THE ROAD IS GETTING SHORTER FOR MILLENNIALS SAVING $1 MILLION
TFSA likely the best way to start to build retirement fund,
If you’re a millennial just embarked on saving and investing, you should know the opportunity to put another $6,000 into your TFSA as of Jan. 1 each year is one you shouldn’t pass up. Why? There are a million reasons why doing so every January for the next 45 years is your best route to building a hefty retirement fund.
Unlike a million-dollar RRSP, a million-dollar TFSA is all yours to spend, free of taxes on investment income and withdrawals. A $1-million RRSP really belongs about 30 per cent or 40 per cent to the government after taxes incurred once you start to withdraw from it.
Not so with the TFSA, which lives up to its name: tax-free savings account. If you annuitize and earn a 4.7-per-cent return in a TFSA, that will earn you a taxfree annual $55,000 retirement income for 25 years!
The key is to start now, ideally when you turn 18, which is when you can first invest in one. Every January, contribute another $6,000, or more as inflation adjustments occur. Do this for 47 years until you reach 65, which means coming up with and contributing $282,000: 47 multiplied by $6,000.
But that’s just the initial contribution value. With proper investing in some combination of stocks and bonds, or ETFs holding them, balanced portfolios should get you to a million well within this time frame. While a five-per-cent return gets you there in 45 years, six per cent gets you there in 41 years, seven per cent in 37 years and eight per cent in just 34 years, estimates wealth adviser Matthew Ardrey, vice-president with Toronto-based TriDelta Financial Partners. “An eight-per-cent return over a long period of time may actually be reasonable for someone with sufficient risk tolerance to stick to a plan through all of the markets ups and downs.”
That could leave you with a million dollars in your early fifties, and ready for a final push of prime compounding.
The evidence suggests coming up with contribution money is doable for most Canadians, even if it’s at the expense of RRSP contributions. BMO’s latest
TFSA study found 66 per cent of us have TFSAs, with average contributions of $5,332, up from $4,826 in 2018. Average balance is $28,214, up from $27,053.
Financial planner Aaron Hector of Calgary-based Doherty & Bryant Financial Strategists says individuals can get off to the fastest possible TFSA start by saving up even before they can put the full $6,000 into an initial contribution at 18. “This allows the TFSA to start compounding sooner than if someone simply started to sock away $500/month starting at age 18.”
Since the TFSA limit rises by $500 increments to keep up with inflation, Hector estimates that at two-per-cent inflation we can expect a bump every four years or so, which may shorten to every two or three years as contribution amounts gets larger. Under those conditions, by the time our 18-year old is 65, the annual contribution rate will be a whopping $15,500.
While a strategic mix of RESPs, RRSPs and TFSAs is advisable, starting the race to $1 million “with a TFSA is likely the best and easiest way to take off from the starting line.” However, he cautions the feds could change the rules, as occurred after the Harper government bumped the limit to $10,000 only to have the Trudeau administration lower it back down to $5,500. Also, debt repayment should take priority over the TFSA. One veteran financial adviser says a $6,000 TFSA saves only $72 a year in tax on a three-per-cent GIC investment, while an unpaid $6,000 credit card balance at 29-per-cent interest costs $1,740 in after-tax money.
So recent graduates should prioritize paying down student loans and credit-card debt. Sylvain Brisebois, a regional president for BMO Private Wealth, created a spreadsheet to estimate the impact of missing contributions in early years. If you can’t start until 25, a six-percent return generates $1,049,000 by age 65, $600,000 less than the $1.63 million earned with the extra $42,000 you’d have saved and compounded starting at 18.
Another scenario is contributing for seven years between 18 and 25, then using it to buy a home. Assuming no more contributions the next 10 years and resuming $6,000 contributions at 36, by age 65 you’d have $829,000. Brisebois also created a scenario where you only contribute $3,000 a year, which generates $815,000.
Adrian Mastracci, portfolio manager for Vancouver-based Lycos Asset Management Inc., says many investors start saving at age 30, young enough to be 80 per cent or more in equities in TFSAs, if life expectancy is 85. By 60, assuming you live 10 more years, he suggests the overall asset mix across all vehicles (not just TFSAs) should be a more balanced 50-per-cent equities to 50-per-cent fixed income; but the TFSA asset mix can range between 50 per cent to 80 per cent in equities, assuming an investment horizon extending to age 95 for at least one spouse.
The ability to compound savings and investments tax free is one of the most powerful tools for building wealth, and the sooner you start, the shorter the road to $1 million will be.