I have a confession. I am lazy. Lazy with a capital L.
Before I started working full time, I never contributed towards a Registered Retirement Savings Plan (RRSP). I had some catching up to do.
I started reading up on it in Personal Finance Blogs and books. I went down to HR to talk to the manager, and asked him questions about how our group account worked. Even though my company matching hadn’t kicked in yet, I wanted to be ready. I learned two very important things that day.
$100,000 in RRSP’s at 30
We were given a nifty sheet that had pre-calculated our required monthly contribution in order to result in different annual incomes during retirement.
The assumptions are that you will retire at 65, you live until you are 85. Inflation is 2% annually, and your average return rate is 8%. According to this model, if I have $100,000 in my RRSP by the time I am 30, I will not have to contribute another cent and just have to let it sit. Then, when I retire at 65, I will have an annual income of $50,000. Not bad, eh?
I know, I know. This is just an estimate and I shouldn’t start popping the champagne bottle just yet. But what I realized was the power of compounding interest. Since I am young, I have time on my side. I had exactly 5 years until I turned 30, and based on my expenses and income, putting $100,000 towards my RRSP would certainly be do-able*.
I was really excited – instead of working really hard, I could make my money work for me!
Immediate Tax Benefits
When I contribute to my RRSP through my company, the amount towards my RRSP is not taxed. This is great because when I direct $200 from each paycheck to my RRSP through my company plan, my paycheck decreases by less than $200 since I am taxed on my income less the amount I contributed towards my RRSP.
Prior to contributing to my company plan (before the RRSP matching started), I contributed to a self directed RRSP with ING Direct. I contributed to the RRSP with my after tax dollars, and got a tax refund at the end of the year. And even though it’s nice to get a big fat check in the mail, it’s not so nice to be giving the government an interest free loan and not making my money work for me the past year!
With my current situation, it’s a lot easier to save more towards my future (i.e., retirement) now than it will be later on in my life. Right now, I have no mortgage, no car payments, no dependents, and no debt. By prioritizing my spending, I can put more towards my future now, so that my future self can have more freedom. I am also assuming that my future self may have more obligations, such as, mortgage, caring for my parents, kids, etc.
What if I Need the Money?
In Canada, you can take money out of your RRSP before you retirement at 65 without being penalized for two reasons:
1) Life Long Learning Plan – You can take out the money up to $10,000 per calender year to put towards tuition. You will not be taxed on this income, and you have up to 10 years to repay your RRSP.
2) First Time Home Buyers Plan – You can withdraw up to $20,000 from you RRSP to put towards buying or building your first house. You will not be taxed on this income, and you have up to 15 years to repay your RRSP, with a minimum payment of 1/15 each year.
I will most likely not take out my RRSP for either of these two options. I would rather let my RRSP sit and compound, and I would rather save separately for the education or house down payment. It is prudent to note that when you are paying back the RRSP, you are paying it back with after tax dollars (i.e., no tax benefits).
Note*: Putting away $20,000 a year towards RRSP is no easy feat. And also, I wouldn’t want to lock in more than my maximum RRSP contribution since that money does not lower my taxable income. For me, the $20,000 goal would be a combination of RRSP, TFSA (Tax Free Savings Account) and investing outside of these two vehicles. That doesn’t include emergency fund or other savings. Even if I can’t make $20,000 a year, that’s OK. It’s a goal, and knowing the number is better than not knowing.
What are some tips that you’ve learned over the years? Are you lazy like me when it comes to saving and money? 🙂