What Is Retirement Planning?
Retirement planning is the process of determining retirement income goals and the actions and decisions necessary to achieve those goals. Retirement planning includes identifying sources of income, estimating expenses, implementing a savings program, and managing assets and risk. Future cash flows are estimated to determine if the retirement income goal will be achieved. Some retirement plans change depending on whether you’re in, say, the United States, or Canada.
Retirement planning is ideally a life-long process. You can start at any time, but it works best if you factor it into your financial planning from the beginning. That’s the best way to ensure a safe, secure—and fun—retirement. The fun part is why it makes sense to pay attention to the serious and perhaps boring part: planning how you’ll get there.
KEY TAKEAWAYS
- Retirement planning refers to financial strategies of saving, investment, and ultimately distribution of money meant to sustain one’s self during retirement.
- Many popular investment vehicles such as RRSP's allow retirement savers to grow their money with certain tax advantages.
- Retirement planning takes into account not only assets and income but also future expenses, liabilities, and life expectancy.
- It is never too early – or too late (although earlier is better!) – to start retirement planning.
Understanding Retirement Planning
In the simplest sense, retirement planning is the planning one does to be prepared for life after paid work ends, not just financially but in all aspects of life. The non-financial aspects include lifestyle choices such as how to spend time in retirement, where to live, when to completely quit working, etc. A holistic approach to retirement planning considers all these areas.
The emphasis one puts on retirement planning changes throughout different life stages. Early in a person’s working life, retirement planning is about setting aside enough money for retirement. During the middle of your career, it might also include setting specific income or asset targets and taking the steps to achieve them. Once you reach retirement age, you go from accumulating assets to what planners call the distribution phase. You’re no longer paying in; instead, your decades of saving are paying out.
The emphasis one puts on retirement planning changes throughout different life stages. Early in a person’s working life, retirement planning is about setting aside enough money for retirement. During the middle of your career, it might also include setting specific income or asset targets and taking the steps to achieve them. Once you reach retirement age, you go from accumulating assets to what planners call the distribution phase. You’re no longer paying in; instead, your decades of saving are paying out.
Retirement Planning Goals
Remember that retirement planning starts long before you retire — the sooner, the better. Your “magic number,” the amount you need to retire comfortably, is highly personalized, but there are numerous rules of thumb that can give you an idea of how much to save.
People used to say that you need around $1 million to retire comfortably. Other professionals use the 80% rule, i.e., you need enough to live on 80% of your income at retirement. If you made $100,000 per year, you would need savings that could produce $80,000 per year for roughly 20 years, or $1.6 million. Others say most retirees aren’t saving anywhere near enough to meet those benchmarks and should adjust their lifestyle to live on what they have.
Whatever method you, and possibly a financial planner, use to calculate your retirement savings needs, start as early as you can.
People used to say that you need around $1 million to retire comfortably. Other professionals use the 80% rule, i.e., you need enough to live on 80% of your income at retirement. If you made $100,000 per year, you would need savings that could produce $80,000 per year for roughly 20 years, or $1.6 million. Others say most retirees aren’t saving anywhere near enough to meet those benchmarks and should adjust their lifestyle to live on what they have.
Whatever method you, and possibly a financial planner, use to calculate your retirement savings needs, start as early as you can.
Stages of Retirement Planning
Retirement planning safeguards a person's financial future. Depending on which stage of life an individual is at, there are deliberate steps to take to ensure there are enough funds by retirement age.
Young adulthood (ages 21-35)
This is an exciting stage as you're probably advancing your education and building a career. As you approach your mid-20s to 30s, your career will likely have progressed, translating to more personal savings that can enable you to build a solid retirement nest. It is important to focus on investments that will generate a large return in the future. Remember, you have the advantage of time.
Here you can choose an employer-sponsored pension plan or personal savings offering options such as a Registered Retirement Savings Plan (RRSP) and a Tax-Free Savings Account (TFSA).
As a tax-deferred retirement plan, the RRSP offers several advantages. First, when you contribute, you receive a tax break. The limit of contribution is usually the lowest of 18% of the previous year's earned income or a specific amount. Any contribution outside this range is carried forward, which helps to reduce the tax burden. In addition, investment savings grow on a compound basis and are tax-free, generating higher returns. It also offers flexible investment options such as mutual bonds and ETFs. Furthermore, you are allowed to borrow a loan of up to $25,000 under the Home Buyers' Plan and up to $20,000 for education under the Lifelong Learning Plan.
With a TFSA, a person with a Social Insurance Number (SIN) can start their savings journey from as early as 18 years of age. TFSA allows for tax-free withdrawals and a wide range of investment options. If you have a spouse, you can extend their tax shelter, as you are not prohibited from sharing your contribution room. There is also more room for all income earners, starting from lower-income brackets. Even better, you don't need an earned income to make any contributions, unlike an RRSP.
Here you can choose an employer-sponsored pension plan or personal savings offering options such as a Registered Retirement Savings Plan (RRSP) and a Tax-Free Savings Account (TFSA).
