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10 Retirement Savings Tips

By Olev Edur

For those whose retirement savings were invested primarily in stocks, calling 2002 a bad year would be a gross understatement. The benchmark S&P/TSX Composite Index lost more than 10 per cent during the year, some equity mutual funds lost more than 20 per cent, and some individual stocks lost more than half their value.

The net result, for many existing and prospective retirees, was a serious erosion in the value of their nest egg. If you are in this position, where do you go from here? How can you ensure you won’t lose even more money in future, while maximizing the mileage from whatever you have left?

Although there is no magic answer that guarantees investment success, there are many steps you can take to protect your retirement savings. For starters, consider the following 10 basic guidelines as you map out your financial future:

1. Pay off all personal debts. Before you invest in anything, you should be paying off all your outstanding personal credit card and loan balances, because the effective yield from doing so will likely exceed the yield from just about any other safe investment.

An 18 per cent credit card debt, for example, would be the equivalent of more than a 25 per cent pre-tax yield for someone in the lowest marginal tax bracket (income of less than about $30,000); a 7 per cent mortgage would equal a 10 per cent yield. And unlike stock market investments, these returns are totally guaranteed.

2. Don’t forsake equities just because they’ve gone through a bad year or two. Stock markets move cyclically and now that prices have fallen, this is actually the time to start thinking about stocking up again. In fact, while the overall yearly figures were bad, the markets did start picking up in November and December.

In choosing stocks, avoid the temptation to try for the big score. Look first of all for stocks of companies with a solid reputation and established earnings, the so-called “blue-chip” stocks that are household names. If a company sells good products and you’re familiar with them, you should be on as solid ground as you’ll find in the equity markets.

Bear in mind, too, that only half of any capital gains you earn will be taxable (assuming the investment is not inside an RRSP), and the tax generally doesn’t become due until you sell the asset. So you get a lower tax bill, and most of that (other than annual distributions) can be postponed as long as you care to keep the investment.

3. As a corollary of Tip #1, try to maintain a balanced and diversified investment portfolio at all times. You might want to consider adding to your equity holdings, but nevertheless you should also maintain a suitable amount of fixed-income investments.

The ratio between the two asset classes will depend on your age, risk tolerance, and personal preference, but balance and diversification are the two cardinal rules of investment at all times. You don’t want to overdo it, but you do want enough different investments in your portfolio that if one security performs badly, others can pick up the slack. If your savings are limited, consider mutual funds so you don’t end up paying out a big chunk of your profits for trading fees and commissions.

4. Consider stocks with solid dividend yields. Generally, these shares – either common or preferred – tend to be issued by large blue-chip companies with proven earnings ability. In fact, the reason they can pay dividends is because they are profitable, since dividends are simply profits redistributed to shareholders. And since those profits have already been taxed in the hands of the corporation, shareholders benefit from significantly reduced taxes on such earnings.
As part of the diversification process, keep in mind, too, that both capital gains and dividends receive favorable tax treatment outside an RRSP, but will be considered fully taxable income if earned inside. So wherever practical, give preference to keeping interest-bearing investments inside the RRSP, and capital gains or dividend-generating investments outside your RRSP.

5. Consider income trusts. Although these are a relatively new class of investment, they now have a 10-year track record of providing a reasonably high level of income – the average has been around 9 per cent a year on top of recent gains in value – while being relatively safe.

Some income trusts are riskier than others, of course – oil and gas royalty trusts, for example, tend to be more volatile than real estate investment trusts (REITs) – and the unit value can go down as well as up. But income trusts are really a long-term holding, designed to provide annual income rather than value growth, so these are paper losses or gains triggered only when you sell; in the meantime you earn a very good income.

In addition, because part of your earnings from income trusts are considered to be a return of your original invested capital rather than income, you get what may amount to a significant tax deferral on the proceeds. This can serve to further enhance your net earnings.

