“It seems that an RRSP is basically the worst investment vehicle you can put your money into.”
Those were my friend’s words as we were discussing the upcoming RRSP contribution deadline for 2014 (it’s today, by the way). Why such pessimism? Because the RRSP is getting put through the ringer lately, being pegged as a last resort only if you have nowhere else to stash your cash.
Personally, I love the RRSP as a savings vehicle. I always have. I’ve been nursing mine with monthly contributions since my 25th birthday (I’m now 29): I even blogged about it right here. I’ve frequently said the magic number to get into your retirement accounts by age 30 is $25,000. It hasn’t always been met with a positive response, but I stand by it.
If you manage to put $25,000 into your retirement accounts by age 30,
you only have to save $200/mo and earn 9% (below the historical average for the stock market) from then on to retire at 65 as a millionaire.
In other words, clear that $25,000 hurdle and you’re off the hook for painful scrimping and saving in your 30’s, 40’s and beyond.
So why are so many young people, like my friend, NOT saving for retirement now?
We’ve scared them out of it!
The RRSP vs. TFSA debate has taken polarizing sides, and young people that aren’t familiar with the nuances of each vehicle are heeding bad advice. As a result, millennials are not saving at all, not saving enough, or saving in the wrong places.
I don’t blame them. If you’re new to personal finance, the rules, acronyms, and choices are overwhelming. Couple that with strong debates on what’s the best option, and you end up with millions of confused young Canadians saving next to nothing.
I understand all the reasons not to opt for an RRSP in your twenties: your income is low so you don’t need the tax break, you can’t predict what your income will be in retirement so you don’t know if you’re paying higher taxes now or later, the TFSA is the magical unicorn savings account, and so on. But people don’t hear “this is how you determine the best tax-advantaged account for you right now” they just hear “RRSPs are bad”. And so they don’t put any money in them.
We need to change our message. And the first part should be, “the TFSA is not enough”.
The TFSA is an invaluable savings tool, but it isn’t without flaws. Because people can withdraw contributions without penalty, no one using the TFSA at it’s real capacity. On average, Canadians have only $17,450 in their TFSAs — about half of the actual contribution limit. TFSAs haven’t really been sold as a retirement savings tool. We’ve been telling people to save up for everything from vacations to weddings in their TFSAs. I only recently changed my tune as early as 3 months ago, finally admitting that your TFSA is for saving for retirement. Prior to that I stupidly kept all my planned spending in my TFSA and smugly patted myself on the head for being such a great saver. It wasn’t until those articles came out about people getting to six-figures in their TFSAs that I realized my revolving-door contributions and withdrawals had totally screwed me out of a huge earning opportunity. I’m in a hurry to mend my ways, but I can never get back the earning potential I’ve missed out on.
The RRSP is inherently more complex than the TFSA, but it still provides a smart savings space for Canadians. If you’re young and have money to spare after maxing out your TFSA, the RRSP is your next best bet. If you don’t need the tax break and think you’ll be earning more later, simply make your contributions now and claim them in future years when your income is higher. The RRSP has a tax-penalty that’s painful enough to deter early withdrawals. Consequently, the money is often left to grow unhindered by the temptations of now. It will bump along, attacked by market downturns and facing erosion by inflation, but will ultimately emerge in a tidy sum at the end that will spare you eating cat-food and living in a cardboard box.
If someone begins saving $5,000 per year at age 25, by retirement they’ll come out $200,000 ahead of someone who starts at age 30, assuming a modest 5% return. This means their 5-year head start only cost them $25,000 out of pocket, but produced an extra $175,000 in retirement income.
Let’s start communicating to 20-somethings that it is better to pay income taxes on an extra $175,000 in retirement, than to pay no income taxes on $0.
Right now, young people are running from the RRSP and half-assing their TFSAs. They’re reluctant savers because saving is painful and annoying and there are too many options. It is easier just to “do it later”, when it matters more but the best opportunities have passed. By pushing the TFSA vs. RRSP debate, all we’re doing is creating an either-or equation in people’s minds, and they’re picking sides. Imagine if we instead told them to save in both accounts and outside of them.
We’re doing a disservice to millennials by pretending the saving and investing conversation is a complicated one. The message is simply, “save now, have more later”.