Your boy Nelly has long been a fan of RRSPs, even preferring them over TFSAs for a lot of people.
Basically, the logic goes like this. As long as you’re making a decent amount of money, you’ll trigger a nice immediate tax refund by investing in your RRSP. That refund can then be reinvested. If you’re in the 25% tax bracket, it’s basically like getting a 25% guaranteed return and then you get years of compounding on that return.
To really illustrate the power of this, allow me to consult my oldest and best friend, the compound interest calculator.
Reinvesting $2,500 of free money turns into an additional $16,000. All you have to do to make that money appear is to reinvest your tax refund, which you only got from contributing to your RRSP in the first place. It’s truly amazing.
If you do this for a decade you can really see how immediately reinvesting that tax refund starts to add up. All it takes is a 10-15 years of investing a decent amount when you’re young to ensure there’s enough for retirement.
But we often forget about what happens once you hit retirement age. That cash has to be taken out, which becomes a problem if you’ve got a mil or two sitting there. Not a big problem, mind you, but a problem nonetheless. Just how can you deplete your RRSPs without paying a boatload of tax?
I’ve been thinking about this lately. I first started contributing to my RRSP as a slightly chubby 15-year-old flush with cash from my first job. That contribution was approximately $500 and God does that make me feel old today.
Surprisingly, the 15-year-old ladies of 1998 were not impressed with my savings ability. It’s okay though; they’re all clearly lesbians.
Remember, there were no TFSAs back then. So I continued to contribute despite not having much of a tax liability. I consistently put money away over the years to the point where I’m now sitting on some pretty solid RRSP assets.
I’ve crunched the numbers and if I compound these assets at 8% for the next 30 years — which is when I’ll hit the traditional retirement age — I’ll have well over $1 million in just RRSPs alone. I should also have another $1 million from my TFSA, which I plan to max out annually for as long as I can.
I’ve also got stocks and other investments outside of these registered accounts.
So what’s a guy to do?
The problem with all this is I’m looking at big tax bills when I hit age 65. I guess I can delay it until age 71, when I’ll be forced to contribute 4% of the portfolio.
Say it’s worth $1 million even. I’ll have to withdraw $40,000 per year that first year and then even more going forward. If I have a portfolio spinning out lots of tax-efficient dividend income (which is the plan). I add the $40,000 per year — which is fully taxable — to say $50,000 in dividend income and I’m looking at a relatively high tax rate.
And that’s assuming I only get $50,000 in annual dividend income. Considering our savings rate today and having 30 years of growth ahead of us we could easily have $150,000 to $200,000 in household dividend income by the time I hit retirement age.
It was valuable to me to defer tax when I was younger. But the more I look at it the more I realize deferring tax is no longer the right answer for me. I will likely only contribute during heavier taxed years going forward, choosing instead to channel savings into my TFSA and taxable accounts.
Yes, you can oversave for retirement
Is oversave one word or two? Screw it, I’m going with one. Even if Google doesn’t agree with me.
Somebody who blindly invests the maximum into their RRSP for their entire 45 year working life is doing it wrong, IMO. They’re going to end up with a massive amount of money set aside that’ll all have to be withdrawn at a high tax rate.
The better strategy is to end up with a moderate amount in your RRSP and go nuts maxing out your TFSA.
But at the same time, this only really applies to the very small percentage of the population that has consistently maxed out their RRSPs as a young person. If you’re 40 and are sitting with $25,000 in your RRSPs ignore this whole post and put in as much money as you can afford. Your problem is saving enough for retirement, not avoiding tax caused by oversaving.
Essentially, I’m getting close to oversaving for my retirement. If I don’t settle down on the RRSPs I’ll have a big tax bill when I get older. I’m the first to admit this is the very epitome of first world problems, but it’s still something I’d like to avoid.
It’s taken me a little while to realize this, but hey. Apparently getting things in a reasonable amount of time is not my strong suit. Hell, it took me 18 years to figure out long division.
