How Much Could You Have?
I received two questions this week on very different topics that dovetail quite nicely. The first was from a young investor who wanted to know what types of safe investments were available that could return a rate greater than the 3% or so available on a GIC to grow retirement assets at a decent pace. The second came from someone who said:
You said to a couple in one of your shows if they save 500$ a month they will have 700,000$ for their retirement. The couple was around 30. How is this possible? My banker told me it’s not. It doesn’t matter what you do.
Ah, yes. Another case of The Banker! Hmmm.
I’m going to answer question number 2 first.
You can most certainly have $700,000 in assets if you start investing in your retirement plan early enough, earn an average return of 7%, and (this is important) reinvest your tax benefit.
A $500/month RRSP contribution adds up to $6,000 a year, resulting in a refund of about $1,800 (at a marginal tax rate of 30%) which then increases your contribution to $7,800. Iin each subsequent year, your refund is slightly larger, pushing up your overall contribution.
I do use an average rate of return of 7% for these calculations, which you should be able to achieve over the long term, with a balanced investment portfolio.
How, when GIC rates are at a pathetic 3%, barely beating inflation? Well, a GIC would be considered a very conservative investment. Remember the investment pyramid? (If you didn’t read these articles, go find them in the retirement section.)
As you move up the investment pyramid, you’re taking more risk, but earning a higher rate of return.
Which brings me to the first question. If you want to earn more than you can get on a GIC, you must look beyond a GIC, and it’s safety, to do so. And even if you decide to stick with a GIC, you’ve got to be more selective about WHERE you buy your GIC. While The Banker may only be offering 3%, there are alternatives today offering as much as 4.7% for the same level of security.
However, the rate of return is only one aspect. The other is how long the money will have to grow. Start investing in your 20s or early 30s and even with a fairly low rate of return, you’ll have a very handsome amount when you’re ready to retire because your return will have had time to compound — earn a return on your return. And — like the idea of using your tax-refund to boost your RRSP contribution each year –this painless growth of your assets can mean BIG BUCKS over the very long term.
Ready to try something new? You need to learn about various alternative investment options - things like bonds, preferred shares, and balanced mutual funds.
I will tell you that using 7% as a rate of return over 35 years (some years will be higher, some lower, this would be the average), $500 invested a month, with tax refunds reinvested, would grow to:
- $107,000 in 10 years
- $204,000 in 15 years
- $338,000 in 20 years
- $528,000 in 25 years
- $793,000 in 30 years
So, yes, it can be done.
May 2nd, 2008 at 11:17 am
I’m in the business of dealing with investor complaints. I would like to add one comment to clarify Gail’s point about risk, where she said “As you move up the investment pyramid, you’re taking more risk, but earning a higher rate of return.” It is more accurate to say you’re taking more risk, with the POTENTIAL of earning higher rates of returns, but typically these returns are not guaranteed. As you take on more risk, the risk of loss also increases.
I see it all the time with investors (usually as they approach retirement without enough savings), they take on the higher-risk so that they can earn higher returns. When the returns aren’t realized they say they could never have afforded the losses and truly couldn’t tolerate the risk.
So remember, live and invest within your means. Pick investments of which you have a good understanding and know how much risk you can tolerate.
May 2nd, 2008 at 1:53 pm
Interesting how you said ah a banker’s answer in regards to the making of money off the RRSP. I too wonder how they could make that kind of money of they investment, but now that it’s been explained I get it!
One of my friends who is employed part time was told by her investment advisor that she could not invest in RRSPs Could it be that she misunderstood what he said? I’m of the understanding that if you are employed, you can contribute up to your max regardless of your emplyment status: f/t or p/t.
What’s the truth?
May 2nd, 2008 at 1:56 pm
Did anyone catch the segment on W-5 last weekend about the shady business of some investment advisors? Sounds like they know no more than most of us but make us believe we are ignorant.
May 2nd, 2008 at 2:53 pm
Yes, I watched the W-5 documentary on what some investment advisors are doing - it’s frightening! I think they know what they are doing - which is, making money for themselves at the expense of the client. Very scary. Thanks.
May 2nd, 2008 at 3:16 pm
I didn’t get to see that W-5 episode. I’ll have to see if it’s available on-line.
We need to remember, like everything in like, we need to be careful about whom we deal with. When it comes to money, trust your insticts and deal with companies that you know. Companies that have a history of good returns and have good reputations. It pays to do your homework.
May 2nd, 2008 at 5:03 pm
As a contractor, I don’t have the option of “re-investing my tax refund”.
Any suggestions for a contractor?
May 2nd, 2008 at 5:33 pm
Cynthia:
RRSP eligiblity has to do with simply having earned income that you report on a tax return. So it doesn’t matter if it’s P/T or F/T or self-employed.
May 2nd, 2008 at 5:37 pm
Cynthia: I’m of the understanding that if you are employed, you can contribute up to your max regardless of your emplyment status: f/t or p/t.
Well, sort of. My “pension adjustment” on my T4 is so high that my “limit” is in the hundreds of dollars, not the thousands. I literally can’t contribute $500 a month to my RRSP.
Ermm… or can I? Maybe I’m missing something. Can I put in more than my calculated limit without a problem, or am I forced to invest in unregistered stuff once I put that, oh, $700 into the RRSP for the year? I mean, I now have the money to spare and I feel like a fool not investing it.
