Happy Days Were Way Back When

(Sung to the tune of Happy Days are Here Again!)

Happy days were way back when.
When retirement savings meant nothin’,
You had a decent pension, way back then.
Happy days were way back when!

Just a couple of generations ago, during most young adults’ grandparent’s heyday in the mid-fifties, the average retirement age in the U.S. was 68.4 for men and 67.8 for women. The good news was that life expectancy was 68.7 years. Ipso facto, not much worry about how to fund one’s retirement. And if you were so bold as to live beyond the age that you were actuarially expected to die, then you were probably supported by your former employer’s defined benefit pension plan.

Well. How things have changed. Although, as the Monty Python troupe described the hardships of their youth, today’s young adults may not have had to “walk three miles to school, through deep snow, uphill both ways”, they do face a much greater task of successfully executing retirement plans. The average retirement age in Canada is now 64 years old, and the life expectancy of a person currently aged 65 is 85.0 for men and 87.6 for women. As recently as 2017, the probability of one survivor of a couple living to 100 was 8.7% for a couple aged 65, 12.1% for a couple aged 45, and 15.7% for a couple aged 25. These days it’s probable that individuals will need to fund retirements that could last anywhere from 20 to 35 years.

The funds to support lifestyle expenses through retirement will generally come from three sources – government plans, private pensions, and personal savings.

The most commonly utilized government plans in Canada are CPP and OAS. The current maximum benefit from the Canada Pension Plan (CPP) for someone who begins to claim at age 65, is approximately $15,040 per year. The annual maximum from Old Age Security (OAS) is about $8,225, (this begins to get clawed back when your total income from all sources rises above $82,000 per year). These government programs are indexed to inflation so while the number will be greater in future years, you are not gaining any purchasing power. So, there’s your fall back. The best you can do with government plans works out to about three-quarters of what the average apartment in Toronto would rent for.

It’s possible that you may have contributed throughout your working years to a company pension plan, but that defined benefit plan that I talked about earlier is likely not your type. As life expectancies rose through the 1960’s, 70’s and 80’s, employers and pension consultants realized that it would be tougher and tougher to fund and maintain the extended flow of benefits to their plan members. Defined benefit (DB) plans quickly gave way to defined contribution (DC) plans, where employers are obliged to contribute to the plan on behalf of working members, but no longer obliged to pay defined benefits to its retirees. With this change, the responsibility of managing the investments in the plans shifted from an industry of investment professionals to individuals more interested in their children’s soccer schedules and summer vacations. Sounds dangerous.

The final source of common retirement funding is personal savings. Setting money aside from an early age can significantly supplement the retirement funds available from government programs and private pensions and is generally necessary to support a lifestyle similar to that lived while working. Considering that you may be spending it for 30-odd years, it’s not ridiculous to think that you should be saving for the same period.

So, what’s a (young) person to do?

Take advantage of the power of compounding.

The Rule of 72 allows you to calculate how many years it will take money to double, given an annualized rate of return. Dividing an annual return of, say, 7.2% into 72 means that your money will have doubled in 10 years. If you were to set aside $500 per month for 30 years and achieve a 7.2% annual return, after 30 years, your combined $180,000 in savings would be worth $634,613.

Take advantage of government savings vehicles.

Tax-Free Savings Accounts (TFSAs) shelter investments held within from tax on interest and dividend income, and capital gains. Savings should be made in a TFSA before using a non-registered account. The maximum contribution room for a person born before 1992 is currently $81,500. Each year, that amount increases. In 2023, the annual additional contribution will be $6,500.

Registered Retirement Savings Plans (RRSPs) can help reduce your income tax bill. Contributions made to an RRSP are tax deductible, thereby reducing the taxes you pay in the year the contribution is made. Investment returns within the RRSP are not taxable, but eventual withdrawals are. The higher your income and tax rate, the greater the benefit provided by making RRSP contributions.

Tax-Free First Home Savings Accounts (FHSAs) were proposed in the 2022 federal budget. While not currently available, if you imagine saving for your first home, it is proposed that the FHSA will allow you to make tax-deductible contributions, shelter your investment returns, and withdraw the funds to purchase your first home without paying any tax. FHSAs will effectively combine the best components of TFSAs and RRSPs.

Invest responsibly.

If you’re lucky, there may be a time when you can afford to lose all of the money invested in a risky investment. If so, then “swing for the fences” with the amount that you can afford to lose. However, your retirement savings should be invested in a high quality, disciplined, conservative manner. Permanent loss of capital caused by a bad investment is the greatest enemy to long-term returns.

Don’t count on inheritance.

With increased life expectancy, inflation and taxes, Mom and Dad will be hard pressed to make their own retirement savings last. While there may be something coming down the road, best not to count on it.

Young adults have a lot of exciting things going on in their lives – advancing careers, getting married, buying houses, having babies. All those things make the saving for retirement discussion seem pretty stodgy and boring. But speaking as a sixty-something, I’ll tell you that you won’t regret acting early.