Saving for Retirement One Step at a Time
I occasionally hear, either in writing or in person, that saving for retirement is almost hopeless. The argument is that they are living paycheque to paycheque, and that there is simply no point in even trying. Consequently, and perhaps with a wry smile, they say that they will never be able to retire. That may be all well and good if your job is not terribly demanding either physically or mentally, and you can carry it on well into your 70s or even 80s. However, for most, there will come a time when you either will not or cannot work any longer. In that case, you will most likely want to retire with some savings in place.
Certainly, there are some for whom it is a real stretch to save anything at all. For those in that situation, it may not make that much sense to save, or if you do save, make sure you save in the right account. People at the lower end of the income spectrum in Canada, though, do have a safety net. If you have lived in Canada for at least 40 years after age 18, at age 65 you can begin receiving Old Age Security (OAS), which is currently set at a maximum of $614.14 per month. That applies to everyone in Canada, regardless of income, unlike the Canada Pension Plan (CPP) where contributions from employment income, including self-employment income, are the deciding factor.
If you are receiving OAS, you may also be eligible for the Guaranteed Income Supplement (GIS), which a single, widowed or divorced person can receive if their income is below $18,624. Note as well, that OAS income does not count as income for determining the amount of GIS. And by the way, as an incentive for even the low-income earner to save, money held within or withdrawn from a Tax-Free Savings Account (TFSA) does not count against GIS either.
What difference does saving make?
What difference could it make if we were to regularly save money over time?
According to Statistics Canada, the median after-tax income of Canadian families in 2018, the most recent year for which data has been published, is $61,400. Assuming that two adults (married spouses or common-law partners) are contributing to this income more or less equally, that works out to about $74,000 in before-tax income. With limited tax refunds available from this relatively low income, it likely makes more sense to contribute to a TFSA than to a Registered Retirement Savings Plan (RRSP).
In the table below, I lay out a few more assumptions for the purposes of this exercise.
The couple in question is 25 years old now. We will project out 40 years to age 65. As they each get paid bi-weekly, they will make 26 contributions per year, on their pay dates. The investment portfolio is made up of 50% fixed income and 50% equities that returns 4 percent before inflation each year. Inflation averages 2 percent annually, leading to a “real return” (the return after inflation is accounted for) of 1.96%. Finally, combined they contribute $100 every pay period.
How much will they have saved after 40 years? After inflation, the balance would be $157,153.
Now, let’s assume this couple uses their saved-up funds to supplement their income in retirement, and they live to age 95, or an additional 30 years. As CPP and OAS are paid out monthly, we will calculate a monthly payout from the TFSA, too.
These figures yield a tax-free “real” income of $576 ($288 each) per month for the next 30 years.
What sort of overall income might a couple receive in retirement? Let’s assume their earnings held steady over their working careers such that they receive CPP of about two-thirds of the maximum, which works out to about $740 per month each. They also qualify for the maximum OAS, which is currently about $614 per month per person. Without any pension plans from their employer, it turns out that they qualify for GIS. At their income level, that is worth about $142 per month each.
Please note that CPP and OAS figures have been reduced by an assumed average tax rate of 5%. Income from GIS and TFSA is tax-free.
If this couple’s after-tax income was $61,400 per year, and they then contributed $100 per pay period, or $2,600 per year, to their TFSAs, then their available income after tax is actually closer to $58,800. A monthly after-tax real income of $3,432 equates to an annual income of $41,184, which is about 70 percent of $58,800. Since many people in retirement live on 50 – 70% of their working income, this is a very reasonable outcome.
It may not be much, but if you are diligent about saving and investing even a modest amount of your income during your working years your retirement years can be quite affordable.
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.