Well after thinking about it for a few days I think I have worked out my plan to not invest an additional funds in my wife’s RRSP other than my current $100/month.
It comes down to taxes.
Situation #1 – In the RRSP (Spousal)
Let’s say I put in $1000/year additional to my wife’s RRSP. That would generate a $350 refund on my taxes which I would roll over to the RRSP. So I keep doing that I would average $112/month at 5% for 15 years I would get about $32,050. I would get tax free growth until I hit 45 but then we would start paying tax on all the gains and the original investment to the tune of about 26%, or about $8333 of that. So her nest egg after tax would be $23,717.
Situation #2 – Outside the RRSP in my spouses investment account.
In this case the wife invests $1000 in a Canadian Blue Chip stock. Dividends would be taxed at a -5% rate, so better than tax free growth and then once she sells she would only pay capital gains at a rate of about 13%. So we kept putting in $1000/year or $83/month and she got dividends to a tune of 1% for a 6% rate of return she would have $26,592 in 15 years. Now tax in this case is only on the capital gain, so drop off $15,000 for monthly investment to $11,592. Then drop the reinvest dividends for another $115 to $11,477 at a 13% tax rate, she would owe $1492. So the nest egg after tax would be $25,099.
So outside the RRSP beats inside by $1382 and I did not include any bonus for getting that -5% tax on the dividends outside the RRSP.
I should point out those numbers were made with a lot of assumptions (like all numbers are in current dollars, that the wife doesn’t sell the stock early and trigger a capital gain, and that any RRSP withdrawals would be fully taxed), but with numbers like these you have to make some assumptions otherwise you can’t come up with anything. I still feel that having an RRSP is a great idea for those investments which are tax equal to income like interest or holding non- Canadian stocks.
Early retirement is a wonderful dream, but in some cases that ends up being a nightmare. So let’s looks at some common pitfalls of planning for early retirement.
1) Underestimating expenses. It’s amazing how during your working left you get use to your lifestyle that you tend to forget about certain items like health benefits, replacing your car, your water heater, roof and the list goes on. When your planning for an additional 20 years of retirement you better make sure you check your expense list twice. One way to plan for this is to make sure when you go into retirement that everything is new or that you have planned for an extra replacement money. So for cars and houses a good minimum is $2000/year extra expense to cover those unusual expenses.
2) Not having any margin of safety on your calculations. It’s nice to hope that things turn out just the way you plan, but let’s face it, life doesn’t work that way. So you better leave some wiggle room when doing the math. In my case I drop my expected rate of return by an extra 1%. Some people like to boost their expenses by an additional 10%. Either way works out fine, but you do want to have some cushion there.
3) Not enough diversification in your investments. In order to avoid having your retirement savings go up in smoke you need to make sure you can suffer some serious damage to your savings. The solution is to avoid putting all your nest eggs in one basket. You most likely want a conservative mix once you get near retirement, but not too conservative that inflation takes you down in twenty years. So you most likely want a high interest savings account, bonds/CD’s, at least one REIT and a mix of other equities in Canada, US and the world.
4) Forgetting about taxes. Knowing your Canada or US tax law is required to build a good portfolio as much as diversification. For Canadians you need to know about the three types of investment income and how each is taxed.
5) Unrealistic expectations. You can’t travel the world and live in five star resorts and leave work at 30. Ok, perhaps one in 13 million can, but I know that isn’t me and most likely not you.
6) Emotional considerations. Some people do all the math and planning but forget one thing. What are you going to do with all that time? So they end up bored and go back to work. My question is what’s the point of saving if you don’t have a plan for your activities in retirement! Early on in your planning you want to start considering this. After all you don’t want to forget about enjoying your life now and you also want to ensure you will continue to enjoy your life in early retirement.
I recently had a comment left on another post wondering if I max out my RRSP’s every year. Up to now the answer has always been no. I was focused on debt reduction for a number of years and with what I was putting in to my RRSP’s and my pension adjustment I don’t have much extra room built up. But now I’m not sure if I should max the RRSP’s or have my wife invest in dividend paying stocks and hold them for the long term.
Option 1: I buy spousal RRSP’s and max out each year for the next 16 years or so. I would get back about $35 per $100 invested and then I would get tax free growth for a number of years. The problem would be I would get taxed at my new lower marginal rate when I pull them out in retirement.
Option 2: I have my wife buy quality dividend paying stocks and hold them for the next 15 years. She would have a negative tax rate on her dividends, so no tax on that growth. If I don’t sell for that long I would only trigger capital gains at the end, which would be a lower tax rate than my marginal rate at that time.
Has anyone seen a good calculator that is updated with the latest tax rates? I have yet to find one during the weekend and I’m still working out how to simulate the buying stock option well. Once I get some good results I will be sure to post them.