The key to happiness is to design the life you want to live from scratch. Some people like the routine of going to work each day, but most of us don’t. We want to be able to randomly take a Thursday and go to an interesting event two cities over without having to worry about the consequences at the office on Friday.
I’ve recently taken steps to do this myself. Gone are the days where I’m going into my grocery store job five days a week. I’m down to 1-2 days a week and couldn’t be happier. I get the interaction with the guys without falling into the trap of workplace politics. I feel more like a casual observer than someone who actually cares about what’s going on.
I should have done this a year and a half ago rather than quitting my writing job.
Speaking of my writing job, I’m back at it, baby. You can read my stuff here if you’re so inclined. I’m also available to write on your blog. Because, hey, who doesn’t need a bunch of dick jokes and incomplete sentences masquerading as actual serious points about finance.
Just think about it is what I’m saying.
Anyway, let’s get to the point of this article — you don’t need to wait for financial independence to make the life of your dreams.
Unhappy? Then change things, stupid!
Back when I had a more conventional job, I used to fall into the same trap whenever things weren’t going well. I’d vow to quit my lousy job and travel around North America, seeing a ball game at all 30 MLB parks. Only then would I be happy.
This was not healthy, of course. It was nothing more than escapism. I didn’t really want to travel long-term. I just wanted to be away from my crummy situation.
After doing this a few times I began to realize something. If I’m fantasizing about being away from a particular thing on a regular basis, then it’s probably a good idea to quit that activity. It doesn’t matter if that thing is a job, or a hobby, or some other form of commitment.
Of course, things aren’t always that simple. You can’t quit things willy-nilly. Most people can’t live without a job, and many have become accustomed to having a certain lifestyle. In other words, taking a pay cut is out of the question. Which means they’re stuck between the proverbial rock and a hard place. The only way they can quit their lousy job is to replace it with one that offers a similar level of pay. That wage comes with similar responsibilities and duties, which negates the whole point of quitting the lousy job in the first place.
So they turn to financial independence. That’ll solve all their problems.
Remember, you don’t need financial independence to be happy
Let me tell you guys about a buddy of mine who lives a pretty interesting life.
He discovered he doesn’t need much to make him happy. He lives in a small house in an extra quiet part of a small town. His leisure time is spent watching movies, reading books, and going online. He doesn’t own much stuff because there simply isn’t room in his small house for it. Besides, things don’t really make him happy anyway. Much of his disposable income is spent going on random road trips.
These decisions were a result of a long thought process about his life and what made him happy. About 15 years ago he was on the fast track to an upper management post at a certain Canadian retailer I used to own shares in. Once he hit middle management it didn’t take him long to conclude being in charge of people made him miserable.
He realized he would be much happier if he wasn’t in management, trying to motivate retail employees who want nothing more than to slack off all day. So he made a choice. He vowed to live a life so simple that it could be sustained on a entry-level salary. He then quit his stressful middle management job in favor of one that barely makes more than minimum wage. It’s been 15 years now and he doesn’t regret his choice for a second.
Don’t Wait. Act
The point is you don’t necessarily need financial independence to live the life of your dreams. You need to define what your ideal life is first before striving to become so rich you no longer need to work.
Say you want to become a full-time writer, or blogger, or whatever. Do you really need to hit a $1 million net worth to do that? Hardly. The world is filled with entrepreneurs who quit their jobs to start something new. Hell, some people might argue having no safety net will make someone more likely to succeed. Failure just isn’t an option.
For many people, financial independence ultimately becomes something they need before embarking on the life of their dreams. I’d argue waiting to design your best life is silly. Do it today, and do it with gusto. Don’t wait for your net worth to hit that magic number, just go for it.
But at the same time, I get it. The kind of person who waits until they hit a seven-figure net worth to make significant life changes is obviously a little risk adverse. Quitting their job and moving to a tiny house in the middle of nowhere is out of the question. So they wait until they hit their number and then make the change.
