Planning for retirement can happen at any age. While some people may push off saving for their retirement until they have a steady income, others will start contributing to their retirement as soon as they start earning an income. Investing early and consistently is the best path to being financially stable in your retirement years, but not everyone has that luxury. Regardless of when you can start saving, it’s essential to know what accounts you have access to and what you need to plan for.
Understanding asset allocation
Before you start investing, you need to understand asset allocation. That’s the mix of fixed income and equities in your portfolio - or, in simple terms, the mix of safe and risky investments you have. This is essential since your asset allocation will determine how your portfolio performs.
Safer investments, such as guaranteed investment certificates and bonds, are less risky but provide limited yield. Stocks, mutual funds, and exchange-traded funds offer potentially higher returns, but they could also decrease in value.
Generally speaking, the closer you get to retirement, the more fixed income products you want in your portfolio. That’s because you’ll need to soon draw down on your savings to fund your retirement, so you’ll want your money to be relatively safe. On the flip side, it wouldn’t be unusual for someone in their 20s to have most of their portfolio invested in equities. That’s because they have decades to ride out any ups and downs in the market.
The accounts available to you
As an investor, you have multiple accounts available to you. Each one has its own pros and cons, so you need to know how each of them works. To be clear, the following are just accounts. You would still need to purchase investment products within them when saving for your retirement.
Registered Retirement Savings Plan
As long as you’ve worked in Canada and have filed a tax return, you’re eligible for a Registered Retirement Savings Plan (RRSP). With RRSPs, your taxable income is reduced by an equal amount for every dollar you contribute. For example, let’s say you have a salary of $60,000 and you contributed $6,000 to your RRSP. Your taxable income for the year would be $54,000.
What’s nice about RRSPs is that you get contribution room based on 18% of your previous year's income. If you don’t use it, it carries forward. All of the capital gains you make within your RRSP are tax-free. That said, when you eventually convert your RRSP to a Registered Retirement Income Fund (RRIF), withdrawals will be taxed as income. The assumption is that when you’re retired, you’ll be in a lower tax bracket and pay less taxes.
RRSPs are also appealing since contributions often result in a tax refund. However, RRSPs are more beneficial to people in a higher tax bracket. Generally, if you make less than $50,000 a year, you’re better off focusing on your Tax-Free Savings Account.
Tax-Free Savings Account
A Tax-Free Savings Account (TFSA) is another account available to you that can be used for retirement savings. Although TFSA contributions don’t give you a tax break, all capital gains are completely tax-free, even when you withdraw the money. As you can imagine, this account can be highly appealing for the tax benefits.
Unlike RRSPs, you don’t get TFSA contribution room based on your income. Instead, every eligible person is given the same amount of space each year. Any unused room carriers forward. In addition, when you take money out, you get that contribution room back the next year.
Non-registered accounts
Since RRSPs and TFSAs have a defined limit, you could potentially max them out in any given year. If you still have some extra funds, you could invest them in a non-registered account. With non-registered accounts, there are no tax benefits. That means any interest or capital gains earned will be taxed at your marginal tax rate. Even though your gains will be taxed, it’s often still worth it to invest your money in a non-registered account as it has the potential to grow.
Which account is right for you
You don’t necessarily need to choose an RRSP over a TFSA. Most people will have both. That said, it really depends on your stage of life. Students and young adults who have limited income will likely gravitate toward TFSAs since it’s an easy place to park their money for short-term savings goals.
For those who have already established their careers and started a family, an RRSP might make more sense as they start to think about the future. In an ideal world, you’ll use both accounts, but that’s not always possible. Overall, as long as you save early and regularly, you’ll hopefully have a good amount in your nest egg once you retire.
Barry Choi is a Toronto-based personal finance and travel expert who frequently makes media appearances. His blog
Money We Have is one of Canada’s most trusted sources when it comes to money and travel. As a completely self-taught, do-it-yourself investor with no formal training, he makes money easy to understand for all Canadians. His specialties include personal finance, budget travel, millennial money, credit cards, and trending destinations.