So far this week we have looked at your yearly spending in retirement (Part I), government programs (Part II) and company pension plans (Part III). Today we are going to look at RRSP’s, taxable investment accounts and Tax Free Saving Accounts (TFSA).
All of accounts are very similar in the fact they can be just about any investment product. The only real difference is how they are taxed. In a RRSP you get a tax refund on the income tax you originally paid for that money and then that money can grow tax free until you withdraw it (presumably in your retirement).
Despite the almost universal advice that investing in a RRSP is a good thing by most mutual fund companies and banks it actually doesn’t help some people. An RRSP is used to delay the tax not avoid it. So if your in the lowest income bracket already and you expect to be the same in retirement it really doesn’t give you much of a break (a TFSA might actually be a better choice). Yet as you climb tax brackets an RRSP becomes increasingly useful since you hope to avoid the high tax rate now and take it out at a lower tax rate in retirement.
Case in point my wife doesn’t have her own RRSP. Instead we buy her a Spousal RRSP which gives me a tax credit and puts the money in her name. The idea of the this is to split the RRSP’s I would normally buy between two people so when we pull them out in early retirement we can reduce our total tax paid on the money. So for example instead of withdrawing $20,000 a year in my name, we can split the money up and only pay tax on $10,000 each.
But can’t we split pensions now? Yes you can split pensions, but the government never said you could split an RRSP. In fact the only way an RRSP fall under those rules if if you covert it to a RIF and your older than 65. So keep buying those Spousal RRSP for early retirement.
In my case we have around $18,100 in my RRSP (I’m transferring in my old pension from prior to my employer being bought out) and $7900 in my wife’s Spousal RRSP. Using that same calculator from yesterday’s post, I input the following:
My RRSP is at $18,100
Adding $100/month personal plus $225/month from work group RRSP
At 5.5% interest (to keep it in today’s dollars just like yesterday)
For 15 years, I end up with $131,816
Spousal RRSP is at $7900
Adding $100/month personal plus $168.50/month from my work group RRSP
At 5.5% interest
For 15 years, I end up with $92,836So in total we will have $224,652 to help fund our retirement. Note I haven’t put in my tax refund here. I’m going to leave it out for now and see how I do in these calculations.
2) Taxable Investment Accounts
As I mentioned before a taxable account is similar to an RRSP with the choices you have to pick from. The major difference is how you are tax on your gains. You need to understand the differences between interest, dividends and capital gains. For details I suggest reading this. The overall summary is capital gains and dividends are better than interest in a taxable account.
Currently we are investing on average $658.50/month into our taxable accounts. Rather than giving me a headache and try to break out each account separately I’m going to treat them as one single account here.
Starting at $13,029
At 5.5% interest
For 15 years, I end up with $213,228.
Now out of this amount I’m going to assume I’ve got $50,000 of it producing dividends of $2000 per year when I’m 45. So that leaves $163,228 for general retirement use.
I’m not how I’m going to work the new TFSA account into my retirement plans. I’m considering for now just letting the contribution room build up until we downsize our current house later in life. That would then allow me a float fund which I could use to cover use in case I’ve made any mistakes during these calculations. Or additionally I might use some of the room to store excess saving so I have the option of either using now or possible extra fun money in retirement. Of course yet one more option is to build up a large cash fund in the account to provide some buffer to my main savings in case we enter a down market as I retire. For now I’m not planning on doing much but move over the high interest savings account to avoid the tax on the interest.
Alright in total from the above accounts I have $387, 880 to pay for most of my early retirement, plus $2000/year in dividends (which I’m going to assume keep pace with inflation). Tomorrow I’ll try to string this all together to show how I plan to retire at 45 with no where near a million dollars.