Can you afford to retire?

It's RRSP season and I'm really busy so I thought I'd post on retirement planning since it is the topic that is so popular this time of year.

How much do you need to save in order to afford the lifestyle you want in retirement?
What rate of return do you need from your investments in order to make your retirement goal?
What is a comfortable retirement for you?

Here are a couple places to start if you don't know the answers to these questions:

http://finance.sympatico.msn.ca/SavingsDebt/savings_calculator.aspx
http://www.fiscalagents.com/Yahoo/calcs/retplan.shtml

Canadians not saving enough to retire:

Report By Ottawa Business Journal Staff
Thu, Jun 14, 2007 12:00 PM EST

Younger baby boomers are not saving enough money to cover even their basic household expenses in retirement, according to a study released Thursday.

A study by the University of Waterloo's Department of Statistics and Actuarial Science found that only one in three Canadians expecting to retire around 2030 are saving enough to meet basic household expenses in retirement. They are left with the option of retiring in poverty or working past the age of 65 unless they significantly increase their retirement savings.

The study, titled "Planning For Retirement: Are Canadians Saving Enough?", was carried out in April and focused on baby boomers born in the early to mid-1960s. two different income levels were examined: households earning the Average Industrial Wage ($40,000 in 2005) and those earning twice that amount. The study was sponsored by the Canadian Institute of Actuaries. "The message for most Canadians in their early to mid-40s is they will need to save more if they expect to enjoy an independent retirement," said institute president Normand Gendron.

"Governments need to provide Canadians with more education about the role that different savings vehicles can play in generating retirement income, and provide tools and incentives that encourage more households to save."

The study found that diversity is the key to saving enough. The one-third of households that is saving enough is doing so through a combination of home equity, company-sponsored pension plans, registered retirement savings plans and personal savings, the study found. These sources of income would supplement the modest monthly cheques from Old Age Security and the Canada/Quebec pension plans. Households that depend on only one type of savings vehicle for retirement consistently fall short of what they will need.

The study found that home equity is an important element for many Canadians, so much so that it suggests the government should make interest paid on a residential mortgage tax deductible. "We found that home equity can make a significant contribution to narrowing the gap, provided your home is paid for when you retire," said Steve Bonnar, one of three actuaries who directed the University of Waterloo project team. "Yet while home equity is important, on its own it is not enough to close the gap."

The study suggests many Canadians fail to appreciate how much money they will need to retire comfortably, since its results contradict a poll the institute also commissioned in April. The poll, conducted by Pollara Inc., found that "55 per cent of Canadians aged 40 or older feel some level of confidence that they will have the financial resources to retire comfortably."

Mohican's blunt evaluation is that it is very true that the average Canadian DOES NOT save enough to even meet basic expenses in retirement and I don't know where they expect the money to come from - the magic money fountain in the sky I guess.

As far as making mortgage interest tax deductible, that idea is bunk! bunk! bunk! If the government wants to encourage saving for retirement they should make it more lucrative for companies to have pension plans, encourage group retirement savings plans, and give bigger deductions for RRSP contributions. Encouraging people to buy a bigger house through mortgage interest deductability is not a good way to encourage savings.

Investing - Registered Retirement Savings Plans

Its that time of year, during the month of February, when we hear non-stop commercials from the major financial institutions about RRSP this and RRSP that. Get a loan. Invest now. It goes on and on. I wanted to briefly comment on this fervour in an informing way that I hope will dispel some myths and encourage some sound behaviours.

What is an RRSP?

Quite simply, an RRSP is an account that is registered with the Canada Revenue Agency as a retirement savings account. This registration allows investments held within the account to grow without the yearly impingement of taxation on the investment earnings. This registration also causes the CRA to allow RRSP contributors to deduct the contribution from their income and deferring that taxation until the contributor withdraws the funds. There isn't really much more to it than that.

It works like this:
January 7th, 2007, Joe puts $1000 into an RRSP account and buys a 4% GIC. During 2007 he earns $40 of interest income which he is not taxed on because it is within a RRSP account - this protection continues until he withdraws the money from the account. He also receives a slip as a confirmation of his contribution and he is allowed to deduct that from his 2006 income resulting in a $200 to $400 tax refund, depending on his marginal tax rate. Don't worry about the CRA though, Joe will pay those taxes back plus more when he withdraws his money, hopefully in retirement!

If Joe invested that same amount of money in a non-registered account he would pay $8 - $20 of taxes on his $40 of interest income every single year, depending on his marginal tax rate. Of course that taxation reduces his overall rate of return.

Why is an RRSP account good or bad?

Canadians, given the right circumstances, should use RRSP accounts for the obvious benefit of allowing the investment earnings to be untaxed until withdrawal. From what I see, this is not why most Canadians have an RRSP account. Most have simply just followed the advice of their financial institution not really giving much thought to actual retirement or investment planning. This isn't necessarily a bad thing since it encourages people to set aside money for the future, something that is quite important, but it is generally done with the care and planning it should be done with.

What I see on a day to day basis is the obsession with the yearly tax deduction and a general lack of care and a misunderstanding about the actual investment choices within the RRSP account. The majority of people display their misunderstanding by referring to an RRSP as an investment - it is not an investment - it is only a type of account which can hold investments. The annual obsession is also harmful in another way, which is, not encouraging a regular dollar-cost-averaging plan which would involve regular monthly or weekly contributions. This method is far more disciplined and results in more savings and better investment growth over the long term. It also helps people avoid things like RRSP loans and the mad scramble for cash at a tough time of year.

All of that said, many Canadians do make good choices about using RRSP accounts for the obvious benefits and do understand the positives and negatives associated with these accounts.

What are some of the social behaviours you have witnessed regarding the RRSP season?