It usually makes sense to co-ordinate contributions into your various plans, writes Frederick Vettese.Nadezhda Buravleva/iStockPhoto / Getty Images
Many Canadians saving for retirement will likely be putting money into two or more plans. There is the mandatory Canada Pension Plan, or CPP, and the Quebec equivalent, called QPP. And many are probably also contributing to a registered retirement savings plan, or RRSP, or a workplace pension plan.
It might seem obvious, but it usually makes sense to co-ordinate the contributions into the various plans. In other words, you want the total contributions to all plans to be a constant percentage of pay, or possibly a smoothly rising percentage.
What you don’t want is to contribute a high percentage of pay in your early years when your financial situation is likely the weakest.
To illustrate this point, let’s look at the case of a self-employed person named Victor. Victor is 30 and his business is just becoming successful. In year 1, he earns an amount equal to 80 per cent of the average national wage (which is currently about $70,000 so 80 per cent is $56,000).
Your retirement savings target is probably lower than you think
Victor expects to succeed and hopes to have his final pay at age 65 equal to three times the average wage, or about $210,000 in today’s dollars. His goal is to save enough to retire at 65 with retirement income from his RRSP, Old Age Security, or OAS, and CPP equal to 55 per cent of his final pay.
How much should Victor save each year in his RRSP? We can ignore OAS since it is a non-contributory plan.
The answer depends on how he is setting his RRSP contributions. If he is co-ordinating RRSP contributions with CPP contributions, he will contribute a minimal amount to the RRSP in the early years. In fact, he would contribute nothing for a few years since his CPP contributions will be so high (they are twice as much for the self-employed).
If he is stacking his RRSP on top of the CPP, his total contributions in his early working years will be much higher than later on. As shown in the chart, stacking makes little sense because he will be a lot more cash-strapped in his early years.
Why do many savers tend to stack RRSP onto CPP instead of co-ordinating their contributions from different sources? Likely it is because they are told to do so – look, for example, at the classic personal finance rule to “save 10 per cent a year every year in an RRSP.”
Second, figuring out the right contribution by co-ordinating contributions is more difficult but ultimately worthwhile. But there are calculators that can do that, and at the very least financial planners can do this too.
While people like Victor will have a hard time putting co-ordination into practice, there is no excuse for employers who sponsor workplace pension plans – both defined benefit and defined contribution – not to co-ordinate contributions. They have the resources to do so.
The takeaway is that it may seem strange or at least difficult to co-ordinate RRSP contributions with CPP but this is what most people should be doing.
Frederick Vettese is former chief actuary of Morneau Shepell and author of the PERC retirement calculator.
