This is a guest post from Enoch Omololu from Savvy New Canadians, a personal finance website dedicated to discussing relevant personal financial information as it relates to money, investing, freedom from debt, frugal living, entrepreneurship, productivity, creating multiple streams of income, and much more.
One of the top questions people ask themselves (and financial advisors) as they age is: “how much income will I need in retirement?”
While the answer to this often results in a lot of handwringing and worry about a comfortable future retirement, we are a bit lucky in Canada to have default retirement income pillars and safety nets to fall back on.
Whether you will need a million dollars or more in retirement, a good place to start your journey is to first figure out your retirement income sources and then take things from there.
Canada’s Retirement Income Pillars
The “three pillars” of retirement income in Canada are:
- Old Age Security (OAS)
- Canada Pension Plan (CPP) or Quebec Pension Plan (QPP)
- Workplace pensions and private savings
Some type of a combination of all three pillars are crucial if you want to have enough money to live your dream retirement lifestyle.
Old Age Security
The Old Age Security is a monthly benefit paid to eligible retirees who are 65 years of age or older.
This publicly funded pension plan does not require you to make contributions during your working years. You don’t even need to have worked at all. Instead, the amount you receive is based on how long you have lived in Canada as an adult.
For example, you qualify for the full old age pension if you have lived in Canada for at least 40 years after turning 18. Since the benefit is calculated based on a 40-year residency, someone who has lived in Canada for 20 years as an adult would only receive half of the full OAS pension (i.e. 20/40th).
Eligible retirees can delay their OAS pension for up to 5 years until age 70 in exchange for higher payments equivalent to an increase of 0.6% each month the benefit is deferred.
The OAS also includes other benefits including the Guaranteed Income Supplement, Allowance, and Allowance for the Survivor benefits.
Guaranteed Income Supplement
Seniors with a low income may qualify for an additional benefit under the OAS.
The Guaranteed Income Supplement provides extra monthly payments if your income falls below an annual threshold published by the government.
Unlike the OAS and CPP benefits, GIS payments are non-taxable.
The spouse of a GIS recipient or a low-income surviving spouse aged 60 to 64 years old may also qualify for the Allowance and Allowance for the Survivor Benefits respectively.
What happens to OAS and GIS if you move abroad?
A good question to ask is whether you will continue to get these benefits if you decide to retire in a foreign country. Snowbird, anyone?
OAS benefits continue to be paid if you have lived in Canada for 20 years or longer after age 18. If not, you get the cheques or direct deposits for 6 months after leaving Canada and then the payments stop.
GIS benefits stop after you have been outside of Canada for 6 months and only resume when you again become a resident.
How do you apply?
Service Canada will send you a letter if you have been automatically enrolled into the OAS pension. If you do not get a letter after turning 64, you should contact them to inquire about applying.
Online OAS applications can be completed through your My Service Canada(MSCA) or you can print and complete the paper form ISP-3550.
You can also reach the OAS by phone at 1-800-277-9914 to inquire about your eligibility.
Canada Pension Plan
The Canada Pension Plan (CPP) is a monthly benefit paid to eligible seniors who have made at least one valid contribution to the plan during their working years. In Quebec, it is known as the Quebec Pension Plan (QPP).
Unlike the OAS, you can only receive this retirement pension paymentif you have made contributions from your paycheque to the plan.
The standard age to begin receiving CPP benefits is at age 65.
You can choose to collect CPP earlier at age 60 and receive a reduced pension. Alternatively, you can also choose to delay collecting CPP for up to 5 years, in exchange for higher monthly payments equivalent to an increase of 0.7% for every month your CPP benefit is delayed.
Other CPP-related benefits include the disability pension, survivor’s pension, children’s benefit, and death benefit.
What happens to CPP if you move abroad?
Because you contributed to the CPP or QPP, your payments continue whether you live in Canada or abroad.
When abroad, a 25% withholding tax rate is applied to your payments except in cases where your country of residency has a tax treaty with Canada that may change the tax rate applied.
How do you apply?
You can apply for the CPP online through your My Service Canada Account or by completing Form ISP-1000 and mailing it to a Service Canada office.
Online applications are processed within 7-14 days, while paper applications sent by mail can take up to 120 days.
Workplace Pensions and Private Savings
Your employer may offer a registered pension plan (RPP) or group registered retirement savings (GRRSP).
