You’re probably used to hearing so-called experts in the financial industry tell you how important it is to save steadily for retirement starting early in your career. But you may wonder how that’s possible when you’re in your 20s or 30s and up to your neck in enormous mortgage payments and hefty child-care costs.
As is often the case, something has to give.
In my view, the best way to resolve this dilemma is take a flexible approach to saving. For many Canadians, it makes more sense to focus first on getting through the “financial crunch” years of huge mortgage and child-rearing costs. Try to do sensible things to keep your financial head above water during this period, like avoiding spiralling consumer debt. Then focus later on saving for retirement in a concentrated period.
The best-known advocate of this approach is Malcolm Hamilton, a retired actuary and senior fellow with the CD Howe Institute. “Saving for retirement is the deferrable one,” he argues. “You can’t say, ‘I’m going to have my children in my 60s when I can afford them.’ And it doesn’t make sense to raise your children and then, after they leave home, buy a nice big house.”
Of course, the traditional viewpoint is correct in telling you that saving a steady 10 to 15 per cent of your salary over a long career should allow you to achieve a comfortable retirement.
The experts are also right in warning you of a potential pitfall (one which Hamilton also acknowledges): after you get through the “financial crunch” years, you need to really focus on ramping up savings. At this point, salting away 10% to 15% of salary usually won’t cut it. You’ll need to put aside much more per year because you have a much shorter period in which to save.
Fortunately, your capacity to save tends to open up as you get through the financial crunch years. You gradually pay down the mortgage, and child rearing costs typically start to fall off after your children reach school full time. Often your salary continues to grow with raises and promotions that come with greater experience.
But what you do next is critical.
The “steady saving” traditionalists worry that when your disposable income expands, you’ll be tempted to spend the extra cash without putting enough into savings. But to the “save later” advocates, turning your focus to saving should come naturally. To them, it’s a matter of simply redirecting into savings the money that used to go to child-care costs and the bank, with no sacrifice to your accustomed lifestyle. From either perspective, you need to have the discipline to save what it takes when the time comes.
Of course, even if you have the best intentions, other factors impact the result. Timing is particularly critical. Typically, the potential to save starts slowly then snowballs. If you can reach the point where your mortgage is fully paid off and your children are financially self-sufficient while you’re earning a fairly high salary, you can usually save enormous amounts each year if you set your mind to it.
If you’re able to reach this point of pre-retirement super-saving for a lengthy period of, say, 10 years, you can build an impressive nest egg even if you have very little in savings to start with. On the other hand, if you continue to shoulder high mortgage payments and hefty costs supporting your kids into your 60s, then you may not have capacity to save nearly as much.
Because individual circumstances can vary so much, it’s important you figure out for yourself where you stand. Here’s where a financial plan focused on retirement can be a big help. Typically that kind of plan helps you set financial objectives for retirement and then maps out a savings strategy to get you there. It can help ensure you are on track for saving enough and not spending too much while you have plenty of time to boost savings further if need be.
Ideally you should draw up such a plan when your capacity to save starts to open up, which typically happens in your late 30s or early 40s (but could be earlier or later). However, it can still be an enormous help if — as is pretty common — you don’t manage to get to it until your late 40s or 50s or even later.
One question many people have when they get through the crunch years is whether they should focus more on building financial savings or paying down the mortgage. You’ll appreciate that building equity in your home and building your investment portfolio are both forms of saving. So it should come down to which approach motivates you most in the right way.
If you despise debt, focus on paying off the mortgage quickly and build financial savings later in a concentrated period. If you like the imposed discipline of regular mortgage payments, then just make the scheduled mortgage payments and put all the extra funds into building financial savings. If you like to see progress on both fronts at the same time, then make sizable RRSP contributions and use the RRSP tax rebates for extra mortgage payments. Each approach can work just fine.
Of course, there are other situations where the “steady savings” approach works best. If you never buy a home or have children, then you never go through the financial crunch years. In that case, you generally don’t have reason not to save a sizable and steady amount from early on in your career.
In addition, many employers match voluntary contributions you make towards a group RRSP or defined contribution pension plan up to a certain level. While it may be tough to keep voluntary contributions flowing during the financial crunch years, the “free money” generated by maximizing your employer’s matching contribution should usually trump the difficulty in scrounging up the funds.