phases, based on your life stage. During each stage, there are specific
investment and financial strategies you should consider to help you achieve
your retirement goals.
Life Stage 1 – Building your retirement nest egg
- Start
early to maximize the impact of tax-deferred compounding over time - Catch
up on any unused RSP contribution room as soon as possible - Contribute
earlier in the year or on a monthly basis to enhance growth potential - Consider
opening a spousal RSP to reduce future taxes
Starting early – the power of tax-deferred compounding
It’s important to get an early start on building your
retirement nest egg – whether you’re saving through a Registered
Retirement Savings Plan (RSP), Registered Pension Plan (RPP), or both.
The earlier you start, the greater the impact of
tax-deferred compounding. Because any income earned within your RSP (or pension
plan) accumulates tax-free until withdrawn. If possible, contribute the maximum
every year, while catching up on any unused contribution room from previous
years.
How you time your RSP contribution can also make a big
difference. If you contribute $5,000 at the end of each tax year for 30 years,
your RSP will be worth roughly $566,000, assuming an 8% annual growth rate. But
if you contributed the same amount in monthly installments instead, your RSP
would be worth approximately $587,000. And if you contributed the lump sum at
the beginning of each tax year, your RSP would be worth about $611,000 –
$45,000 more than if you contributed at the end of the tax year.
Reducing tomorrow’s taxes – today
A spousal RSP is an excellent way to potentially reduce your
future taxes. With a spousal RSP, the goal is to equalize retirement income
streams between you and your spouse.
For example, if you have one retirement income of $100,000
and pay income tax at a marginal rate of 45%, you would pay $45,000 in tax,
leaving you with $55,000. But if you had two smaller income streams instead,
$50,000 each, you would pay tax at a lower marginal tax rate on each of the
incomes, resulting in lower combined taxes. Assuming the tax rate is 35%, you
would only pay $35,000, saving $10,000.
Life Stage 2 – Protecting what you’ve built and taking
it to the next level
- Reduce
risk and enhance return potential with advanced diversification strategies - Rebalance
your portfolio to ensure the optimum level of global diversification and sector
diversification
Advanced diversification strategies
Diversifying your investments is a proven strategy for
reducing risk and increasing return potential. One of the fundamental ways you
can diversify your investments is by asset type – stocks, bonds and cash.
Stocks provide long-term growth potential, while bonds and
cash provide a safety cushion.
But diversifying by asset type is just a starting point when
it comes to properly diversifying your retirement savings. You should also
consider other diversification techniques, including:
Global diversification. Studies show that a portfolio
balanced between Canadian and global investments reduces risk and enhances
return potential. With the elimination of the 30% foreign content limit in
2005, it’s now much easier to increase your level of global diversification.
Sector diversification. Today, stocks tend to perform based
on the industrial sector, regardless of international borders. Diversification by
sector, in addition to international exposure, may enhance your opportunity for
greater returns.
Life Stage 3 – Maximizing your retirement income
Consider alternatives to boost your after-tax income
Boosting your income
Getting the income you need from your retirement savings can
be a challenge given the low interest rates currently offered by GICs and
government bonds. Seeking higher income, retirees are increasingly turning to
other investments, like corporate bonds, income trusts and dividend-paying stocks.
The key is maintaining the right balance between secure investments and
investments offering the potential for higher income.
Corporate bonds. Carefully selected high-quality corporate
bonds can provide higher interest payments compared to a government bond,
without substantially higher risk. Risk is determined by the credit rating of
the issuer. A high-quality corporate bond issued by a well-established
corporation may have a credit rating of “A” compared to “AA” for a government
bond. A medium-grade corporate bond might have a credit rating of “BBB” but
would most likely offer a higher interest rate to attract investment.
Income trusts. Like stocks, income trusts are publicly
traded equities and should be considered part of the equity component of your
portfolio. But unlike stocks, income trusts distribute most of the cash earned
from underlying assets directly to investors. Income trusts can provide much
higher income than bonds, but bear in mind the distributions are not guaranteed
and can vary.
Dividend-paying stocks. You can boost your after-tax income
with dividends from Canadian corporations, which are effectively taxed lower
than interest income due to the dividend tax credit.
John Exler is an Investment Advisor with RBC Dominion
Securities Inc. This article is for information only. Consult with your
professional advisor before taking any action.john.exler@rbc.com905-895-2949