Tag Archives: Financial Independence

A million reasons young people should contribute $6,000 to their TFSAs the moment they turn 18

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My latest Financial Post column looks at how Millennials and other young people can create a million-dollar retirement fund if they start contributing $6,000 to a Tax-free Savings Account (TFSA) the moment they turn 18. You can find the full column online by clicking on the highlighted text: The Road to the million-dollar TFSA is getting shorter for Millennials. It’s also in the print edition of Wed., Feb. 26th, under the headline “The road to saving $1 m for millennials: TFSA likely the best way to start.” (page FP3).

I’ve always been enthusiastic about the TFSA since it was first possible to contribute money to them in January 2009. My wife and I, as well as our daughter till recently have contributed the maximum to them from the get-go, always early in January to maximize the power of tax-free compounding. All three accounts have done very well. (I won’t reveal the balances but they’re consistent with heavy equity exposure through most of the bull market we appear to have been in at least until this week.)

Suffice it to say that our daughter’s TFSA has done better than ours, despite her not having contributed in the last two years because she has been working out of the country. She insisted in owning most of the FANG stocks (including Apple) and even Tesla, which was underwater until very recently but began to make headway in recent months.

It’s purely by chance that having been born in 1991, our daughter became 18 just in time for her first TFSA contribution, which naturally we funded in the early years. We viewed this as maximizing our wealth and minimizing taxes for the family as a whole.

And that’s exactly the thrust of the FP article, which cites several experts who will be familiar to most readers of the Hub: Aaron Hector of Doherty & Bryant Financial Strategies, Matthew Ardrey of TriDelta Financial, Adrian Mastracci of Lycos Asset Management. Mastracci created the chart below that appeared in the FP story:

There was also valuable input from BMO Private Wealth’s Sylvain Brisebois, who created a spreadsheet to estimate the impact of missing contributions in early years. If you can’t start until 25, a six per cent return generates $1,049,000 by age 65, $600,000 less than the $1.63 million earned with the extra $42,000 you’d have saved and compounded starting at 18. Another scenario is contributing for seven years between 18 and 25, then using it to buy a home. Assuming no more contributions the next 10 years and resuming $6,000 contributions at 36, by age 65 you’d have $829,000. Brisebois also created a scenario where you only contribute $3,000 a year, which generates $815,000.

As we experienced in our family, a long time horizon favours Millennials, who can afford to take a little more risk in return for stronger returns. That in turn translates into either a bigger nest egg 40 to 45 years from now, or it means you can get to the magic $1 million mark 5 or even 10 years ahead of schedule. Of course, if you’re even younger than a Millennial (technically they must be age 24 in 2020 to qualify) so much the better, and all these principles apply equally to Generations X, Y or Z.

For that matter, as I have often written, TFSAs are equally attractive for those already in Retirement. Unlike RRSPs, you can keep contributing to your TFSA long into old age: I had a friend who proudly told me she was still contributing after she turned 100!

Mind you, after the Coronavirus fears of the past week, who can really say? Not so good for aging Baby Boomers and retirees but of course if you’re a Millennial any young person with multi-decade time horizons, it should be viewed as good news when stocks go on sale.

 

 

RRSPs are not a Scam: A Guide for the Anti-RRSP crowd

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The anti-RRSP crowd must come from one of two schools of thought:

1.) They believe their tax rate will be higher in the withdrawal phase than in the contribution phase, or;

2.) They forgot about the deduction they received when they made the contribution in the first place.

No other options prior to TFSA

RRSPs are misunderstood today for several reasons. For one thing, older investors had no other options prior to the TFSA, so they might have contributed to their RRSP in their lower-income earning years without realizing this wasn’t the optimal approach.

Related: The beginner’s guide to RRSPs

RRSPs are meant to work as a tax-deferral strategy, meaning you get a tax-deduction on your contributions today and your investments grow tax-free until it’s time to withdraw the funds in retirement, a time when hopefully you’ll be taxed at a lower rate. So contributing to your RRSP makes more sense during your high-income working years rather than when you’re just starting out in an entry-level position.

Taxing withdrawals

A second reason why RRSPs are misunderstood is because of the concept of taxing withdrawals. The TFSA is easy to understand. Contribute $6,000 today, let your investment grow tax-free, and withdraw the money tax-free whenever you so choose.

With RRSPs you have to consider what is going to benefit you most from a tax perspective. Are you in your highest income earning years today? Will you be in a lower tax bracket in retirement? The same? Higher?

The RRSP and TFSA work out to be the same if you’re in the same tax bracket when you withdraw from your RRSP as you were when you made the contributions. An important caveat is that you have to invest the tax refund for RRSPs to work out as designed.

Future federal tax rates

Another reason why investors might think RRSPs are a bum deal? They believe federal tax rates are higher today, or will be higher in the future when it’s time to withdraw from their RRSP.

Is this true? Not so far. I checked historical federal tax rates from 1998-2000 and compared them to the tax rates for 2018 and 2019.

Federal tax rates 2018-2019 federal-tax-rate-1998-2000

The charts show that tax rates have actually decreased significantly for the middle class over the last two decades.

