Everybody dreams of having a retirement where they can travel the world, spend time with their grandchildren or are free to enjoy their favorite hobbies or take up new ones. But of course all this means that they have the financial flexibility to afford to live out those dreams. Although most people plan what they will do in their retirement, do we really stop to put in place a financial plan to make sure we can have our ideal retirement?
In order to financially plan for retirement, it is important to understand where your income will come from. Generally speaking, retirement income will come from one of, or a combination of, government funded plans, private registered investments and workplace sponsored retirement savings plans. Let’s take a look at how each of these sources function;
Government Funded Plans
The Canada Pension Plan (CPP) is a monthly benefit in which the amount is dependent on your earnings and contributions throughout your working years. It is taxable income and is capped at a maximum of $1134.17 per month (2018), although the amount actually earned by Canadian retirees on average according to Statistics Canada in 2018 was just $666.56.
The second government plan which provides a benefit to retirees is the Old Age Security (OAS) which is a pension that is available to low-income earners who have lived in Canada for at least ten years after their 18th birthday or must have lived in Canada for at least twenty years after their 18th birthday if they are currently residing outside Canada. The maximum monthly benefit of $596.67 as of 2018
Although these benefits are a valuable assistance to pensioners, they should not be the sole source of your retirement income, as even if a pensioner was receiving both maximum CPP and maximum OAS, they would only be earning $20,770.08 annually. According to the Statistics Canada, the “poverty line” is $22,133 for a single person, or $38,335 for a family of three, which means if you were solely relying on the government pension plans for your retirement, you would be just below the poverty line, meaning it would be difficult to make ends meet. This makes it essential of us all to plan ahead through other sources of savings to achieve a greater income during our retirement years. So let’s now look at privately funded registered savings.
Private Registered Investments
The most common private investment vehicle associated with retirement is the Registered Retirement Savings Plan (RRSP). An RRSP allows Canadian residents to privately contribute funds towards retirement by putting aside money to save for retirement, while also reducing your taxable income in the years you make contributions. There is an annual maximum of $26,500 in 2019 or 18% of your earned income in the previous year. This contribution reduced your taxable income during the contribution year. Once you are ready for retirement, (no later than the year you turn 71) you can choose one of the following options for your RRSPs: 1) withdraw the full amount; 2) transfer into a Registered Retirement Income Fund (RRIF) or 3) use them to buy an annuity. Either way, the withdrawals are taxable at your tax rate at the time of withdrawal, which is usually lower than your income earning years when you made the contribution.
Another investment option for retirement income is the Tax-Free Savings Account (TFSA). Although not generally thought of as a retirement saving plan, the TFSA can have a large impact on your retirement income if used. The TFSA accumulates your savings tax-free and you don’t have to pay any taxes on your investment income when you make a withdrawal. So an investment made in your 30’s or 40’s can grow until retirement tax free.
Workplace Sponsored Retirement Savings Plans
Workplace plans are common for employees in the Canadian workforce. These plans will usually fall into one of two categories: Defined benefit plans and defined contribution plans. The value of a defined benefit plan is often a defined value based on a combination of factors such as age, years of service and/or average income. In this type of plan, the employee can usually plan ahead with some certainty, how much they will receive as a retirement income. For example, a plan might say, the retiree’s pension is 50 percent of their average income over the last five years of service if the employee has 30 years of service and if the employee is at least 60 years old. In this example, an employee that is 60 years old and has worked 30 years or more and earned an average of $100,000 over the last five years of service, would be eligible for a $50,000 per year pension. This $50,000 is the “defined benefit”.
These plans are very expensive for companies to administer because regardless of how much the contributions have grown; the employee is entitled to this defined pension amount. Therefore, many plans today are actually Defined contribution plans, where the amount is determined by the value of the assets in the plan when you retire. In this type of plan, the contribution is defined rather than the benefit, meaning how much the employer and the employee is contributing to the pension plan is defined, but the amount of income at retirement is unknown. The income amount instead is based on the value of the plan at retirement. Once the employee reaches retirement, they must ensure the value in the plan is invested wisely in order to last throughout their retirement years while providing an adequate annual income. The employer is not responsible to provide a minimum defined annual income to the pensioner.
As we have seen, there are a variety of sources that may contribute to income during our retirement years, yet not all Canadians are aware of these options or have not been taking full advantage of them. According to Statistics Canada, only 22.5% of Canadians contributed to their RRSPs in 2016 with a median contribution of only $3,000. Planning for retirement can be one of the most important, yet most confusing financial activities we can do, so having the proper professional advice along the way can help to ensure we have the best laid plans to reach our retirement goals.
For more tips in setting up your plan, speak to your financial services advisor.
 Statistics Canada, 2018