Retirement saving: Your family years

The family years: Make the most of those bonuses.

Illustrations by Joel Kimmel.

You’re now in your late 30s or early 40s. You’re carrying those big mortgage payments, plus the costs of raising kids. That eats up so much of your income that you find it a struggle just to keep from sinking into debt. You may be anxiously wondering how you can manage to also save for retirement.

Statistics show that the median Canadian in your situation has accumulated financial assets of about $45,000 and has a net worth of about $155,000. (This holds for families with a major income earner aged 35 to 44.) If you seem to be falling behind, there’s lots you can do to catch up. First priority is keeping your head above water financially. Fortunately, your mortgage payments are generally level while your salary should continue to grow. Those salary increases will probably at least cover inflation, but you may also get bonuses and promotional increases. That gradually raises your capacity to save.

One good strategy is to save bonuses and at least half of every salary increase, and keep doing that year after year. You should feel little or no lifestyle impact because you’re saving new money that you never before relied on to cover day-to-day expenses.

But what if your salary growth is modest? Consider putting your existing spending under the microscope to find areas where you could cut back. As a start, track your discretionary spending by category for a month or two to see where the money goes. That will allow you to see how much you’re spending on, for example, restaurant meals, groceries and clothing. Many people that do this are shocked to see how much money slips between their fingers with little to show for it. At the least, you’ll identify spending that’s a bit frivolous. That can help you prioritize cutbacks that will hurt the least.

Small reductions in weekly spending can have an enormous impact if you keep up with them. Say you spend $50 each time you eat out and do it twice a week, for a weekly total of $100. Eat at home instead and you might save $3,000 a year. That’s a goodly sum by itself. But consider what happens if you keep doing it, and put the saved money to productive use. Say you’ve just taken out a $300,000 mortgage with a 30-year amortization at 4% interest and monthly payments of $1,427. If you put the $3,000 you saved into the mortgage as a lump-sum extra payment at the start of each 12-month period, it not only goes straight to reducing your principal, but it has a compound impact in causing a larger proportion of future payments to go to the principal. The result: you chop a full 7½ years off the end of your amortization. That should make those home-cooked meals taste even better.

It also helps to pay yourself first, a strategy made famous by David Chilton in The Wealthy Barber. Rather than saving what’s left over after spending, try saving a set amount from each paycheque by having it automatically withdrawn from your account. That forces you to allocate what’s left over after saving to various spending needs without the hassle of keeping a formal budget.

If you’re able to make sizable RRSP contributions, top up your savings by also salting away the RRSP rebate. If you can’t quite manage to scrounge up all the money at RRSP time to maximize your contribution room, consider taking out an RRSP loan. It works best if you can pay off the loan with the rebate. Say you’re in a 35% tax bracket and you have $6,500 you can contribute. Borrow $3,500 to bring your RRSP contribution to $10,000. As a result, you get an RRSP rebate of $3,500 a few months later, which you use to pay off the loan. If you have no cash to contribute to your RRSP, borrowing the full contribution amount might make sense, provided you pay it off in a few months.

When you get your hands on extra money, you’re probably torn between paying down the mortgage and saving for retirement. Generally, the mortgage wins: you need to pay it off before you retire just as much as you need to accumulate a nest egg. Malcolm Hamilton, who recently retired from Mercer Human Resource Consulting, says that after considering risks as well as returns, paying down the mortgage is the superior option. If you put RRSP money into stocks, you’ll probably earn a better return compared to paying down the mortgage, but you could also do a lot worse. Those interest savings are a sure thing.

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