Disclaimer: The following post is sponsored by Sun Life Financial.
The biggest mistakes most Canadians make when it comes to retirement planning is not saving anything at all. A recent study from Sun Life Financial shows that 25% of retired Canadians are in debt and 24% of working Canadians have raided their retirement savings. Canadians seem to be underestimating the amount of income they will require to spend their sunset years comfortably. Some may expect that government benefit pension programs will be adequate, believing that government money would be sufficient for their needs late in life. While the exact amount required for retirement can vary between individuals, the final years can be financially excruciating for those who don’t plan ahead and save for retirement. Lacking a workable plan is not the only mistake Canadians make when saving or investing for retirement.
Not Taking Advantage of Government-Supported Savings Plans
The defined benefit pension plan an employer offers is an increasingly rare retirement option for Canadian employees. In fact, relying entirely on a pension plan is risky. Because these pension plans are very expensive for employers, employees risk having their retirement savings seriously underfunded. The Canadian government supports multiple alternate pension plans that average income earners can benefit from. The Canada Pension Plan, or CPP, will cover you in addition to an employer’s pension, if one exists. Along with this, Canadians can also take advantage of retirement vehicles such as the Registered Retirement Savings Plan (RRSP) or a Tax-Free Savings Accounts (a TFSA). Using both RRSP and TFSA plans are highly beneficial retirement savings strategies, however, there are several key differences between the two; therefore, it’s up to the individual to choose a plan that best suits their needs. Canadians are more familiar with RRSPs than TFSAs because the RRSP has been around since 1957. TFSAs are a more recently introduced savings tool that can actually be more beneficial than RRSPs for some Canadians. What matters is that there is a retirement saving option in your life that is not limited to the defined benefit pension.
Not Considering Tax Implications
Your retirement savings are not necessarily free of taxation. All Canadians ultimately have to pay taxes sometime in the retirement-saving process; either when sourcing contributions or upon withdrawal in retirement. And because your retirement savings won’t be the same after paying taxes, don’t ignore this consideration when planning your retirement fund. Canadians ultimately face a dilemma on whether it’s best to choose a TFSA or an RRSP for current and post-retirement tax purposes; one influencing factor could be whether you expect to receive a defined benefit pension.
Whether an RRSP or a TFSA is better for you depends on your marginal tax rate at the time of contribution and at the time of withdrawal. RRSP holders pay taxes upon withdrawal. This tax rate is calculated based on the person’s income at the time of withdrawal. If your income level is low at the time of withdrawal compared to when you made contributions, then you can enjoy a lower tax rate on your withdrawn RRSP funds. However, like RRSP withdrawals, a person’s pension receipts are considered to be taxable income. In this light, RRSP withdrawals that are made while receiving pension amounts can actually be disadvantageous tax-wise, if the receipt of pension amounts has already put the tax payer in a high tax bracket.
Retirees don’t have to worry about increases to taxable income with a TFSA, because all contributions to such an account are made with after-tax dollars. As per the TFSA withdrawal rules, no additional taxes apply regardless of income levels upon withdrawal of fund. If you are in a higher income bracket in your sixties than you were in your thirties, a TFSA would be an excellent source of income-neutral account withdrawals.
Think about seriously planning for retirement right now, even if you are just 20 years old. Use professional financial advice to come up with a retirement savings strategy. Remember that taxes and fees will take a chunk out of your available funds, and plan accordingly; avoid the above-listed mistakes to enjoy your retirement without having to worry about taxes or debt.