How much should I save in my RRSP?
Markus Muhs - Oct 23, 2020
You've got your first grown-up job and you're wondering how much you'll need to put away for retirement and how best to make use of RRSPs. Well, here are a few considerations to start.
This is the first of a series of posts tackling some more foundational retirement planning concepts. I’m going to try to keep them short, so rest assured if I don't answer your questions here, they'll be answered in future posts. I also love it when people send in questions via my "ask me anything" form on my contact page. How much cashflow you'll actually need for retirement will be covered in my next post, but let’s just focus on your RRSP for now.
This is probably the first question a lot of people ask when they get their first grown-up job and start putting some money aside for retirement. Thankfully, there’s a little bit of direction in the fact that many employers offer some sort of pension plan or a group RRSP that nudges you toward certain contribution levels.
The CRA also has limits in place as to how much you’re allowed to put into your RRSP, so the simplest answer, that yields the best retirement outcome, is to maximize your RRSP contributions all your life, if you can afford to do so.
Things got a bit more complex in 2009, with the introduction of the TFSA (also a very capable retirement savings vehicle), but I’ll tackle the question as to how to allocate limited savings between TFSA and RRSP in a future post. For now, let’s get the RRSP question out of the way.
If your company offers a Registered Pension Plan
Quebec is the only province requiring employers to offer their employees retirement benefits if they have more than 5 employees. That said, it’s become the norm for most employers to offer some form of retirement benefits to their employees simply due to competitive pressures, whether through Group RSPs or more formal pension plans.
I’m not going to cover differences between defined contribution and defined benefit plans with this post. If you work for the government, or one of very few remaining large corporations still offering DB plans to new employees, congrats. A full career of contributions to that DB plan, along with CPP and OAS, pretty much has you covered for a comfortable retirement.
Usually a DC plan also has you contributing sufficiently to it to fund a pretty comfortable retirement. Any employer offering a DC plan is offering it as a bit of a perk to attract talent (because most competing companies offer them), so while the minimum that any employer needs to contribute is a paltry 1% (waived for 2020!). Typically such plans range from having a 50% employer match of employee contributions, to equal matching, to the rare plan where the employee doesn't have to contribute anything.
Combined employer/employee contributions usually tend to be in the range of 8-12% of salary. Sometimes the amount employers will match goes up based on tenure. If your employer is matching 1 to 1, or actually putting the majority of contributions into your pension plan, and the total is in excess of 12% of salary, you've found yourself a pretty generous employer!
As far as workplace retirement benefits go, DC pension plans, while not as cushy as DB plans, are an absolute must if you have the option to participate in one. These should be the first dollars you contribute to any retirement plan.
If your company offers a group RRSP or Employee Stock Purchase Plan (in RSP form)
Your employer might offer a GRSP and/or ESPP in addition to a pension plan, or in place of one. Usually, such plans offer an employer match of some sort to your contribution. Sometimes they don't and they're just a convenient way to have money come right off your paycheque and go straight into a retirement account. If matching is available, you should always take advantage of such plans and get the maximum employer match that you’re able to, before contributing to a personal RRSP.
While GRSPs typically invest in a diversified mutual fund portfolio (usually also lower-costing than if you bought similar mutual funds at your bank), ESPPs invest in your own company’s stock. You can leave a GRSP on autopilot all your life, but with an ESPP you’ll have to watch out that you don’t become too over-exposed to your employer’s stock. If things go badly for your employer, you wouldn’t want to be hit with both job-loss as well as a depleted retirement account. It's usually pretty easy to periodically shift assets from an ESPP-RSP to a regular RSP, and diversify as needed.
Only once you’ve maxed out your benefits from the above should you start contributing to your own RRSP. How much? I can’t give you perfect answers here, as everyone’s situation is different, but here are some considerations:
Your contribution limit is 18% of your income the prior year. For higher income earners, this dollar amount reaches certain annual statutory maximums. For 2020 this statutory limit is $27,230. What this means is if your income was $100K in 2019 then your limit is simply $18K (18%), but if your income was in excess of around $151K, then you're capped at $27,230. Each year this statutory limit goes up a bit with inflation, while the 18% limit has been in place for a long time.
