So i’ll start this one of with a couple of disclaimers, first off that neither one of us are professional financial planners – so before making any decisions contact your tax professional/planner.
The second is that we will use some generalizations in this post for simplicity, if you have extraordinarily high expenses or some other outliers in your life then you may have to account for those in your own calculations.
Now, with that out of the way what is it we’re getting at here today? Well that’s the thought of a self-funded, tax protected retirement fund to live off of forever without having to pay any (or very little) taxes! How? Glad you asked.
We’re going to start with what it costs you to take from your RRSP account as taxable income. As of 2019 you can pull approximately $14,650 from your RRSP account, which in Alberta will cost you a withholding tax of of approximately $2,930. Not exactly tax free is it? Well no, not immediately. But you will get the entirety of that $2,930 back at tax time which does result in the entirety of the $14,650 ending up in your pocket from your RRSP account ($11,720 up front, $2,930 in tax season).
Now- who out there has a spouse? If you are in a coupling of some sort then you and your mate can each pull this $14,650 amount out resulting in $29,300.
Can a couple live off of $29,300 per year? Probably not, unless they’ve got a paid off house, car and don’t intend to travel a whole bunch- but in a low cost of living location it is definitely possible.
How do we tackle the rest of what is needed then? Enter the Tax Free Savings Account (or TFSA).
The TFSA is left out of income tax calculations altogether, as in you don’t need to tally this income up anywhere else while calculating taxes payable for the year. The current limit for the year of 2019 was $6,000 with a total since inception a person could contribute is $63,500. Now, assuming you’re able to max this out year on year for say 25 years you’re looking at $175,000 in additional contributions + the $63,500 you already had in there = $238,500 per person!
I understand that’s a hard task to continue maxing this out year over year for a lot of people out there, but keep in mind these numbers above are also assuming a 0% return on your investments which if you ask a majority of the investing community out there, a 7% return in more than reasonable so we’re really playing worst case scenarios here.
For some context, if a 40 year old right now had their $63,500 saved and just left it without making another contribution until they were 65 with a 7% return they’d be left with approx. $344,640! — If you x2 these numbers for a couple, then again you start to see how easy it might be to supplement your $29,300 per year we are getting from our hypothetical RRSP withdrawals and bring us up to a more comfortable living standard.
Now, at the start we mentioned a never ending fund. This is our personal favourite part of this whole scenario. The secret to this step is a simple one: DIVIDENDS. For this quick calculation we will use a married couple striving for a $50k income in retirement combining their joint efforts of saving and investing during their working lives.
What we’ve established is that $29,300 will come from RRSP and $20,700 will come from TFSA’s. Assuming a dividend yield of 4.5% which is good, but not unrealistic by any stretch the couple would need the following balances:
RRSP: $29,300 / 0.045 = $651,111 or $325k per person.
TFSA: $20,700 / 0.045 = $460,000 or $230k per person.
Two very noticeable benefits of this method are that dividends tend to raise at a higher rate than inflation, meaning you’ll increase your buying power over time. The other is that when you pass on you leave virtually your entire nest egg on to your children which will be quite a sizeable amount.
We hope that this raises some questions for you and potentially changes the way you think about your retirement numbers moving forward. This is meant to be an exercise for each individual to work through on their own to see where they are personally at and how these benefits can help them in their own situations. If you’ve got any questions please feel free to ask and we’ll get back to you.
Thanks for stopping by,
Mr. FIC