5 Common Mistakes When Planning for Retirement
Executive Summary
We all plan to stop working someday, but approximately 70% of Canadians have NO retirement plan; the five common mistakes that are made when it comes to retirement are:
Not planning or setting any funds aside
Not utilizing TFSAs as part of your strategy
Too much reliance on government benefits
Starting too late/ not using time as your ally
Not investing the funds that are in your RRSP
According to a recent survey by BNN Bloomberg, approximately 70% of Canadians do not have a retirement plan. I think almost everyone of us plans to stop working at some point, or if we don’t plan to, it may be we reach a point where we need to. Its important to plan ahead, its what any prudent individual would do for something we know is going to happen.
Given February is “retirement month” (due to the CRA deadline for RRSP (Registered Retirement Savings Plan) contributions to be eligible for 2022 tax year), I have decided to focus this month on retirement planning. It needs to be part of your financial plan.
When making retirement plans, there are 5 common pitfalls that you should watch out for. In the end, how much you need for retirement is contingent on the lifestyle you want (retirement is a number, not an age), and there are numerous ways you can go about reaching that number. This blog focuses on common principles and pitfalls to watch out for as you plan retirement…to actually plan for your retirement you should put in the work on your own, and in all likelihood consult with a financial advisor or coach.
5 common mistakes when planning for Retirement:
1) Not Planning at all or Not setting enough funds aside
In the end, we are all going to stop working at some point. To not plan for an eventuality is foolish. Realistically, we should create a solid plan, based on when we want to retire, and then also ensure we set funds aside to reach that plan, and review at least once per year.
If you aren’t sure where to start, or how much to put aside, I encourage you to reach out and work with a financial coach, planner or advisor. That being said, it is better to start with something rather than nothing. To start, you can look to set aside 15% of after-tax income. It is not perfect, but looks to strike a balance between meeting your current demands, while also ensuring enough is set aside for later in life. If you are comfortable putting more to retirement than 15%, then do so. Time is your friend…start early and be consistent!
2) Not Utilizing Tax-Free Savings Accounts (TFSA), or non-locked in accounts as part of your strategy
When we hear retirement, most of us think immediately of Registered Retirement Savings Plans (RRSPs) or 401Ks if we are “south of the border” in USA. While RRSPs do have a vital role to play in retirement, not using TFSAs in the strategy at all can be risky. To understand why it is “risky” to put all your money into RRSPs, we have to look at the benefits and mechanics of an RRSP. When deposits are made to an RRSP, taxable income is reduced, however, those funds are then locked into the RRSP until it is converted to an RRIF at our retirement. If funds need to be withdrawn, a 30% withholding tax would apply (as taxes would then be payable). So put simply, we save some money in taxes now, but have now locked in our funds until we are somewhere between 65 and 71 (perhaps a bit earlier if we are confident in our savings). If we need those funds for an early retirement, or perhaps a large purchase to facilitate retirement (ie) a property), we pay a large tax to access those funds. If we plan properly and utilize a tfsa (or perhaps one spouse’s tfsa), we could access those funds and give ourselves flexibility.
I would also add that even when an RRSP is converted to a RRIF, withdrawals are taxed as income then. Utilizing a TFSA (paying a bit more tax now), gives phenomenal (tax-free) growing power, and for me personally, seems to be the more prudent approach. Talk to your financial coach, planner or advisor to discuss your situation, but I strongly encourage you to avoid getting “blinders” on.
3) Too Much Reliance on Government Benefits
While there are a number of Government programs here in Canada (and other countries have similar programs), we should not rely solely on these programs as they are designed as “supports” for the general population, and not for our special unique situation or as full income replacement. Here are some key details on the programs
a) Canada Pension Plan (CPP) – based on having contributed to the CPP when working, you can receive approximately $8,600 per year
b) Old Age Security (OAS) – If you worked in Canada for 40 years, OAS can give you approximately $8,200 per year
So put simply – isolating government programs you are looking at less than $17,000 per year from government supports. I would add that these programs are NOT guaranteed and could be reduced or removed at any point (given the rapidly increasing debt levels, definitely something to watch!). You should not rely solely on government benefits – sure, they offer good value and support, but they are NOT sufficient for retirement. I coach clients to look at these as a bonus, but plan for retirement on our own terms, if we can fund our own retirement and these programs go away, we will be ok. If we rely solely on these, and they go away, we will be in a difficult position.
Note: If you want to look at your personal situation, and incorporate current savings, company pension plans, as well as government programs, I encourage you to look at the following tool from the Government of Canada website: https://srv111.services.gc.ca/generalinformation/index
4) Starting too late/ not using time as your ally
As I mentioned above, time is your best friend when saving and building funds. Here is an example of what can happen even with a modest 7% return:
a) Save $500/month ($6,000 per year) starting at 25, until age 65: $1.3M
b) Save $500/month starting at 45, until age 65: $260,000 (20% of Scen. a)
c) Save $1,000/month starting at 45, until age 65: $521,000 (40% of Scen. a)
Based on this simplified analysis, even at modest returns, we can see that putting $500/month aside for 40 years will deliver 2.5X the total return as contributing $1,000 per month for 20 years (the same total amount deposited of $240,000). Clearly, contributing earlier and consistently will deliver more in the long run than starting later, even if we play “catch-up”
With the above principle in mind, it is important to remember that debt needs to be cleared first (ie) consumer debt, not mortgage debt). In reality, debt is a guaranteed negative return (you are paying someone else), so you need to clear that first to truly unlock your future gains. If you are in debt, I urge you to create a plan to pay it off, then you can take those payments once the debt is gone, and put them to your retirement – no change in lifestyle or sacrifices vs what you are already doing! You can do it! Reach out if you don’t know where to start, it would be my privilege to speak with you (www.hopefinancialsolutions.ca/get-started).
5) Not investing the funds you have put into registered accounts (TFSAs and RRSPs)
This sounds basic, but it is very important.
Think of TFSAs and RRSPs as “containers”, based on the container you pick you get special tax treatment (both give tax-free growth, while RRSPs provide less taxes payable now, but taxes due on withdrawal). However, if you just put money in a container and let it sit as money (like a fancy piggy bank), it won’t grow. The key to the above numbers I shared is repeated gains, year after year. You should consult with a financial advisor to come up with an investment strategy that works best for you, but do not put funds in your RRSP and TFSA and just leave them there. You lose all the advantage and benefit of the accounts…and also won’t be keeping up with inflation, so you actually are losing purchasing power.
Is there some risk by investing…SURE. However it has been shown that over the long-term, compounding interest/returns (ie) time at consistent returns) are the most powerful tool. Since its inception, the average return on the TSX has been just under 12%!! So the 7% return used above is very much feasible, and provided you are in it for the long haul, much of the “downside” risk can be eliminated – speak with an advisor to learn more and develop a strategy that works for you.
Based on the above list of 5 Common Mistakes when retirement planning, I would summarize the steps you SHOULD take when looking at retirement as follows:
1) Get a plan together – talk to someone, make sure you know what kind of life you want and have a plan to get there
2) Start investing early, and often – an investment made over 40 years will be worth more than 2.5X the same dollar investment over 20 years
3) Speak with a financial advisor and invest the funds. Without investing, you lose all the benefits of the RRSP or TFSA (the tax free growth).
Be intentional.
Design the life you want to live, then execute!
YOU CAN DO IT!