Someone who made $40,000 in 1998 would have paid $6,639 in federal taxes, or 16.6 per cent. After adjusting the income for inflation, someone who earned $59,759 in 2019 would pay $7,820 in federal taxes, or just 13.1 per cent.

Minimum RRIF withdrawals

It became clear over the last decade that the minimum RRIF withdrawal rules needed an overhaul. No one liked being forced to withdraw a certain percentage of their nest egg every year, especially when that percentage didn’t jive with today’s lower return environment and longer lifespans. Continue Reading…

Think you’re the only one without a retirement plan? Don’t press the panic button

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By Jordan Damiani, CFP, TEP, RRC 

Special to the Financial Independence Hub

Like many Canadians with retirement on the short-to-midterm horizon, you may have spent more than one sleepness night worrying that you’re not prepared.

In fact, at least half of Canadians over the age of 50 think they’re not on track with their retirement planning and about the same number of non-retirees don’t have a financial plan.

Experience suggests that people may be afraid that they won’t have enough money to retire, but in reality, they may not even know the true answer. I take the view that not having a formal plan in place doesn’t necessarily equate to not being on track to retire. There are many steps you can take in the critical count-down years to retirement that will reframe your planning and investment approach and alleviate anxiety and stress.

Take inventory of present Financial Situation

I recommend assessing your last six months of credit, debit and cash spending: grouping your expenses into categories. To project for the future it’s important to understand where your money is being spent today. This activity will help to identify where better savings could be achieved. Completing a net-worth statement is also important to determine what you own vs what you owe.

Understanding your pension entitlements is also a key stress reliever. Pension plans will typically offer retirement projections. At 65, CPP has a maximum benefit of $1175.83 monthly and $613.53 for Old Age Security. It’s important to call Service Canada to get an accurate CPP projection to find out what you are eligible to receive. Similarly, OAS is tied to Canadian residency, with 40 years being a requirement for the maximum eligible payout.

Goal Setting and Strategic Planning

After taking inventory, the next step would be determining what income you actually need in order to retire. Completing a pre-and post-retirement budget is an exercise that will help determine the after-tax figure to target. Likely the targeted income would be tiered with a higher spend being projected for the first 10-15 years of retirement ($5000-$10,000 a year for travel) and lower lifestyle costs thereafter, with some planning as a buffer against long-term care costs. Continue Reading…

They have $1.2 million in their 50s and no pensions: can they retire?

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A million dollars isn’t what it used to be, especially C$ and with no employer pension

By Mark Seed, MyOwnAdvisor

Special to the Financial Independence Hub

 

They say a million bucks or so ain’t what it used to be … but I still think that’s a pile of money.

Which begs the question: does this couple with C$1.2 million in invested assets have enough to retire on?

Before we get into this latest case study however (thanks to a reader question by the way, I’ve changed the names of the readers for privacy reasons), this is a great time to remind you I’ve done other case studies like this on my site before: there are a few on this Retirement page in particular.

Mike and Julie want to spend $50,000 per year. Did they save enough?

This couple believes they could fulfill their early retirement dreams at age 52. What does the financial math say?

This single senior hopes he can retire at age 60 on a lower income. Is it possible?

What is enough for some is not enough for others

Passionate readers of this site will know I believe personal finance is personal. What works well for some investors or families will not work at all for others.

You need to carve your own financial path.

The 4% rule says you should be able to ‘safely’ withdraw 4% of your original portfolio each year, adjusted for inflation, for at least 30 years and have a reasonably high chance of having money left over.

This means, in more practical terms based on this rule, that a $1.2 M portfolio should be able to last ~ 30 years (or more) by withdrawing $48,000 in year 1 of retirement ($1.2 M x 0.04), then increasing that amount over time with inflation.

That said, while having a core spending plan is all fine and good, it’s also having flexibility designed into your plan that is essential for success. You need to consider your spend on travel, hobbies, home renovations but also the ability to cover emergencies and more during retirement.

Rates of return also matter

The potential sequence of many bad years in the stock market could crush a retirement plan if you’re not careful. Also, while less risky portfolios (i.e., more fixed income portfolios) might fluctuate less in the short term, over the long term this will have a big impact on your returns. This means a more conservative portfolio can actually increase the risk of running out of money …

Karla and Toby case study

To help us figure out if this couple, who has a seemingly healthy $1.2 M in the bank, have “enough money” I’ve once again enlisted the help of Owen Winkelmolen, an advice-only financial planner (FPSC Level 1) and founder of PlanEasy.ca.

Owen let’s get into it!

Sure Mark!

Case study overview

First off, I want to say Karla and Toby are in a very good financial position for retirement with over $1M in financial assets in their 50s. That is excellent.

That said, they face some risk in the future. Let’s look at the information and numbers they sent you:

  • Karla, was and remains stay at home mom, Age 54. 
  • Toby, marketing manager, makes $110,000 per year now. Age 56. Toby wants to retire early next year in January when he turns 57. You told me they would love to start their winter renting from a Florida condo: sounds great!
  • They have lived in Canada their entire life. (re: they expect CPP and OAS benefits to come).
  • They live in Calgary, Alberta and own their home. 
  • They have no debt other than $19,000 Line of Credit (LOC) balance used for a recent vacation and monies borrowed to fund their adult daughter’s wedding earlier this year.
  • Karla has no workplace pension whatsoever although Toby has a small LIRA from a former employer to draw down.