May 2nd, 2008 at 5:43 pm
From someone who works for a bank:
You have to talk to the right banker. Those bankers who sit at your neighbourhood branch would NEVER be able to achieve 7% rate of return for you. I have a feeling that those bankers are traded more to offer you a line of credit, and less on doing financial planning for you.
I suggest that those who want to invest should ask your friends, family and neighbours them for recommendations on good financial planner/investment advisors. Don’t just walk to your bank where you have a chequing account and ask for one.
Cynthia, if your friend is making under some $8000 a year, I could imagine an advisor telling her not to invest in RRSP because she couldn’t get the tax benefit from contributing (although to me that might not be a good advice either). But you are right in saying that if one has an income, one should be able to contribute (And that’s one of the reasons we tell kids to file a tax return, right? So that they could save up some RRSP contribution room). Sounds like your friend should seek for a second opinion.
May 2nd, 2008 at 6:50 pm
It is true that if you have a pension that the amount you can contribute to an RRSP is much less due to the pension adjustment. As a teacher (not working full time) my contribution room is around 2K. If I were making the maximum salary I could see that I might only be able to contribute in the hundreds of dollars.
Do you have contribution room left from previous years? I know that while my current annual limit isn’t that high, I do have quite a bit of room from years when I contributed nothing. Obviously once it’s gone I could no longer contribute large amount to my RRSP.
May 2nd, 2008 at 7:00 pm
bigasssuperstar: You need to look into the tax concequences of RRSP over-contributions on the CRA website. My hunch is that you have a small window for over-contributions before penalties set in. Probably safer to be investing in non-registered options. Because of this, ensure that you organize your investments so that the ones subject to the most taxes (think interest, at your marginal tax rate) are in your RRSP and those subject to less tax (think dividends with their tax credit formula) are held outside the RRSP for maximum tax savings.
May 2nd, 2008 at 7:31 pm
bigasssuperstar:
You can over-contribute up to a total of $2,000 before penalites apply.
Best investments to hold outside an rsp are those that give rise to capital gains because only half the amount of the gain is taxed.
For those with not much rsp contribution room, look forward to the new tax free savings account.
May 2nd, 2008 at 9:15 pm
The $2000 over contribution is a lifetime limit.
May 3rd, 2008 at 10:16 pm
Thanks for the answers, gang. I’ve been wondering about this for a while, and you’ve cleared it right up.
May 4th, 2008 at 12:00 pm
But an RRSP .. that’s just deferring the tax you’ll end up paying at retirement right?
I dunno, I’m not sure I buy into the RRSP thing any more, I’d rather pay tax on it now when my income is quite low compared to what I’ll probably earn later, and just put it into investments at 7% interest earnings as liquid cash… no penalties if I withdraw early etc..
May 4th, 2008 at 6:44 pm
@ Fabulously Broke: yes, you are right. That’s just deferring the income earned to a later year, when, presumingly, you are retired thus you’ll be in a lower tax bracket.
I’ve also heard argument about not buying RRSP when one is in a lower tax bracket. I buy into that argument, too. However, I guess not many people are as sensible as you are, who still save while they don’t have an RRSP account.
Gail, any advice on this topic?
May 4th, 2008 at 8:27 pm
I am a whole-hearted believer in RRSPs, particularly for people under 50. Over 50, it depends. As for the tax implications, just because you make a contribution doesn’t mean you have to take the deduction in the same year. Go ahead and put your money in an RRSP so it can start growing on a tax-deferred basis. Hold the deduction for when you move up into a higher tax bracket. How’s that.
May 4th, 2008 at 9:18 pm
RRSP during retirement and taxes:
Yes, you are deffering, but it is more complex than that. A portion of the RRSP that you take out might not be taxed (base amount deduction), another portion might be at a lower tax bracket than the one you currently pay (lowest tax bracket) and if you saved enough, the rest goes in higher tax brackets. So ON AVERAGE you might end you paying less tax than you would without your RRSP because you originally pay less tax on your highest tax bracket.
The great thing about investments within RRSP is tax-free growth. This will be true from the new TFSA.
Delaying RRSP contributions until you are in a higher tax bracket:
It is very hard to catch up and to introduce something new to a budget. It will take me a few years to do that (strict budget and extra job) and I missed out on growth. It is possible that the growth would have been greater than the amount of tax difference from going up a ‘bracket’ (5-7% total difference between some tax brackets; so 5-7% of the contribution amount as a tax return).
[again, seek advice from a professional... and read Gail's post!!!]
May 5th, 2008 at 11:56 am
Ohh, Gail, that’s an interesting idea … and I may be confusing myself a little now. Are you suggesting that I can put *more* money in my RRSP — maybe even more than my “contribution limit” — and have it start growing now … and only claim it down the road?
Say, if I have a $700 “limit” this year, but I put in $2000 … can I put off claiming that $700 for this tax year, and put it on the following year’s taxes? IOW, not really tell revcan that I put anything in this year?
… or am I just totally spinning myself silly now?
May 5th, 2008 at 4:51 pm
Hey bigasssuperstar! What a handle! Since the over-contribution limit is $2K, you could do just as you say. However, my comment was more along the lines that you could put in the $700 but not claim the deduction until you had a higher marginal tax rate and would get a bigger bang for your buck. g