Education on Pre-Retirement Planning is Critical for Millennials

Despite recent reports that Millennials are worried about facing tougher financial times in their retirement, a little information can go a long way for this well-educated generation.

Their concern can largely be dispelled by enhancing their tax literacy and boiling down this big issue into four important opportunities that can create significant future wealth. First, they have better opportunities to save through tax assistance than baby boomers did, primarily because of their access to the Tax Free Savings Account (TFSA). Here’s what saving the maximum $5500 a year at a 2% return brings you after 40 years: $338,855. Even that very modest growth keeps you ahead of inflation (at current inflation rates). Earning 1% more gives you a real return after inflation: at 3% return, your savings will reach $427,148 after 40 years. If inflation were to eat away 2% of those returns annually, your savings would still have a purchasing power of $271,564 after 40 years of deposits.

Second, younger people have longer lifespans in which to maximize the compounding time in their savings efforts. This means the earlier you start to save, the more traction you will have on your efforts to grow your investments. A Millennial who saves $200 a month, or $2400 a year, and earns 2% doing so will have $146,535 in 40 years and will at least keep up with inflation in a non-registered savings account. But that won’t be enough to stay ahead of the tax department. Earnings will have to beat 2% to get a real dollar return (based on the Bank of Canada’s target inflation rate); income source will make a difference too, as illustrated in the Knowledge Bureau’s Marginal Tax Rate Calculator.

Third, Millennials’ tax-deferred savings options through the RRSP have been enhanced by the ability to use the fund not just for retirement savings, but also for tax relief when major financial disruptions occur. Specifically, the Home Buyer’s Plan (HBP) can be accessed tax-free to help fund a home; in addition, going back to school later in life can be funded through the RRSP savings under the Lifelong Learning Plan (LLP). Both options require periodic repayments to avoid tax consequences. Fourth, many Canadian Millennials are earning more money than their parents did.  They will, therefore, be able to put more money into their RRSPs. But to take maximum advantage, they need to understand what earned income is according to the RRSP rules. Here’s a breakdown from Knowledge Bureau’s EverGreen Explanatory Notes: A taxpayer’s earned income for the year for RRSP purposes is defined in S. 46(1) of the Income Tax Act. It is composed of the sum of:

• Employment earnings minus union dues and employment expenses
• Net business income (subtract if a loss)
• CPP/QPP disability benefits
• Royalties from a work or invention
• Net rental income (subtract if a loss)
• Taxable support payments received
• Net research grants
• Employee profit sharing benefits
• Supplementary employment benefits

Less:

• Gains of Eligible Capital Property included in business income
• Deductible support payments

Note that for periods of non-residency, employment, business and rental income must be from Canadian sources. Millennials who are disciplined savers, with a good understanding of their tax consequences, can really pull ahead, despite expensive lifestyles. A good chat with a DFA-Tax Services Specialist and an MFA-Retirement and Estate Services Specialist can be a worthwhile investment. Alternatively, millennials may wish to take a certificate course on these subjects—it could be the best investment they’ll ever make. Knowledge Bureau features several online training options — books and certificate courses — to help.

Evelyn Jacks is President of Knowledge Bureau, Canada’s leading educator in the tax and financial services, and author of 52 books on family tax preparation and planning.

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