The best way to save for retirement depends on your finances

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By Jason Heath, CFP  

If you’re hoping for a hot stock tip, options-trading strategy, or crypto recommendation, then this article isn’t for you. There is no silver bullet when it comes to saving for retirement, nor is there a single strategy that works for everyone. That said, there are often better ways for each individual to save, depending on their personal financial situation and the options available to them. Here’s a look at a few categories of savers and the strategies that are most likely to lead them to financial freedom.

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For those with pensions

Workers with pensions can have a less risky path to retirement than those who are saving on their own. If you have a defined-benefit pension plan, it may make sense to take on more risk with your retirement savings. This is because your pension is like a bond and significantly reduces the variability of your future retirement income.

Someone with a low risk tolerance should still be careful. It may not be enough to remind yourself that you have a pension when stock markets fall. If you have a high equity allocation and a low risk tolerance and panic when stocks are down, whether you sell or not may not matter. If you sell, you can make a temporary loss permanent and reduce your future retirement savings. If you hold but feel really uncomfortable for an extended period, this anxiety may not be worth the trade-off for a potentially higher retirement nest egg.

If you have a defined contribution pension or group retirement plan, you should do everything you can to contribute the maximum amount that is subject to a matching contribution from your employer. Employer contributions commonly range from 25 to 100 per cent of employee contributions, which provides a huge instant return on your investment.

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For the self-employed

If your income exceeds your spending, and you can retain some of your savings corporately, incorporation can accelerate your retirement accumulation. The tax differential between the top personal tax rate and the small business income tax rate is in the 40 per cent range but varies by province. This can provide significant tax deferral. You can invest money in your corporation or set up a separate holding company to which you can transfer corporate savings on a tax-free basis.

That said, most incorporated business owners should at least consider making registered retirement savings plan (RRSP) and tax-free savings account (TFSA) contributions before building up corporate investments.

Someone who is self-employed should also consider risk mitigation in the form of disability insurance. If you become disabled and cannot work, disability insurance replaces a portion of your income. This can ensure you do not have to draw down your retirement savings prematurely and may allow you to continue to contribute to your retirement fund despite a disability. So, while paying disability insurance premiums detracts slightly from retirement saving capacity, becoming disabled without coverage can significantly detract from it.

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For low-income earners

If your income is low, TFSA contributions may be a better option than RRSP contributions. The reason is your tax savings on contributions may be modest relative to your tax payable on future withdrawals. RRSP withdrawals may also reduce entitlement to means-tested federal and provincial benefits in retirement.

So, do not default to RRSPs simply because they have “retirement” in the account name. A TFSA can be an effective retirement savings account for all savers, particularly those with low incomes.

It is also important to determine your Canada Pension Plan (CPP) and Old Age Security (OAS) entitlement. CPP and OAS may not provide enough for most retirees to live on, but for a low-income worker with a long career and a low retirement budget, they may not need to save as much as they think. Especially if their savings are primarily in TFSA accounts, those funds, being tax-free, can be stretched further.

For high-income earners

RRSP contributions are still probably the best high-income retirement tool, allowing tax deductions while income is high and deferring income to be taxed in the future at a lower tax rate. Some retirees will also be in a high tax bracket, reducing the benefit of RRSPs, but most high-income retirees will have a tax win deferring some of their income to their golden years.

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Couples with an income or asset differential should consider having the high-income spouse contribute to a spousal RRSP in the name of the lower income spouse. A low-income spouse can own a spousal RRSP that their high-income spouse contributes to, using that high-income taxpayer’s RRSP room to claim lucrative tax deductions. In retirement, the low-income spouse can take withdrawals and pay tax on the income.

Some people contend that pension income splitting of registered retirement income funds (RRIFs) from age 65 negates the benefit of a spousal RRSP. But since tax rules can change at any time, a spousal RRSP may be a tax risk mitigation strategy for high income savers who have a spouse or common law partner.

For those in good health

When you deposit money to an investment account, the account grows, as do the future withdrawals you can take from the account. When you defer government pensions like CPP and OAS, they rise for each month you delay receiving them. The concepts are similar.

The maximum CPP at age 60 in 2024 is $873 per month. If someone turning 60 in 2024 entitled to the maximum CPP defers their pension to age 70, it is estimated to be $2,362 per month at that time, assuming two per cent inflation. Someone in good health with a good family history who expects to live well into their 80s or 90s could receive significantly more CPP income over their lifetime by delaying their pension. The math is similar for OAS, though it can only start as early as age 65. It can also be deferred to age 70.

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Deferring your pensions does not mean you need to keep working either. You can consider drawing down other investments, reducing the sequence of returns risk that could deplete your nest egg if investment returns are poor early in retirement. Government pension deferral can work particularly well for people with low investment risk tolerance who do not have other defined benefit pension income to protect against the risk of living too long.

Summary

Saving for retirement requires a multi-faceted approach. You might get lucky buying shares of a junior mining company or cryptocurrency coins that go to the moon. But you are probably better off building a low-cost, diversified portfolio with as much risk as you are comfortable taking to grow your wealth.

Then focus more attention on things you can control, like maximizing employer-matching contributions, structuring your business for tax savings, investing in the right accounts and tilting pension income in your favour.

Jason Heath is a fee-only, advice-only certified financial planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever. He can be reached at jheath@objectivecfp.com. 

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