This is perfectly okay, of course. Just remember, you don’t need to wait that long. If it’s your dream to write or open a small store, take steps to do that today. Not tomorrow, not 10 years from now when you’re moderately wealthy. Do it today. Start designing your ideal life now.
Today we’re going to be talking about safe withdrawal rates. And you people said I’m not fun at parties.
Most people don’t spend much time on safe withdrawal rates. They go to work until they think they can retire. And then they hope like hell their nest egg lasts them long enough. This seems like a bad strategy, but most of the time it works. People are remarkable creatures sometimes.
Early retirees are obsessed with safe withdrawal rates. Some people might even mock them for this obsession, but I never would. After all, they were kind enough to not make fun of me that time I had a very visible booger in my nose for four years. Yeah, that happened. I prefer not to talk about it.
Many U.S.-based bloggers have done a ton of work on safe withdrawal rates, which I’ll sum up in about a sentence and a half. You can safely withdraw 4% of your portfolio each year and not run out of money, at least historically. If you’re looking for a bit more of a cushion, then only withdraw 3-3.5% of your assets each year.
So if you plan to spend $30,000 a year, then feel free to call it quits after amassing $1 million. If you’re feeling frisky, you could wrap it up after coming up with $750,000. Many of these folks do exactly that, successfully supplementing their income with part-time work or small online businesses.
These numbers have been proven to work for U.S. investors. But will they work for Canadians? Let’s find out
Safe withdrawal rates Canada
Oh, Canada. You crazy place. With all the poutine and socialized medicine and whatnot. Will you ever learn?
Are you talking to Canada like it’s your cat after it has been mischievous?
You bet your ass, Italics Man.
Personally, I both love and hate the Canadian stock market. On the one hand, we have a number of sectors that are pretty much guaranteed to provide great returns going forward, at least in my humble opinion. Our banks have been historically stellar investments. Our pipelines have also been fantastic places to park money. It’s also been pretty hard to lose investing in the telecoms.
The bad part of our stock market is the amount of oil and resource companies. These are mostly trash and can easily be avoided, freeing up your mental energy to analyze companies that don’t suck. Unfortunately, this means I’m not a fan of most Canadian market ETFs. I just won’t tolerate 20% of my portfolio in terrible sectors.
I’m convinced a portfolio stuffed with Canada’s best dividend payers will allow investors to spend the dividends without having to worry about the principal. Easy, peasy. But we’re not talking about that, so let’s take a closer look at investors who just buy the Canadian indexes and call it a day.
Sorry, you’re not hitting 4%
Unfortunately, there’s no Trinity Study for safe Canadian withdrawal rates. We’re going to get a little less scientific here.
A firm by the name of Resolve Asset Management specializes in putting investors into these types of portfolios. They caution against using one firm number for a safe withdrawal rate, since there are a number of factors that could matter. Say you retire when stocks are in a bubble. That would reduce equity returns going forward, which means your withdrawals would be limited.
Resolve Asset Management believes a safe withdrawal rate for Canadian investors is somewhere between 3.23% and 3.87%. Personally, I don’t think two decimal places is precise enough. Three or you’re not trying.
Wade Pfau, who writes over at Retirement Researcher, studied whether a 4% withdrawal rate would have worked around the world.
His findings were a little bleak. The 4% rule would have failed surprisingly often in many countries over the years, including Japan, Germany, and France. The good news is according to Pfau’s research, a safe withdrawal rate in Canada would be slightly higher than in the United States. The bad news is he’s not convinced a 4% safe withdrawal rate is safe.
Still, he found the safe withdrawal rate for a 50/50 stock/bond allocated portfolio in Canada would be 3.96%, slightly higher than the U.S., which has a 3.94% safe withdrawal rate. Japan’s safe withdrawal rate would be 0.2%. No, that’s not a typo. No wonder the Japanese are so weird.
Morningstar also tackled this problem back in 2017. They found that low fixed income returns would push down the likelihood of a 50/50 portfolio lasting much longer than 25 years being withdrawn at 4% annually. They figure investors who invest in 100% equities could survive even a 40 year withdrawal period, but introduce greater variance by going about it this way.
