We've only just begun...

By Anne Chun, C.A., CFP
Originally published in Forever Young

Over the holidays, my client John invited me to his father-in-law, Fred's retirement party. Fred has been asking John a lot of questions about his retirement and John wanted Fred to talk to me.

In this party, I also met Bryan, Fred's son. They are both starting a new phase in their lives and have "only just begun", as the song says.

Fred is 55 and has decided to take early retirement. His son, Bryan, is 25 and has just finished university. Bryan is starting full time employment on February 1. I had a brief discussion with each of them about some financial planning strategies.

First I talked to Bryan who is looking forward to his new job and making more money than when he was a student. He wanted to buy a new car, clothes, and to move out of his parents' house and eventually buy his own home. He is planning to propose to his long-time girl friend Amanda and start a family soon.

Typical of young people Bryan's age, he is both excited and worried. I suggested totalling the cost of potential purchases. Then, based on his take-home pay, determine a time line for these purchases. He should save some money for his wedding and down payment for a new house. Another often-overlooked priority is to start a Registered Retirement Savings Plan (RRSP).

The benefits of an RRSP include:

1. Saving taxes from his full-time employment.

When Bryan starts working full-time, he will not have any tuition and education tax credits. Contributing to an RRSP will save income taxes. Based on Bryan's salary, his marginal tax rate is approximately 30%. Therefore, his RRSP contributions will save taxes of 30 cents for every $1.

2. Tax free compounding of investment income within the RRSP.

Investment income is taxable, unless it is earned within an RRSP. Since Bryan is only 25, he will also benefit from tax-free compounding for many years. For example, by starting an RRSP with $1,000 and adding $1,000 every year for 25 years, this will grow to $63,000 plus assuming a rate of return of 7.00%.

3. Withdrawal of up to $20,000 towards the purchase of a home.

Withdrawals from an RRSP are taxable, except for Home Buyers Plan withdrawals. Bryan and his girl friend Amanda can each withdraw $20,000 for their down payment. Due to tax-free compounding, they can accumulate this faster within an RRSP.

4. Family Planning source of income.

If Bryan contributes to a spousal RSP for Amanda, he can deduct the contribution. After 3 years, Amanda can withdraw an amount from this plan and use it to supplement their income if she chooses to stay home with their new baby.

Fred has been listening and wanted to know what strategies he should have, for his retirement. I outlined a few points:

1. Maximize his RRSP contributions.

If he has not made his contribution, he should do so and get a deduction against his income before he retires. He may not have any RRSP contribution limit if he does not have "earned income" after he retires.

2. Determine whether part of his "retiring allowance" is eligible to be transferred into his RRSP.

This will lower his tax bill and increase the tax-free compounding inside his RRSP.

3. If his spouse is younger, continue to make RRSP contributions until she turns 69.

4. At age 69, consider rolling his RRSP into a RRIF or Registered Retirement Income Fund.

Contributions are made into an RRSP to build up a retirement fund. A RRIF is not an accumulation tool like an RRSP. You cannot add to it but must make minimum withdrawals each year. This can be used to supplement his pension income.

A RRIF can be started earlier than age 69, but since you won't be able to add to the balance, most people wait till 69 when they must close their RRSP.