As a tax-deferred retirement plan, the RRSP offers several advantages. First, when you contribute, you receive a tax break. The limit of contribution is usually the lowest of 18% of the previous year's earned income or a specific amount. Any contribution outside this range is carried forward, which helps to reduce the tax burden. In addition, investment savings grow on a compound basis and are tax-free, generating higher returns. It also offers flexible investment options such as mutual bonds and ETFs. Furthermore, you are allowed to borrow a loan of up to $25,000 under the Home Buyers' Plan and up to $20,000 for education under the Lifelong Learning Plan.
With a TFSA, a person with a Social Insurance Number (SIN) can start their savings journey from as early as 18 years of age. TFSA allows for tax-free withdrawals and a wide range of investment options. If you have a spouse, you can extend their tax shelter, as you are not prohibited from sharing your contribution room. There is also more room for all income earners, starting from lower-income brackets. Even better, you don't need an earned income to make any contributions, unlike an RRSP.
Early midlife (36-50)
At this stage, you are gradually getting closer to retirement. It is also realistic to assume you already have a family and have been steadily climbing the career ladder.
If you started off contributing to an RRSP in your twenties to mid-thirties, do not be tempted to cash out. It is critical to keep the momentum as you now have larger responsibilities such as a mortgage and student loans. Keep capitalizing on the employer-matched RRSPs to gain the tax benefits and return on investments as your savings grow cumulatively. You are likely at the peak of your earnings, so you can save more while putting off paying taxes until later. When you retire and decide to withdraw, you will fall under a lower tax bracket.
Life insurance is also vital, as now you have more at stake, especially with a family and owning property. According to a recent study conducted by the Policy Advisor, 44% of Canadians have already bought life insurance coverage or are planning to due to the Covid-19 pandemic. The good thing is, many service providers allow Canadians to choose plans that fit their financial priorities and budgets. It is wise to choose the best coverage to protect yourself and your dependent from life's never-ending surprises. If you are employed, you can sign up for group life insurance to help cover mortgage, debts, and your children's education.
In addition, there is disability insurance in case you are unable to work in the future. You can choose to have both employer offered and personal insurance. There is short-term disability insurance, which provides benefits for six months when you are sick or injured. Long-term disability insurance covers 60% to 70% of your earnings.
If you started off contributing to an RRSP in your twenties to mid-thirties, do not be tempted to cash out. It is critical to keep the momentum as you now have larger responsibilities such as a mortgage and student loans. Keep capitalizing on the employer-matched RRSPs to gain the tax benefits and return on investments as your savings grow cumulatively. You are likely at the peak of your earnings, so you can save more while putting off paying taxes until later. When you retire and decide to withdraw, you will fall under a lower tax bracket.
Life insurance is also vital, as now you have more at stake, especially with a family and owning property. According to a recent study conducted by the Policy Advisor, 44% of Canadians have already bought life insurance coverage or are planning to due to the Covid-19 pandemic. The good thing is, many service providers allow Canadians to choose plans that fit their financial priorities and budgets. It is wise to choose the best coverage to protect yourself and your dependent from life's never-ending surprises. If you are employed, you can sign up for group life insurance to help cover mortgage, debts, and your children's education.
In addition, there is disability insurance in case you are unable to work in the future. You can choose to have both employer offered and personal insurance. There is short-term disability insurance, which provides benefits for six months when you are sick or injured. Long-term disability insurance covers 60% to 70% of your earnings.
Later midlife (50-65)
As you clock down from active work life, you have to set your priorities right. Your concerns will centre on your health and streamlining your income for a comfortable retirement. An RRSP is still important because your investments will not be highly taxed when you withdraw.
It is important to note that the age limit for RRSP contributions is 71 years. Even if you have not started saving, you have at least 5 to 20 years to make up. The majority of people here are in a higher income tax bracket and therefore have more disposable income (money left over after taxes), allowing for more savings. As you pump up your savings, continue enhancing your investments, but be conservative. You can invest more in, for instance, bonds than stocks because of lower risk.
Also, consider other forms of insurance such as long-term care as it will protect your savings. There is also public health insurance (universal health coverage) and private health insurance for health-related services such as dental care and prescription drugs. As you get older, your ability to work and earn will diminish, and with insurance cover, you and your family can still afford to live your chosen lifestyle.
It is important to note that the age limit for RRSP contributions is 71 years. Even if you have not started saving, you have at least 5 to 20 years to make up. The majority of people here are in a higher income tax bracket and therefore have more disposable income (money left over after taxes), allowing for more savings. As you pump up your savings, continue enhancing your investments, but be conservative. You can invest more in, for instance, bonds than stocks because of lower risk.
Also, consider other forms of insurance such as long-term care as it will protect your savings. There is also public health insurance (universal health coverage) and private health insurance for health-related services such as dental care and prescription drugs. As you get older, your ability to work and earn will diminish, and with insurance cover, you and your family can still afford to live your chosen lifestyle.
Achieve your financial goals.