Let me summarize the various Canadian safe withdrawal rate studies out there.
Low interest rates have made the 4% withdrawal rule difficult, especially for those folks who want the added stability of bonds in their portfolios. Rates have crept up lately, which is good news. Five-year GICs now regularly pay out more than 3%.
If I was looking at retiring today — which would mean a 50 year retirement, give or take — I wouldn’t withdraw any more than 3% of my assets. I’d likely bump that down to 2.5%, just to be sure. Which means if I wanted to spend $35,000 a year, which is approximately what my wife and I spend annually, I’d want $1.4 million in the bank.
Maybe I’m overly cautious, but I wouldn’t feel comfortable basing my early retirement on the 4% rule. I’d have to have some sort of backup plan, like earning a little extra income or having a spouse who continues to work.
Apparently it’s RRSP week here on Financial Uproar (the blog you’d LOVE TO TOUCH. BUT YOU MUSTN’T). Check out my latest RRSP investments and how most retirees who aren’t saving 40% of their incomes won’t be screwed come their golden years. And then kindly eat a big bag of dicks.
Let’s talk a little bit today on how not to use your RRSP. Here are five RRSP mistakes the average person makes and how to correct them.
Contributing, but not investing
This is a big RRSP mistake that I’ve made in the past. I make my contribution and then the money sits there while I wait for some obscure value stock to get even cheaper.
There are a number of ways you can remedy this problem. The easiest way is to figure out an asset allocation and stick to it. Thus, when it comes time to contribute to your retirement savings, it’s only a matter of buying a couple of ETFs and calling it a day. Easy. Go golfing champ, you deserve it.
If you’re an active investor like me, there are a few other options. You could put the money to work in an ETF and then sell portions of the investment as you find better opportunities. This works especially well if you hide out in bonds, which don’t usually see big fluctuations in market value. Of course, doing this costs brokerage commissions, which can really eat into short-term returns. Especially when you’re dealing with small amounts of money.
There’s an argument to be made that GICs are reasonable fixed income products that can offer comparable yields to bonds without the risk of capital loss (although with bonds those risks are somewhat small). Additionally, it does make sense to hold any investment which is fully taxable in your RRSP to shield yourself from the taxes.
But I’m not talking about all that. I’m talking about the person who’s too scared of stocks to actually hit the buy button. Instead they hide out in GICs, content to earn 2% in exchange for not losing any of their precious capital. It’s going to be really hard to retire someday only earning 2%. Italics man, can I still call people pussies, or is that not politically correct?
Oh right. He’s dead.
Be mindful of tax brackets
The rule of thumb is simple. If you’re in the lowest tax bracket, you probably shouldn’t contribute to your RRSP. Put your cash in a TFSA instead.
When I was a young lad, when I wasn’t too busy masturbating, I contributed thousands of dollars into RRSPs. I did so while earning less than $10,000 a year working at my part-time job at Dairy Queen. In hindsight, I probably should have keep that contribution room for a few more years until I was in a higher tax bracket. Remember, you keep the room until you use it. There’s no real hurry.
Waiting until 65 to withdraw
If contributing to your RRSP should be a strategic exercise to minimize total taxes paid, then so should withdrawing. Remember, there’s no rule that says you have to wait until you’re 65 to start taking out the cash.
Thousands of Canadians are currently setting themselves up for a fantastic retirement. They max out their RRSPs every year and have accumulated hundreds of thousands of dollars there. That money will grow over time, perhaps even surpassing $1 million. That’s the holy grail for these people.
And then they hit 65 and start taking it out. They have so much invested that they’re pretty much forced to withdraw in big chunks, which comes with a large associated tax bill.
There’s a smarter way to go about it. Have a lean year at work? Take some money out of your RRSP. Sure, you’ll have to pay withholding tax at the time, but it gets treated as any other income. If you do this right, you’ll be putting money in that comes from a high tax bracket and withdrawing it to pay the tax on a low bracket. THAT’S WHAT I’M TALKING ABOUT, BITCHES.