 Portfolio assets:

  • They have $700,000 in combined assets within their RRSPs; invested in a mix of costly mutual funds.
  • Toby has $50,000 in his Locked-In Retirement Account (LIRA). Invested in similar mutual funds above.
  • They have $150,000 (combined) invested within their TFSAs. They hold a mix of Canadian REITs and a few Canadian bank stocks. 
  • They’ve got about $50,000 cash in an interest savings account.
  • Toby has $250,000 invested in a taxable/non-registered account that includes a mix of cash, U.S. stocks and some Canadian dividend paying stocks.

All told, they have about $1.2 million in investable assets and their home value is estimated at $550,000.  They are considering selling their home as they get older and renting, including renting property in Florida each winter. 

You also told me they have one car, now paid for, a 2014 Range Rover SUV and no plans to get a new one until at least five years from now. 

Mark those are great details to start some analysis with …

Owen’s analysis

Based on what details you shared with me Mark, because a large portion of their desired retirement spending will come from their investment portfolio, this creates a high risk of running out of money if they were to experience a period of poor investment returns in the future.  We’ll get into that in a bit. Continue Reading…

Put that $6,000 of TFSA contribution for 2020 to work as soon as possible

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The federal government kept the annual TFSA contribution limit at $6,000 for 2020 – the same annual TFSA limit that we had in 2019. It’s good news for Canadian savers and investors, who as of January 1, 2020, have a cumulative lifetime TFSA contribution limit of $69,500.

The Tax Free Savings Account (TFSA) was introduced in 2009 by the federal conservative government. The TFSA limit started at $5,000 that year: an amount that “will be indexed to inflation and rounded to the nearest $500.”

TFSA Contribution Limit Since 2009

The table below shows the year-by-year historical TFSA contribution limits since 2009.

Year TFSA Contribution Limit
2020 $6,000
2019 $6,000
2018 $5,500
2017 $5,500
2016 $5,500
2015 $10,000
2014 $5,500
2013 $5,500
2012 $5,000
2011 $5,000
2010 $5,000
2009 $5,000
Total $69,500

Note that the maximum lifetime TFSA limit of $69,500 applies only to those who were 18 or older on January 1, 2009. If you were born after 1991 then your lifetime TFSA contribution limit begins the year you turned 18.

You can find your TFSA contribution room information online at CRA My Account, or by calling Tax Information Phone Service (TIPS) at 1-800-267-6999.

TFSA Overview

The Tax Free Savings Account is a flexible vehicle for Canadians to save for a variety of goals. You can contribute every year as long as you’re 18 or older and have a valid social insurance number.

That means young savers can use their TFSA contribution room to establish an emergency fund or save for a down payment on a home. Long-term investors can use their TFSA to invest in ETFs, stocks, or mutual funds and save for the future. Retirees can continue to save inside their TFSA for future consumption or withdraw from their TFSA tax-free without impacting their Old Age Security or GIS.

Unlike an RRSP, any amount contributed to your TFSA is not tax deductible and so it does not reduce your net income for tax purposes.

  • You can contribute room is capped at your TFSA limit. Excess contributions will be taxed at 1 per cent per month
  • Any withdrawals will be added back to your TFSA contribution room at the start of the next calendar year
  • You can replace the amount of your withdrawal in the same year only if you have available TFSA contribution room
  • Any income earned in the account, such as interest, dividends, or capital gains is tax-free upon withdrawal

How to Open a TFSA

Any Canadian 18 or older can open a TFSA. You are allowed to have more than one TFSA account open at any given time, but the total amount you contribute to all of your TFSA accounts cannot exceed your available TFSA contribution room.

To open a TFSA you can contact any bank, credit union, insurance company, trust company or robo-advisor and provide that issuer with your social insurance number and date of birth.

The most common type of TFSA offered is a deposit account such as a high interest savings account or a GIC.

You can also open a self-directed TFSA account where you can build and manage your own savings and investments.

Qualified TFSA Investments

That’s right: you’re not just limited to savings accounts and GICs. Generally, you can put the same investments in your TFSA as you can inside your RRSP. These types of allowable investments include:

  • Cash
  • GICs
  • Mutual funds
  • Stocks
  • Exchange-Traded Funds (ETFs)
  • Bonds

You can contribute foreign currency such as USD to your TFSA. Note that your issuer will convert the funds to Canadian dollars. The total amount of your contribution, in Canadian dollars, cannot exceed your TFSA contribution room.

If you receive dividend income from a foreign country inside your TFSA, the dividend income could be subject to foreign withholding tax.

Gains inside your TFSA

Some investors may be tempted to put risky assets inside their TFSA account to try and earn tax-free capital gains. There are two advantages to this strategy:

  1. Earn tax-free capital gains
  2. Potentially increase your available TFSA contribution room Continue Reading…