Q. I have just turned 40, am single, and earn $86,000 a year. I also have zero debt. I just finished paying off my house, worth $315,000, and I would like to continue to put away my mortgage payment of $1,000 every two weeks as savings.
Because all money went to debt repayment, I’ve never really invested before, but I do have $20,000 in my RRSP that a family member manages for me. I also have a small amount in my TFSA. I will receive a pension upon retirement, but as I would like to retire early, I won’t receive the full amount, and the pension payments will not fully sustain my lifestyle. So some advice on how I should invest the $26,000 in annual disposable income would be appreciated.
A. Despite your lack of investing experience, Mara, your instincts are right on target. Most of us don’t want financial independence, which can easily be achieved by selling everything we own and buying a hut in an impoverished country; we want to achieve and maintain our desired lifestyle.
When you look ahead, what does your desired lifestyle look like? It appears that you may be postponing some of the things you’d like to do; why would you wait until retirement? Maybe because you don’t feel secure with your current or future finances? I think you would benefit from a lifestyle plan, which I will touch at the end of my reply.
First, let me try to answer your question about how best to invest, without knowing your desired lifestyle. Working with your numbers, an $86,000-a-year income is about $67,000 after tax, depending on your province of residence. You’re saving $26,000 annually, so that means you are maintaining your lifestyle on about $40,000 a year.
Using back-of-the envelope calculations, saving $26,000 a year for the next 15 years to age 55 will give you $390,000 plus investment growth. That will likely give you an indexed income of $40,000 per year to age 65.
At age 65, you will have Canada Pension Plan (CPP) and Old Age Security (OAS) benefits, which I’m guessing will be a minimum of $20,000 per year indexed, but will likely be more because of the new CPP enhancements. Plus, on top of the CPP and OAS, you will have your employment pension, which I will assume will be $20,000 a year or more. Based on those assumptions, you’ve got your $40,000 annually for life and will maintain your current lifestyle.
As a general guide, I would suggest you invest your money in this order:
RRSPs. Maximize your annual RRSP contributions. Check your notice of assessment to confirm the amount you can contribute. (In general, working Canadians can contribute 18% of last year’s income, but because you have a pension adjustment, the calculation is not as simple in your case.)
You will have past RRSP contribution room that you can use to make a larger lump sum investment into your RRSP. Take advantage of this, but keep an eye on your taxable income so you can maximize your tax refunds. An RRSP contribution reduces your taxable income by the amount of the contribution. If, after you make a contribution, you are still in the 30% tax bracket, then your refund will be 30% of the contribution. That’s good. But what happens if $10,000 of your contribution lands with the 20% tax bracket? That $10,000 will generate a 20% refund—or 10% less than the remainder of your contribution. Better to save that last $10,000 to contribute the next year, when it can generate a 30% refund. And never take your taxable income to zero with an RRSP contribution, because the last $12,000 of contribution will earn a $0 refund.
- Contribute only enough to your RRSP to bring you down to the bottom of your existing tax bracket. Mara, for you that would be to a taxable income of about $45,000 depending on your province.
- Contribute as much as you want to your RRSP, but when you complete your tax return, claim only just enough of your RRSP contributions to get you to the bottom of your existing tax bracket and defer claiming the remaining contribution to the following year or years ahead.
TFSA. Use your RRSP tax refund and remaining money to maximize your TFSA.
Non-registered investments. The traditional approach is to hold taxable preferred investments, like capital-gain and dividend-paying investments in non-registered investment accounts, and GICs in an RRSP or TFSA.
Remember you also have your home equity, which you could draw upon at some future point. Mara, from a financial perspective you are doing really well. Congratulations!
I’d encourage you now to give some thoughtful consideration to what you’re saving for, and how you want to live now as well as when you retire:
- As a starting point, look at your current lifestyle—the things you have and do. Think about your home, lifestyle, family and career. Then give some thought to the things you’d like in the future. This is lifestyle planning.
- Now, record your assets, liabilities and current cash flow. This will allow you to identify any gaps between your current lifestyle and desired lifestyle. It also gives you the ability to experiment with different lifestyle choices and financial planning strategies you can use to close any gaps. This is financial planning.
- Finally, with the help of an advisor, select appropriate investments to support your lifestyle plan. This is financial advising.
Now you have a draft lifestyle plan, which will always be a draft plan because you and everything around you will be constantly changing. However, if you update your progress each year, you will gain clarity in your numbers, become confident in your decision-making—and the doors to opportunity and freedom will swing wide open.
Allan Norman is a Certified Financial Planner and Chartered Investment Manager with Atlantic Financial Inc.
This commentary is provided as a general source of information and is intended for Canadian residents only. Allan offers financial planning services through Atlantis Financial Inc. and can be reached at [email protected]