Buying expensive mutual funds
Just don’t. Look, I’ve met that nice lady at the bank. She’s really a terrible person who is only good at sales. She murders puppies. I’ve watched.
According to every study that makes the rounds, the average person is screwed come retirement age. More screwed than Jenna Haze’s average day at work.
(Edit: She’s been retired since 2012. Way to be up on the trends, Nelson)
They all point towards the same things. The average Canadian barely has two spare nickels to rub together at the best of times. They’re not putting any money towards a rainy day, never mind their golden years. The only reason why we keep getting richer is because the top 5% keep it going. Everyone else continues to struggle.
But here’s the interesting part. The average person has saved bugger all for retirement for decades now. Sure, many people used to be able to count on pensions, but it’s not like everyone who worked in the 60s had a gold-plated pension.
Enter Nelson’s friend
Let me tell you a story about a buddy of mine, a guy who retired about five years ago.
Despite only qualifying for a small pension from his long-time employer, he’s doing fine. Both he and his wife get CPP and OAS. They shoveled a little money into RRSPs over the years. Put all those income sources together and they earn about $30,000 a year. This is easily enough for them to live a relatively comfortable life.
Perhaps most importantly, they live a simple existence. Only one car is needed, since they spend the majority of their time at home. Fancy business casual clothes aren’t needed as an office wardrobe. There’s no need to put aside 10% of their income for retirement. Their tax bill is nonexistent.
Think about all the expenses a regular working Joe has. The government takes off anywhere from 20% to 50% of his pay for various deductions. Taxes make up a big percentage, of course, but so do CPP and EI. There are commuting costs as well as socializing after work. And somebody is always selling something for their kid. Hell, the cost of working can easily eat up a third of your salary. That’s bananas!
The cost of living goes down in retirement. It’s that simple.
Humans are smart
I’ve long been an advocate of working part-time during retirement. It allows you to do something productive, get out of the house, and, most importantly, will help stretch meager savings so they last longer.
Even if a retiree gets a shit-ass job making $15 per hour for 10 hours a week, that works out to $7,500 a year. Just about everyone can work 10 hours a week. Using the 4% withdrawal rate, that’s the equivalent of an additional $300,000 in retirement savings.
Too old to work a traditional job? No problem. The internet makes it incredibly easy to earn a little money while sitting on your ass. Or you can drive an Uber. By the time automation makes Uber drivers obsolete, you’ll be dead.
People have other levers they can pull too. Downsizing is going to become increasingly common over the next couple decades, especially in expensive markets. Single retirees can get roommates, or, gasp!, move in with their kids. My cheap small town sees a steady influx of retirees who like the laid back lifestyle, decent amenities, and, most importantly, inexpensive real estate.
Humans are smart creatures. They will find a way to survive. Sure, it might not be ideal, but are these options really that bad? Let’s put things into perspective here.
Fear from asset managers
Let’s face it. Many of these fears are hoisted upon us by the people in charge of managing our money. Of course they’re going to tell you to save more. They’re directly poised to benefit from this relationship.
It’s like asking your barber if you need a haircut. Which reminds me — I really need a haircut. I look like a hobo who’s intentionally trying to play the part.
Now don’t get me wrong. Saving for retirement is a good thing. I like knowing I’ll have options in my golden years. And there’s nothing that beats that feeling of security. Except orgasms, of course.
Us financial folk also have to realize we’re preaching to the choir a bit here. The average Financial Uproar reader already knows the benefit of saving for retirement. If anything, y’all are oversaving for your golden years.
Compare that to your friend who can barely keep themselves above zero. Getting them to go from struggling week-to-week to putting aside 15% of their income is going to be a big challenge. Some find the light and get reformed, but most don’t. They’ll struggle for their entire lives, yet somehow won’t starve.
Besides, if everyone invested, think about how expensive the stock market would be. I’d have to slit my wrists.