In my last few columns I have discussed step 2 of Dave Ramsey's 7 Baby Steps (see http://www.daveramsey.com/new/baby-steps/). I love talking about getting out of and avoiding debt because it is an essential prerequisite for financial success. Now I think it's time to move on to other topics that cover what should happen after getting out of debt. Baby Step 3 is to build 3 to 6 months of expenses in savings, but I have discussed this step in previous columns.
In this column I will address 3 questions regarding Baby Step 4, which is to save 15% of income toward retirement.
Why should I wait until I'm out of debt with an emergency fund before saving for retirement? The answer is simple: FOCUS! You're not going to gain traction if you try to do too much at once. It is true that saving for retirement is very important, and the earlier you start the better, but I am only recommending that you put off retirement savings temporarily. With focus and discipline, the average family takes 18 to 24 months to complete Baby Steps 1 through 3. Once you are free from income-eating debt payments and have an emergency fund to prevent you from going back into debt, you will be in a great position to contribute to retirement.
Why 15%? 15% is not a magic number, but it's enough to make good progress toward retirement but not so much that it's a huge burden. Some of you will want to save less, but I encourage you to stretch yourself to reach this goal. Some of you will want to save more, but I encourage you to dial back unless you have a lot of extra money. Take anything extra you have above 15% and apply it to the next baby steps - fund kids' college, pay off your house early, build wealth in other ways (i.e. real estate), give money away, and yes, even spend some of it!
Where should I put the money? Definitely use a Registered Retirement Savings Plan (RRSP) and/or a Tax-Free Savings Account (TFSA). Both of these provide significant tax advantages. An RRSP allows you to invest pre-tax dollars (what you contribute is a tax deduction) but you are taxed on any withdrawals. A TFSA allows you to invest after-tax dollars (no tax deduction), but the withdrawals in retirement are tax free. If you have the same tax rate now as in retirement, the end result is exactly the same. Of course, we have no idea what our tax rate will be in retirement, so it's best to talk through your options with an advisor. You can think of an RRSP or TFSA as a blanket that protects your investments from taxes, but they are not the investments themselves. Even if you use an investment advisor, such as at a bank, make sure you understand what your RRSP or TFSA is invested in.
There is much to talk about on the subject of retirement planning, but I will leave it at that for this column. If you have any questions or topics you want me to address, please email me
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