Whatever the above number is for you, you would subtract any pension adjustments, if applicable. Effectively, money that you and your employer put into a pension plan eats into your RRSP limit. Potentially, pension contributions can already take up the lion’s share of your RRSP contribution room.
If you've got percentages of income, with employer matching, going into any of the above-mentioned plans, and especially if your income is in excess of $150K, you'll need to pay special attention to what your employer plans are contributing for you. More often than not such plans, in combination with your own monthly RRSP contributions, end up being the root of all RRSP over-contribution dilemmas, as those percentages end up eating all your RRSP contribution space due to income growth.
Contribution room that you didn’t use in prior years carries forward, so if you’ve been working for a good number of years and never contributed to an RRSP, or only had pension contributions, you could have a good amount of carry-forward RRSP room. You can keep track of your RRSP contribution room via your CRA "My Account". More info here.
Just because you have RRSP contribution room doesn’t necessarily mean you should contribute to an RRSP, but we’ll leave that conversation for another day and blog post. If you're at a lower income, there might not be as much of a long-term tax benefit to contributing to an RRSP for you, and the TFSA might be a more appropriate vehicle for retirement.
With all that said, if your pension plan and/or GRSP and/or ESPP are already being contributed to nicely, it might not be a bad idea to allow a little RRSP contribution room to accumulate over the years. I'm saying you don't need to use up every penny of RRSP contribution space each year. When you leave your job or retire, you might be eligible for a severance, or might want to commute your pension plan, and might end up with a surge of additional taxable income. A bit of extra RRSP contribution space would come in handy then.
How much will I really need to contribute?
Let’s say you establish that the retirement nest egg you want to save up by age 65 is $1 million in today’s dollars. For growth projections we’ll assume you can get 7%* long-term in a fairly aggressive portfolio, and subtract 2% (average inflation of the past 30 years). You can actually play along on our Millionaire Calculator and adjust these numbers however you see fit.
Starting at age 25, you need to save just over $400 per month to reach that $1 million by age 65. That said, with 2% inflation, $1 million in 40 years will only have the equivalent purchasing power as $460K does today, so you'll need to save a bit more. Around $900/mo should do it, which still should be in reach. If you’re earning $60K a year, that's actually 18% right on the nose; maybe your pension plan or GRSP covers 10% of that and you just have to save an additional 8% of income in your personal RRSP.
If you don't start saving until 35, hopefully you're making quite a bit more money. Now we're talking about having to save $1600/mo, or almost $20K a year. $1 million doesn’t necessarily have to be your retirement goal, but this just emphasizes how important it is to start saving early.
If you're 25 and can afford to sock away $1600 a month, what on Earth are you waiting for?
Put another way, how early you start saving matters a whole lot more than how much you save per month, what investments you choose, your investment fees, or even what retirement vehicle (RRSP or TFSA) you use.
To sum up the above, if you’ve determined that the RRSP is the best savings vehicle to fund your retirement:
- Max out your employer benefits first and foremost. Don’t leave any money on the table, get that match!
- It’s good to contribute as much as you can afford, within the limits, but more important to start early.
Now that you've read this far, I'm also going to add that retirement is a goal for the future, that should only be of concern if you've got your present sorted out. Don't put a penny into your RRSP (beyond what garners employer matching) until you're free of consumer debt (anything but mortgage and maybe car loan), are cash flow positive, and have a healthy emergency fund built up.
Back when I worked at a bank I witnessed far too many young people shooting themselves in the foot by making RRSP contributions only to pull that money back out when hit with an unexpected expense or job loss. You'll potentially get hit by a triple-whammy of market-loss (usually job loss happens when the economy isn't doing well), RRSP withdrawal fees, and the permanent loss of RRSP contribution space. Just don't do it. If you don't have an emergency fund I forbid you from contributing to an RRSP. Otherwise, consider every dollar you contribute to an RRSP as money you won't see again until you're retired.
There are a ton of factors that go into a retirement plan, from what other income sources you'll have at retirement, to how much you have in a variety of different accounts, to how much you plan to spend (and that varies from early retirement to late retirement), to how much you would like to leave your heirs. If you'd like to explore this a bit more and possibly start the process of putting together a more comprehensive retirement plan, book a free 30 minute consultation with me here.
*Note: presently we are using lower return expectations in our financial planning but for a long-term average, and to stress the importance of starting early, I figure 7% is reasonable