How to boost your RRSP savings rate — and why!
We’re down to the wire. The RRSP deadline is days away, March 3rd, to be exact. Perhaps you pay it no mind because you have an automatic contribution plan set up. Why concern yourself? Wrongo!
The fact is most Canadians are not doing right by their RRSPs.
First of all, we don’t save enough, period. Not that long ago, 20 per cent of after-tax income was a typical savings pattern for Canadians. A decade ago it dropped perilously close to zero. Since the Great Recession the rate has crept up a bit to around five per cent today.
According to TD Economics’ 2013 report, Canadians are now saving more as a percentage of income after taxes and non-discretionary expenses (rent, mortgage, utilities, etc.) than we have in 16 years. And TD forecasts that we will reach a savings rate of six per cent in 2014. Good for us.
Still, we do need to do better if for no other reason than the parameters of retirement are changing rapidly.
While the majority of working Canadians still have some form of workplace pension, the percentage is shrinking. Also, the quality of those pensions is increasingly dependent on the vagaries of the stock market, interest rates and the skill of money managers. Guaranteed pensions, i.e. defined benefit pension plans, are likely to be a thing of the past within a generation, except for a small fortunate group.
Private pensions came into being in Canada in 1840 when the Hudson’s Bay Company established an employee plan. In the U.S., the American Express Company was the first to introduce them in 1875. However, it wasn’t until the mid-20th century that workplace pensions became commonplace. Before then, most people relied on personal savings when they retired.
When the Canada Pension Plan was instituted in 1965, a “typical” Canadian family with a working father, stay-at-home mother and two or three kids could look forward to a reasonably funded retirement. Except, of course, women were often left high and dry if their husbands died young because pensions usually died with them.
Now it is fast forward into the past in terms of retirement income. Once more we must increasingly rely on personal savings for retirement.
Personal net worth climbed steadily after 1990 but fell dramatically during the financial crisis. Despite record indebtedness, Canadian individual net worth is almost back to 2007 levels, which is good news for those with homes but little savings. However, depending on the value of assets (such as real estate) to fund retirement is foolish.
Don’t forget: There have been nine real estate declines of at least five per cent since 1981 in Canada. Assuming one’s real estate assets will rise consistently offers a false sense of security.
RRSP season should trigger not only a rush to make contributions, but also an assessment of the state of your savings and a look at future needs. Unless you have a kick ass budget, it can be difficult to figure out the ratio of savings to disposable income. Instead, use gross income and aim to squirrel away 10 per cent. Ten per cent is a commonly used figure but sometimes it is set against after-tax income. I suggest you use gross income for your calculation.
The second step is to examine your whole savings picture, not just RRSPs. Include Registered Education Savings Plans (RESPs), Tax Free Savings Accounts (TFSAs), non-registered savings such as investment or savings accounts and any contribution (yours not your employer’s) to a workplace pension.
Do not include short-term savings. Any money that falls into this category is likely earmarked for spending, be it for a vacation, new car or home. Also, don’t count RRSP contributions that are intended for a house purchase under the Home Buyers' Plan (HBP) or for education under the Lifelong Learning Plan (LLP).
Speaking of which, if RRSP contributions are to be withdrawn for education or real estate, they should not be invested in the stock market either through exchange-traded funds (ETFs), mutual funds or direct stock purchases. Equity investments require a time frame of eight to 10 years. Money needed for the shorter term must be liquid and lower risk even if the return is, as is the case currently, historically pathetic.
The surest way to increase savings is gradually. Like crash diets, drastic changes in financial habits rarely stick. Let’s say your household long-term savings rate is currently only four per cent of gross income. Bump it to five this year, six the next and so on. It’s far better to create a pattern that you can adhere to than alter your life dramatically and fail.
RRSP season is almost over. Remember, it’s not only a time to put money aside. It’s also a time to think about saving generally and your future.