As a result, if chosen carefully, income trusts represent an ideal way for retirees to further diversify their retirement savings portfolio, especially since these securities tend to have different performance characteristics than both equities and fixed-income investments.

6. Minimize your holdings of low-paying GICs and term deposits. At 2 or 3 per cent, the returns from these instruments is barely enough to keep up with inflation and, after you pay tax on that interest, you may well be losing money in real terms.
As noted above, you should always maintain a portion of your savings in fixed-income securities but rather than GICs, you might want to consider fully guaranteed Government of Canada bonds, for example, whose current yields are in the 5 to 6 per cent range. At least that way you’ll actually be making money.

7. Think of your home as a special investment. Many prospective retirees think about downscaling their accommodations when the kids grow up and leave home. While this may be practical from a maintenance or lifestyle perspective, you could be better off financially by retaining that bigger home as long as you can.

The main reason a big house can be an attractive asset is because the value you build up in it will always be tax-free when you sell. You don’t lose a share of the proceeds to the taxman and in the meantime, any growth in the value of your home will not impact negatively on your entitlement to government benefits (see below).
If you don’t really need all that space in your existing home, you might put part of it to work for you by fixing up the basement and renting it out, or perhaps renting a room to an exchange student. The beauty of earning such income is that, although it will be taxable, you are allowed to deduct a proportionate amount of your home’s total expenses, meaning a good part of the income should be tax-free.

More adventurous and active souls might even consider buying a second property as an investment and renting it out. In that case, any gains in value will be taxable, and managing the property will entail a fair degree of work, but you can deduct all your property-related expenses from that income. And of course, you don’t need to pay capital gains tax until you sell the property.

8. Consider working part time after retirement. Although most people initially envision retirement as a time for not working, the simple truth is that doing nothing month after month can become boring as well as expensive. As a result, growing numbers of retirees find themselves working part time, acting as a consultant, or starting a small business.

Working into your retirement can be psychologically rewarding, and the financial impact of continuing to earn a paycheque can be immense. Because the need for income from your savings is reduced, those savings can be left intact much longer. And when left intact, they will compound faster, so there’s actually a double benefit.

9. Maximize your government benefits. Canada has excellent social security benefits for retirees, including not only Old Age Security and the Canada/Quebec Pension Plan (C/QPP), but also the Guaranteed Income Supplement and Spouse’s Allowance. The full OAS benefit is available to every Canadian age 65 or older (subject only to certain residency requirements, and to your income being no more than about $55,000), while C/QPP is based on earnings during your working career, and GIS and SA are for those with very low incomes. Provinces also have programs for those of limited means.

Trouble is, your income has to be almost nil in order to qualify for maximum GIS, and the annual benefit shrinks quickly if you earn other income during the year. For this reason, retirees with very low incomes should try to structure the income from their savings in order to ensure that they maximize their benefits in as many years as possible.

That is why owning a larger home can be advantageous – any growth in its value will not impact your GIS benefits, even when you sell. And investing to earn capital gains in general can be advantageous because your gains do not translate into income until you sell the underlying asset; in the meantime, you pay no capital gains taxes and your GIS remains unaffected.

Other strategies might include triggering a large gain in one year and using the proceeds to fund several years’ living, so that in the other years your GIS can be maximized. Or, you might want to rethink your use of RRSPs, because all your withdrawals will be considered fully taxable income that can reduce your GIS entitlement every year.

The strategies that are best will depend on your circumstances and preferences, and your options may be limited. But anything you can do to preserve your benefits will help, so make sure you take them into account in your retirement planning.

10. Look at the demand side of the equation. A penny saved is more than a penny earned, because you get to keep it all rather than sending part of it to Ottawa. If your retirement finances are tight, draft a detailed budget and see whether you can find ways to save a bit more. Shop around carefully, and keep your eyes and ears open for the many seniors’ discounts available. If you are as frugal as possible with everything you buy, you may be able to enjoy the retirement lifestyle you envisioned, even if at first you didn’t think you could afford it.