According to a study by Deloitte, the savings rate in Canada is 3.51% while the saving rate in the US has climbed to 6.26%. Some have said that savings rates are affected but interest rates. If you think about it, savings rates peaked out back in 1981 at a 17% savings rate. In other words, people were saving 17% of their income. This coindentally happened where interest rates were also at their peak. Do we need interest rates to go higher to get people to save more?
How much should people save?
Although interest rates are low, that does affect people’s need to save for the future. But how much do people really need to save? One very common benchmark for savings is 10% of your gross income. Although this figure has been used for a long, long time, I first read about it 20 years ago when I read my first personal finance book, The Wealthy Barber by David Chilton.
Another benchmark in Canada is so save 18% of your gross income. This figure stems from the RRSP rules. In order to maximize your RRSP contributions you need to put away 18% of your gross income. Although rules are slightly more complicated than that, it can be a good (but not easy) target for savings.
Where can you save for retirement?
In Canada, there are a few common ways to save for retirement:
- Pension Plans – Pension plans are are the foundation of retirement planning. Unfortunately not every one is part of a pension. They are only offered through your work. There are two basic types of pensions – Defined Benefit Plans and Defined Contribution Plans.
- RRSPs – Registered Retirement Savings Plans are very well know in Canada as an account that every Canadian can use to save for retirement. RRSPs are appealing because of two key tax benefits. First you get a tax deduction when you put the money into the RRSP and then you get the benefit of tax deferred growth. The learn more about RRSPs, visit my RRSP online guide.
- Tax Free Savings Accounts – TFSAs have only been around since 2009 and the interest in these financial accounts is growing. Despite the merits of TFSAs and their growing popularity, TFSAs will not replace RRSPs for saving for retirement. When it comes to debating TFSAs vs RRSPs, both have merits. Instead of choosing one or the other, maybe it makes sense to do both. I love the TFSA but as I see it, the biggest problem is that many people do not have the discipline to leave the money there for retirement. It’s so easy to access this money and while that has advantages, it may not be ideal to save for retirement.
- Non-RRSPs – Prior to the introduction of the TFSA, your really had the choice of putting money into a RRSP or investing it outside of RRSPs (non-registered). The TFSA has really made the non-RRSP less attractive except that the TFSA limits prevent people from putting all their money into the TFSA.
- Pooled Registered Pension Plans (PRPP). The federal government introduced the concept of the pooled registered pension plan (PRPP) in late 2011 through Bill C-25, the Pooled Registered Pension Plan Act (PRPP Act). The PRPP is intended to provide a “low cost” and accessible retirement savings vehicle for Canadians who do not currently participate in an employer sponsored pension plan. I'm not sure that PRPPs will have a lot of success
Which account is the best?
Just like I always say, the simple answer is “It depends”. I’ve always said planning is personal and the best way to save for retirement really depends on your personal circumstances. Here are some general rules of thumb to help you out:
- Defined benefit pensions lead to more security in retirement because of the guaranteed lifetime income.
- People who contribute to pensions through work generally have an advantage over those that don’t because of the ‘free money’ from the employer and also the forced discipline of saving emposed on the employee
- The principles of cashflow are universal
- Outside of pensions, start with the RRSP first. Use my ONE FORMULA approach to determining if RRSPs make sense
- Success comes from being a disciplined saver. Do you have the savings gene? Developing the savings habit early can be one of the best financial habits you will ever develop.
- The principles of saving for retirement are truly simple, not easy.