your tax deduction even more. The second-best vehicle is a Tax-Free Savings Account. You can contribute as much as $5,500 per year with no income test needed, and investments grow tax free in the plan and withdrawals are completely tax free. But you don鈥檛 get a tax deduction.
So how do you combine these two plans to make a million? If you start contributing just $770 a month to an RRSP at age 40, and target an 8.5% average annual compounded return, your RRSP will be worth $794,000 by the time you reach 65. Then, if you contribute your annual tax refund from your RRSP contributions, say, $3,228 (the approximate average refund from a $9,240 annual RRSP contribution at the top marginal tax rate), into a Tax-Free Savings Account earning the same return, you鈥檒l have an additional $254,000 at age 65. Put it together, and you鈥檒l have over a million bucks!
I can hear the question now: 鈥淏ut where do I get that 8.5% annualized return?鈥� You might be surprised to learn that according to Fundata, Canada鈥檚 leading fund performance data provider, there are 100 investment funds that have a historical 20-year annualized return of 8.5% or more, with the highest coming in at a whopping 15.8% average annual return.
The 20-year annualized returns for the top 10 funds in the Canadian Equity Balanced category ranges between 6% and 8%; conservative Canadian Fixed Income returns range between 4.4% and 6.5%, and returns for the aggressive growth Canadian Small/Mid-Cap Equity portfolios range between 9.5% and 14.7%.
5. Get free money from your employer
Most people don鈥檛 pay enough attention to pension planning. It sounds dull. It鈥檚 a long way off. It鈥檚 for 鈥渙ld鈥� people. But guess what? It鈥檚 what鈥檚 going to make you rich. So pay attention! Your RRSP is just one part of the retirement planning mix. Check with your employer to see if they offer a Defined Contribution Pension Plan (DCPP). Contributions can be made by your employer, by the employee, or some combination of both.
Take advantage of this, especially if your employer contributes all or part of it. It鈥檚 free money! Much like an RRSP, contributions are tax deductible, and investments grow on a tax-deferred basis in the plan. Unlike an RRSP, funds are locked in until you retire. The 2018 annual contribution limit for DCPPs is the lesser of 18% of your current year鈥檚 earned income, or $26,500. This amount will increase in 2019. Your RRSP maximum contribution will be reduced if you also have a DCPP.
Getting all these moving parts to work properly can be challenging. A Certified Financial Planner can really help you makes sense of it all, and get you on the road to that $1 million retirement.
Courtesy 漏 2018. , is president of . This article is not intended as personalized advice. Securities mentioned are not guaranteed and carry risk of loss. No promise of performance is made or implied.
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