5 Steps To Planning Your Retirement In Canada
Wednesday, December 20, 2023
5 Steps To Planning Your Retirement In Canada
Wednesday, December 20, 2023
Retirement Is An Income, Not An Age
Contrary to popular belief, retirement is an income, not an age. Canadians retire at different ages all the time. While the most common age to retire is between age 55 and 65. That's because that's how most employee and government pensions are structured.
However, some Canadians retire in their 40s while others retire in their 70s. It all depends on your decisions and priorities during your working lifetime.
Nevertheless, retirement should be treated as a desired passive income amount, not an age.
Passive income is earning enough interest, dividend, or pension income from your investments without having to work for it. Most Canadians do this with stocks, bonds, and or real estate investments.
Once you reach a passive income high enough to support your lifestyle, you can retire.
True financial freedom.
Therefore, it makes more sense to choose a desired retirement income.
Step 1: Determine Your Desired Annual Income Before Tax
If you and your spouse want $100,000 annually before tax, then set that as your goal and determine what age you can reach your desired income.
You'll be much happier this way rather than retiring too early and having to penny-pinch your way through retirement. Even if it means working an extra year or two.
Step 2: Subtract Your Government Pension Benefits
There are two main government retirement programs in Canada to help supplement your income.
They are the Canada Pension Plan and Old Age Security.
Canada Pension Plan
It is a forced savings plan for all employees who receive T4 income. Self-employed individuals don't always have to pay CPP premiums.
The maximum CPP amount a Canadian can receive at age 65 in 2023 is $1,306.57/month. However, the average CPP payment in Canada at age 65 is only $811.21/month.
This is because your Canada Pension Plan benefit is determined by:
- The amount you contributed throughout your working career
- How many years you have contributed to the plan
- The age you start taking your CPP benefits. You can get an estimation of your CPP benefits by signing into your My Service Canada Account.
Old Age Security
The second government retirement program is Old Age Security. This program pays a maximum benefit of $691/month at age 65 and $760.10/month for age 75 and older.
OAS is income tested. If your retirement income is greater than $86,912, your OAS income will be reduced by the OAS clawback. If your retirement income in 2023 is greater than $141,917, you will have to repay the entire Old Age Security Benefit.
Once you determine your expected monthly benefits from Canada Pension Plan and Old Age Security, you can subtract the amounts from your desired retirement income.
If you want $100,000/annually in retirement income, and you and your spouse will receive $40,000/annually from your CPP and OAS benefits, then you only need to save for $60,000 in additional annual retirement income.
Step 3: Break It Down to the Week
Long-term goal planning can be overwhelming and hard to sustain.
Continuing the example above, you need to save an additional $60,000 in annual income to reach your $100,000 retirement income goal.
Using the 4% withdrawal rate rule, you will need to save 25 times your annual expenses to sustain a 4% withdrawal rate.
To calculate how much you need to save to earn $60,000 per year at a 4% withdrawal rate, you can follow these steps:
Divide the desired annual income ($60,000) by 4% (0.04) to get the amount needed to save:
$60,000 divided by 0.04 = $1,500,000.
Therefore, based on the 4% withdrawal rule, you would need to save approximately 1.5 million dollars to generate $60,000 per year in retirement income.
Note: It's important to keep in mind that the 4% withdrawal rule is just a guideline, and individual circumstances may require a different approach to retirement planning.
Holy bananas right?!!
But if you can break the 1.5 million dollars into a short-term goal, it becomes much more manageable.
For instance, if you and your spouse are 35 today, and you save for 30 years (age 65), you will have to save $1540/month at 6% average to have 1.5 million dollars.
Easily done with most pensions today.
But for example's sake, let's say your pension only covers $1000/month. Could you save $540/month on your own?
Or could you save $125/week? I believe you could.
Step 4: Pay Attention To Your Taxes
A poor tax strategy can erode your savings efforts very quickly if not done properly.
In Canada, the two main retirement savings accounts are the Registered Retirement Savings Account (RRSP) and the Tax-Free Savings Account (TFSA).
Registered Retirement Savings Account (RRSP)
When it comes to determining your tax strategy, the first decision to make is whether RRSPs are right for you.
An RRSP allows you to deduct contributions from your income, and the contribution grows tax-deferred. However, you'll need to pay taxes on withdrawals as income when you make them.
While the general idea behind RRSPs is that you'll be in a lower tax bracket in retirement, dropping into a lower tax bracket may be harder than you think.
Check your marginal tax rate here to see your income now, and how low you would need to get your retirement income to drop a tax bracket.
My sweet spot is $106,717 (2023). At this income amount, your federal tax rate jumps 5.5%.
Therefore, if you're income is above $106,717, RRSPs could be a good option for you.
RRSPs may be right for you, but they're not the best place to withdraw money from in emergencies. Don't invest in RRSPs if you think you might need the money for emergencies.
Tax-Free Savings Account (TFSA)
On the other hand, if RRSPs don't apply to your situation, consider a Tax-Free Savings Account (TFSA). TFSAs don't offer tax deductions up front, but you won't pay taxes on withdrawals or growth later, and you can re-contribute any withdrawals on January 1st of the following year.
Choose TFSAs if you're earning less than $106,717 annually, or if you'd like to maintain access to your funds in cases of emergency.
Remember that you can transfer your TFSA funds to an RRSP later. You'll need to pay taxes if you want to transfer your RRSP funds to a TFSA. That means, if you're still unsure what's best for you, choose the TFSA until you figure it out.
Step 5: Choose your Passive Income Strategy
There are many ways to create a passive income stream in Canada.
Most Canadians retire with:
- Pension income
- Personal investments in stocks, bonds, mutual funds, or ETFs
- Real Estate
- Business Income, or the
- Sale of a business or farm
Read our Beginners Guide To Investing In Canada here for a more comprehensive guide to investing in Canada.
All of the above choices are adequate options to create a lasting passive retirement income.
My advice to you would be to pick one or two and invest as much as possible.
A Free Retirement Calculator Tool
Did you know the government of Canada has a free retirement calculator?
Neither did I until recently.
This is a great tool to play around with. It will help you see how all of your passive income streams will work together in retirement to build you a sustainable income for life.
You can enter your pension amounts, CPP and OAS payments, and personal investments to generate a picture of your retirement.
Check out the free retirement calculator here.
Conclusion
Retirement planning in Canada should be taken seriously and reviewed often. Retirement is not an age, it's a desired passive income. Creating a sustainable passive retirement income plan is something that everyone should strive to do. It requires careful tax planning, investment strategy, discipline, and foresight.
Hi, I Am Mitch Zaba
Over the past 10+ years, we've worked closely with clients showing them how to grow their wealth, pay less taxes and how to create predictable passive income in the stock market.
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