The two common RPPs are:
- Defined Benefit Pension Plan (DBPP), and
- Defined Contribution Pension Plan (DCPP)
For defined benefit pension plans, you know how much your monthly pension income will be in retirement based on a formula that includes your annual earnings and years of service.
With defined contribution pension plans, you do not know how much your retirement benefit will be as it is not guaranteed.
Group RRSPs are like individual RRSPs, except that they are offered through an employer and may also include employer contributions.
Workplace pension plans are not what they used to be. Defined benefit pension plans are not as common and with the rise of contractor/freelance job positions, you may not even have access to an employer-sponsored retirement plan.
As such, it is increasingly important to build up your personal savings using the:
- Registered Retirement Savings Plan (RRSP), and
- Tax-Free Savings Account (TFSA)
Registered Retirement Savings Plan
The RRSP is a type of registered investment plan you can contribute to while working.
Each year, you get an RRSP contribution room that is equivalent to 18% of your earned income up to a specified maximum. For example, the maximum RRSP contribution limit in 2022 is $29,210.
You can hold a variety of assets in your RRSP account including:
- Exchange-Traded Funds (ETFs)
- Mutual funds
- Guaranteed Investment Certificates (GICs)
- Precious metal certificates
You can also hold alternative investments such as investing in cryptocurrencies, commodities, and real estate using ETFs.
Investment income such as interest income, dividends, capital gains, etc. earned in your RRSP are not taxed until you begin making withdrawals in retirement.
You also deduct RRSP contributions from your taxable income, resulting in tax savings when you file your income tax return.
Tax-Free Savings Account
Like the RRSP, the Tax-Free Savings Account (TFSA) is a registered investment account, and you can use it to save for retirement. The TFSA also works well for other short- and long-term financial goals.
Canadians who are 18+ years of age can contribute to a TFSA account and invest their money in the same assets you can hold in an RRSP.
While TFSA contribution are not tax-deductible, your investment earnings are tax-free for life.
The TFSA contribution limit in 2022 is $6,000 and if you have been eligible since the account was introduced in 2009, your total contribution room is $81,500.
How To Calculate Your Retirement Income Needs
Everyone’s retirement is different and how much you will need to retire comfortably will depend on your planned lifestyle, health status, the age at which you retire, and more.
Experts often advise that you aim for a retirement pot that can provide 70% to 80% of your pre-retirement annual income.
Your needs may be lower if you have a paid off home, no financially dependent children, and you are not making significant changes to your lifestyle. Or you may need much more funds if you have health problems or are looking to live a lavish lifestyle.
Simply put, retirement income needs are not black and white. You will need to figure out what works for you.
To start, let’s look at how much you can expect from the OAS and CPP.
Using numbers for 2022, you could receive a maximum of $7,784 in OAS pension per year (i.e. based on $648.67 per month). For the CPP, the maximum in 2022 is $15,043 (i.e. based on $1,253.59 per month). Combined, the maximum OAS and CPP in 2022 is $22,827 per year.
The reality for most people is that these amounts are lower, and you can see this by looking at the average monthly amount for the CPP which was just $779.32 as of January 2022.
If you have decided that your retirement lifestyle will require at least a $75,000 income per year, the current OAS and CPP maximum amounts leave you with a deficit of $52,173 (i.e. $75,000 - $22,827).
To cover this shortfall, you may need to rely on workplace pensions and your private savings (TFSA and/or RRSP).
So, how do you estimate how much you need to have in these accounts? We can use the 4% rule* which tells us how much you need to have based on how much you plan to withdraw.
For an extra $52,173 per year, the 4% rule tells us you will need $52,173 / 0.04 which is equivalent to $1.3 million (also calculated as $52,173 x 25).
Also, this rule tells us that you will likely not run out of money based on this safe withdrawal rate for at least 30 years.
These are just examples of course, and your retirement income needs are yours to decide.
*The 4% rule was developed by William Bengen. It assumes your portfolio is balanced and that you will adjust your withdrawal amount for inflation every year. It also assumes historical market return averages will continue to hold in the future and does not include taxes or investment fees.
Time is your friend when you are saving and investing for retirement. The earlier you start saving, the better.
Along with putting money aside in an investment portfolio, you should also consider other things like creating a will, getting life insurance, and finding ways to minimize your taxes as part of your retirement checklist.