By Guest Blogger Sinan Terzioglu
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A recent bank poll found a third of Canadians, 45-54, have no retirement savings. About 20% have under $50,000. On average Canadians have saved around $200,000, but most estimate they’ll need $750,000 to fund a comfortable retirement. Depending on lifestyle and years of retirement to fund, $750,000 may not be nearly enough. As life spans increase, more and more Canadians will be living their later years with health conditions, continual inflation, and personal debt that continues to build. They’re heading towards a retirement crisis. Are you?
Everyone’s goals and circumstances are different, so retirement planning is not a one-size-fits-all scenario. The same bank poll found more than half of Canadians didn’t know if they’d have enough savings for retirement. This is a huge risk we’re not taking seriously enough.
Most have no employer pension plan to force savings, so they must create and consistently contribute to their own pension-like portfolio. This should begin with setting aside (ideally through automatic direct deposits) at least 10-15% of income into tax advantaged accounts like RRSPs and TFSAs. When those are full, funds should be directed towards non-registered accounts. While these accounts don’t have initial tax advantages they can form an important part of your retirement income plan. Withdrawing from non-registered accounts first allows the funds in tax deferred RRSPs to continue to grow, pushing out the tax burden. It also maximizes the tax advantage of TFSAs.
Many believe real estate is the only retirement plan required. Housing in many Canadian markets has done very well over the last 30+ years, leading to believe that will continue. But this ignores valuation and personal/family balance sheet risks which could be financially very destructive. Only a generation ago, housing costs were recommended to be no more than three times your income. In Toronto today, a house costs over 10 times the average family after-tax income. In fact, Canada has the highest median home price to median income ratio in the world.
I recently had a discussion with a couple in their mid-30s about their retirement goals. They were thinking of purchasing a house, and planned for this to be a large part of their retirement savings. They were trying to identify an upper price range that would allow them to be comfortable day to day, and still allow saving for retirement. They have a young child with another on the way so they would like more space and a yard.
Their net worth is $500,000 with $250,000 in RRSPs, $25,000 in TFSAs and the rest in cash ready for a down payment. Their jobs are stable but they don’t expect significant income growth throughout their careers. They collectively earn $200,000 and have no employer pension plans. Houses in their desired area are in the $1,000,000 to $1,250,000 with rents of similar properties at $3,000-$4,000 a month. Taking an investor view, this would work out to a cap rate of 3-4%, barely ahead of inflation and significantly lower than historic real estate returns.
This couple’s parents had bought homes 30 years ago for $300,000 which are now valued around $1,300,000. This works out to a compound annual return of 5%. They, like many, have come to believe these historical returns are an expected outcome of real estate ownership. Property has risen traditionally by the rate of inflation, which in North America has been 2-3% over the last number of decades. I explained it is very unlikely residential real estate would again outpace inflation by such a wide margin. If values were to stagnate or contract that would result in significant lost opportunity costs for their family.
Assuming they paid $1,000,000 and put down 20%, amortized over 25 years at 2.65% their monthly payment would be $3,650. Add to that property taxes, insurance, maintenance and the monthly outlay reaches $4,500-$5,000 plus the significant land transfer tax they would have to pay. While their after-tax income would comfortably cover monthly costs they’d be taking on a significant financial risk. First, because the valuation is so high there’s little margin of safety. If real estate prices contract by 10-20% (very possible) the value of the property would drop by $200,000, wiping out their equity and cutting their net worth by half. If they continue renting, invest the $200,000 plus the additional savings from lower rental costs and achieved a 6% annual rate of return this would grow to between $400,000 and $500,000 in 10 years.
After much discussion about their lifestyle, comfort and retirement goals, my advice for this couple was to hold off on the purchase, or consider less expensive options. We spoke about more affordable areas where they might find the space and yard at a price that was manageable for them. This is becoming increasingly possible with remote work options today. If they decided they must be in their desired area, we discussed renting for 5-10 additional years to build up their net worth before purchasing. By delaying an expensive housing purchase they would be able to prioritize early retirement contributions, giving the funds more time to grow over their working years instead of trying to play catch-up closer to retirement. By building up their assets first they would have more flexibility, lower financial risks and importantly for them, less stress and worry when buying later. It would also allow them to comfortably fund their children’s educational savings early on.
When thinking about your long term retirement goals, first understand what you will require on an after-tax basis, indexed to 3% inflation. Work backwards to develop a savings plan allowing those goals to become a reality. Understanding retirement cash flow requirements will make prioritizing savings much easier. As Garth says, you can always rent a roof over your head but you cannot rent cash flow. Ensure you are always on track to build up enough liquid assets so that your money works for you so one day you no longer need to work for money.
When you have enough in liquid financial assets that consistently produces monthly cash flow to cover fixed and variable expenses you’ll have achieved financial independence. This will give freedom and choices. The pandemic has proven just how important financial risk management is. There is no such thing as job security now. Costs will continue to rise. Financial savings should be your number one priority. After that, if you can afford to purchase real estate, go for it. But never, ever make the mistake of thinking it is the only retirement plan you need.
Sinan Terzioglu, CFA, CIM, is a financial advisor with Turner Investments, Private Client Group, Raymond James Ltd.