Best.Retirement Plan.EVER!!!

The Exponentializer!!

That's the stupid name I use for this strategy, but the strategy itself is amazing.

If you are an employee of a company, who doesn't have a company pension plan or a group RRSP, then I would suggest you implement a savings plan similar to this and stick to it for life. If you can do that and you can invest patiently and wisely with someone you trust, it will work out just fine.

Let's lay it out...

Jim is 35 years old and has no savings to his name. He lives in Alberta and makes $65,000/year and doesn't expect his income to change much, with the exception of raises due to inflation. He wants to retire at 65 and has a life expectancy of 90. Jim's Marginal Tax Rate is 30.5%

Step #1

I tell Jim to save $500/month into his RRSP every month until he retires. This annual contribution of $6,000/year is going to generate a tax-return of $1,830/year.

Step #2

Jim is wanting to spend that $1,830 on a bunch of stuff that he doesn't need, because it feels like free money, but I tell him that if he wastes that money he will be defeating the purpose of contributing to his RRSP. Instead, I convince him that he needs to immediately take that $1,830/year and invest it into his TFSA.

Those are the only 2 steps. Now how does this look and pan out?

At the age of 65, Jim wants to retire and this is what his accounts look like if he generated an average annual return of 5.5%. Maybe he did better than that, or maybe he did worse, but it is a reasonable projection.

RRSP Value: $457,000
TFSA Value: $133,000

Now Jim is going to have 4 sources of income available to him, which are:

RRSP Income - $34,000/year (taxable)
TFSA Income - $9,900/year (tax-free)
CPP Income   - $13,608/year (taxable)
OAS Income  - $7,044/year (taxable)

TOTAL Income - $64,552/year

Now, before you get too excited and think to yourself that that was super easy and Jim only had to save $500/month to create a retirement income that is the exact same as his current income, you have to realize that the RRSP and TFSA income are not indexed to inflation.

In 30 years, even though he is able to pull out almost $45,000/year from his retirement accounts (RRSP and TFSA), realize that $45,000 is not going to be a lot of money in 30 years and will be even less in 55 years when he is 90.

CPP and OAS will go up over time, but that $45,000 will only be worth about $24,000/year when he is 65 if inflation is 2.0% over that time.

Therefore, he will have a Total income of approximately $45,000/year in 30 years and that number will dwindle down as he ages.

However, it should be sufficient, because Jim no longer has to pay for a mortgage or save that $500/month for retirement. He won't be rich, but he should be able to live a comfortable life that he's accustomed to.

However, if he wants to have more income in retirement, there are a few things he can do to jack that number up...

Other Steps

1. Increase his contributions with inflation. If Jim gets a 3% raise, he can increase his RRSP contribution by 3% to $515/month. Doesn't seem like much, but if he keeps doing it then he'll be golden, like Ponyboy. 

2. Save a bunch after he pays off his mortgage. Intentions for this are always wonderful, but people usually don't just decide to save every cent they have in extra disposable income once they are mortgage free. However, if he can increase his savings in those last 10 or so years, it will really help.

Back to the Exponentializer

Let's say that Jim didn't listen to me and never invested his tax-return into his TFSA, or never used it to pay his mortgage down faster, or never used it to pay off bad debt. Instead, Jim just used it to buy a bunch of cool things, which is totally fine and totally up to Jim, but is also a pretty big mistake.

That's because if Jim was wasting that tax-return, then he should have just invested that $500/month into his TFSA in the first place, because instead of having $457,000 in his RRSP, which would be taxable at an average rate of about 16% coming out, he could have a $457,000 TFSA account that he could access completely tax-free. His cash-flow could be about $5,500/year higher in retirement.


The Moral of This Story

Use your tax-return to your advantage and you will be set. Blow it on silly things and you'll regret.