Retirement saving: Your early years

Are you where you should be? We can help you find out, no matter what your age.

Illustration by Joel Kimmel

So you’re in your late 20s or early 30s, and you’ve just started your first job. You have hardly any money, hefty student debts and many demands on your modest paycheque. You know that some day you’re going to retire, and you wonder how you’re going to manage that. You feel like you’re already falling behind.

The good news is, you’ve got time on your side. At this age, most people have little money but good prospects. Statistics show your peers have median financial assets of only about $9,000, and a median net worth of about $21,000. The upside is, you’ve probably acquired a good education. You may have a low starting salary, but you’re likely to advance and gain more skills, and your income will grow. Economists call this “human capital.” The key is to begin saving as soon as you can, then increase the amount as your salary grows.

But where to start? You may still have student debts to pay off, plus you’d like to start amassing a downpayment for a home. Fortunately, those are all forms of savings. Generally, the first priority should be paying off debts. The current floating interest rate under the Canada Student Loan program is 5.5%. Paying down your loan allows you to save that amount in foregone interest, which is much better than what you’d earn today on any low-risk investment like a GIC. Once your debts are paid off, saving for a home purchase rather than retirement is perfectly fine. By amassing equity in a property, you’re building an asset that can both lower your living costs in retirement and serve as a financial safety net if you need extra cash.

That said, if you can hunker down and start saving for retirement at an early age, it makes things easier. You accumulate more years of savings, which then earn compound returns, meaning the returns on your investments themselves earn returns. Consider a 30-year-old couple who earn a combined $80,000 a year and have just started saving toward retirement. Assume their salaries grow each year by 2% in real terms (after adjusting for inflation), they save 10% of their annual salaries, and their investments earn a 3% real annual return. At 65, they will have saved about $675,000 in today’s dollars, which is ample for a comfortable middle-class retirement. However, if they start saving at age 35, they’ll need to salt away about 12% of salary to accumulate the same amount at the same age. If they wait until 40, they will need to save almost 15% to achieve the same results.

Whatever your savings objective, it pays to take advantage of government tax-sheltered investments like RRSPs and tax-free savings accounts (TFSAs). The RRSP is a good choice once you reach a moderately high tax bracket and you are saving for a home or retirement. Your contribution will get you a juicy tax rebate, but you pay tax when you take the money out (which is usually at a lower tax rate if you’re retired). Plus, the federal First Time Home Buyer’s Plan lets you tap your RRSP for the purchase of your first home. You can withdraw up to $25,000 ($50,000 per couple) without paying tax to use toward the downpayment, and you’re required to pay it back within 15 years. In contrast, the TFSA gives you no rebate up front, but you don’t pay tax when you take it out. It’s not as good for retirement saving as an RRSP if you’re in a high tax bracket, but it’s a good catch-all savings vehicle.

One thing you should do right away is take full advantage of employer pension plans and group RRSPs. In cases where your employer matches your contribution, try to put in enough to get the maximum employer amount. After all, that gets you a tax deduction from the government and free money from your boss.

If you’re having trouble saving as much as you’d like, consider setting up an automatic withdrawal plan. That way, you have a set amount automatically whisked each month from your chequing account into a savings or investment account. You can set up an investment account with a discount brokerage (all the banks have them) to buy exchange-traded funds (ETFs) or low-fee mutual funds that give you plenty of diversification, if you’re comfortable making those choices on your own. If you prefer working with an adviser, you’ll pay higher fees. At this life stage, it’s usually wise to have most of your longer-term investments in equities. That’s because you have a long time horizon, and you can afford to take on more risk. If your retirement investments plunge in value, you’ll have decades to recover.

David Aston, CFA, CMA, MA, is a retirement expert at MoneySense magazine