By David Kitai, Harvest ETFs
Millennials — the generation born between 1981 and 1997 — are beginning to enter their 40s. With the passing of that milestone comes a new consideration: retirement.
Canadians are living longer and longer, retirement at or around age 65 may need to last 30+ years. Millennials in their 30s and early 40s are ideally placed to plan for their eventual retirement. In those typically peak working years, millennials can take major strides towards a stable financial future and the achievement of their retirement goals. Preparing for retirement, though, is more than just putting a magic number away in a bank account. There are myriad factors a millennial should consider as they begin to plan for retirement. Below are five of those factors.
1.) Understanding RRSPs and RRIFs
Registered Retirement Savings Plan (RRSP) accounts are a key tool Canadians can use to save for retirement. Their mechanism is simple: contributions to these accounts within the annual limit are tax-deductible. Income earned by investments held in the RRSP is also tax exempt, provided that income stays in the account. RRSPs give you an annual tax incentive to save for your retirement.
When RRSP holders turn 71, however, those RRSPs turn into Registered Retirement Income Funds (RRIFs). These accounts are subject to a government-mandated minimum withdrawal, on which some of the deferred tax from these contributions is paid. You can learn more about the problems with RRIF withdrawals, and how to navigate them here.
Millennials considering their retirement should look at how RRSPs can give them a tax benefit for saving now, while also planning for how the eventual transition to RRIFs will change their financial realities.
2.) How the Canada Pension Plan factors into retirement
Canadians between the ages of 60 and 70 who worked in Canada and contributed to the Canada Pension Plan (CPP) can elect to activate their CPP benefits. Those benefits will be paid as monthly income based on how much you earned and contributed during your working years, as well as the age you chose to begin receiving benefits.
The longer you wait before turning 70, the higher your CPP benefits will be, though that appreciation doesn’t go beyond age 70. Millennials planning for retirement at any age could consider how they’ll finance their lifestyles while maximizing their CPP benefits at age 70. It’s notable that even the highest levels of CPP benefits pay less than $2,000 per month in 2022. That won’t be enough for many Canadians to live on, and millennials considering retirement may want to think about other sources of income.
3.) Equity Income ETFs
One of the issues that retirees have struggled with over the past decade has been the extremely low yields of traditional fixed income products like bonds. In 2022 those rates rose somewhat, but only following record inflation eating away at the ‘real yields’ of an income investment.
Many equity income ETFs pay annualized yields higher than most fixed income and higher than the rate of inflation. These ETFs hold portfolios of equities — stocks — but pay distributions generated through a combination of dividends and other strategies. Harvest equity income ETFs use an active and flexible covered call option writing strategy to help generate their monthly cash distributions.
These ETFs still participate in some of the market growth opportunity a portfolio of stocks would, while also delivering consistent monthly cash flow for unitholders. The income they pay can help retirees finance their lifestyle goals and help millennials as they prepare themselves to retire.
4.) Tax efficiency of retirement income
Tax is a crucial consideration for any younger person thinking about retirement. Aside from the tax issues surrounding RRSPs and RRIFs, any income-paying investments held in non-registered accounts, or any income withdrawn from a registered account, will be subject to tax. Dividend payments and interest payments from fixed-income investments are taxed as income.
Other forms of cash flow, however, can be taxed as capital gains. The distributions paid by many equity income ETFs include premiums generated through a covered call option writing strategy. Those premiums are taxed as capital gains rather than income, and therefore only 50% of those premiums are taxable. You can read more about the tax efficiency of equity income here.
5.) DRIP investing can compound savings
While equity income ETFs have advantages for those who would draw on their income yields to cover their expenses, they have an additional benefit for investors with a different time horizon. Through the Harvest Distribution Reinvestment Program (DRIP) the distributions paid monthly to unitholders from an ETF could be reinvested in that same ETF. DRIP investments incur no additional trading charges once approved by your brokerage and allow your investments to compound year over year. For millennials who have a few decades until they hit retirement, DRIP can be a useful ‘set it and forget it’ tool that results in a significant holding of an equity income ETF by the time retirement comes.
6.) A fulsome picture is key to any preparation
As millennials consider the prospect of retirement, and explore the five factors listed above, they should remember that retirement is a reflection of their lifestyle. Every individual has unique needs, means, and goals. Right now, however, all millennials have a time advantage. The decisions they make about retirement now can go a long way towards helping them achieve and live the retirement of their dreams.
Commissions, management fees and expenses all may be associated with investing in HARVEST Exchange Traded Funds (managed by Harvest Portfolios Group Inc.) Please read the relevant prospectus before investing. The funds are not guaranteed, their values change frequently and past performance may not be repeated. All comments, opinions and views are of a general nature and should not be considered as advice and/or a recommendation to purchase or sell the mentioned securities or used to engage in personal investment strategies. Tax, investment and all other decisions should be made with guidance from a qualified professional.