Investing for retirement is generally a lifelong journey, however, high investment costs can make your journey to financial freedom even longer. Or worse, the excessive fees you have paid over the years may hinder you from ever reaching your retirement income goals.
This fee example provided by Vanguard drives the point about the impact of investment fees on returns.
If you invest $100,000 at a 6% annual return for 25 years and zero fees, you will end up with $430,000. On the other hand, if you paid 2% in fees on the same $100,000 and earned 6% every year for 25 years, your net worth ends up being a very diminished $260,000.
The fact is that fees matter.
How Robo-Advisors Can Help
Self-directed investors can lower their investment costs by using an online discount brokerage to build and manage their portfolio.
However, not everyone has the know-how or confidence to set up a globally diversified portfolio, buy and sell investment securities, rebalance their portfolio and stay calm when the markets go awry.
This is where robo-advisors like Wealthsimple come into play. They simplify the investment process so you can sit back and relax.
Not only that, but they also charge a significantly lower fee compared to what you would pay a full-service investment advisor or to your bank’s mutual fund manager.
When you compare your total robo-advisor costs (~0.70%) vs. the average mutual fund MER (~2%), you are saving roughly 1.30% in fees every year.
This is not insignificant, especially on larger portfolios. On a $100,000 account, you are easily saving $1,300 every year.
Robo-advisors offer a variety of accounts you can invest in including TFSA, RRSP, RESP, RRIF, LIF and non-registered investment accounts. They provide you with a customized portfolio that reflects your risk tolerance and investment objectives.
I consulted with Michael Tempelmeyer who is a senior investment manager at Wealthsimple on what investors should consider when thinking about asset allocation for their portfolio.
There are 3 main things to consider when deciding how much risk to take in a portfolio:
- How long you plan to have the money invested.
- How much risk you are comfortable with, which is another way of saying how much potential downside exposure you are willing to have.
- What type of long term average annual return you want to try to generate.
Wealthsimple Investing: TFSA vs. RRSP
When you are in your accumulation phase, an RRSP and TFSA are two of the most important accounts you should consider for growing your retirement pot.
Here are Michael’s thoughts on the popular TFSA vs. RRSP conundrum:
Using an RRSP to save for retirement makes sense when all of the following are true:
- You don’t plan to access the funds until retirement.
- You anticipate a lower or similar average tax rate in retirement than in your working years.
- You have enough earned income in the current year for the tax deduction to make sense. It generally starts to make sense when earned income is over $50k and makes more and more sense as your income level increases from there.
- You have the available contribution room.
And, for the TFSA:
Using a TFSA to save for retirement makes sense when any of the following are true:
- You may need to access the funds prior to retirement.
- Your current annual income is below $50k.
- You anticipate a high tax rate in retirement.
- You have already maxed out your RRSP contribution limit.
Retirement investing is not limited to these two accounts. If you have already used up your RRSP and TFSA contribution rooms, you can continue to invest by using a taxable investment account.
A maxed-out RRSP and TFSA is a great situation to be in. However, what happens if that’s not possible and you only have funds to contribute to one account?
The folks at Wealthsimple offer free expert financial advice and they can help you decide on what’s best for your financial situation.
How To Invest For Retirement Using a TFSA
Based on the questions I have received from readers of this blog, here are some of the reasons why some of them are using a TFSA to invest for retirement:
1. No earned income: Your RRSP contribution room is based on your taxable income. However, you can contribute funds from any source to a TFSA.
2. Avoiding the Old Age Security (OAS) clawback: RRSP withdrawals are taxable income and can result in your total income reaching the threshold at which you start to lose OAS benefits (including the GIS).
3. Young people earning an entry-level wage: A low tax-bracket means a lower tax deduction is available when you contribute to an RRSP.
4. Investing after turning 71: You can continue to invest in a tax-sheltered account after age 71 without needing to make minimum withdrawals. An RRSP must either be terminated and withdrawn as cash or converted into an RRIF/annuity after age 71.
5. Maxed-out RRSP account: They have used up their RRSP contribution room.
A Wealthsimple TFSA Case Study
If you do not already have a TFSA and you have been a resident in Canada and over the age of 18 since 2009, you have $63,500 worth of available TFSA contribution room, up to and including the calendar year 2019, that you can use:
- $5,000 each in 2009, 2010, 2011, and 2012
- $5,500 each in 2013, and 2014
- $10,000 in 2015
- $5,500 each in 2016, 2017, and 2018
- $6,000 in 2019
Over 75% of Wealthsimple clients have a TFSA account. While the RRSP is the primary retirement savings account in the majority of cases, a number of clients use TFSAs as their primary retirement savings account because an RRSP doesn’t make sense for them.
The TFSA is widely misunderstood and is frankly misnamed (Tax-Free Savings Account). Many people think of these accounts as savings accounts that pay a small amount of interest like a traditional savings account when the reality is that you can invest in the same types of investments in a TFSA that you can hold within an RRSP or taxable investment account (ETF’s, stocks, mutual funds, bonds, etc.). For this reason, it makes sense to think of a TFSA as a TFIA (Tax-Free Investment Account).
Below is an example of a Wealthsimple client who intends on using her TFSA to manage her retirement income in order to avoid the OAS clawback:
Colleen, a 44-year-old government employee, engaged Wealthsimple’s team of Portfolio Managers to review her projected retirement income situation. Colleen has a defined benefit pension plan through work. She generates a small amount of RRSP contribution room each year after her pension adjustment is accounted for, and with their guidance is prioritizing her TFSA over her RRSP.
Withdrawals from her TFSA can be pulled out tax-free in retirement, and her expected pension income combined with her government benefits will put her in a position where her Old Age Security (OAS) is at risk of being clawed back in retirement if she has any additional retirement income.
Colleen earns approximately $80,000 and her retirement income expectation is approximately $76,000 ($56,000 pension plus $20,000 CPP & OAS). Her marginal tax rate is approximately 30% and this is projected to be similar in retirement.
A case could be made for someone in a similar situation as Colleen to use an RRSP to a certain extent and delay their CPP income until age 70, but the current approach suits Colleen best from a tax-efficient cash flow standpoint, allows for greater flexibility, and does not impact her OAS payments. OAS claw-backs start to become an issue when current retirement income is approximately $76,000 or higher.
Colleen is single and has designated a family member as beneficiary of her TFSA. The transfer of assets from her TFSA to her beneficiary will avoid probate costs and will also avoid estate taxes that would be applicable had the funds been held within an RRSP/RRIF account at the end of life.
There are a number of important considerations when looking at retirement income planning and each individual has different aspects that need to be considered. It is strongly recommended that you review your particular situation with an advisor, ideally one who is a Certified Financial Planner (CFP®).
How To Transfer a TFSA or RRSP Account to Wealthsimple
If you are thinking about saving on fees and taking advantage of the services that Wealthsimple offers, they have made the process a seamless one.
Transfers of accounts between institutions are always initiated by the receiving institution, so there is no need to contact your existing provider.
After you open a new Wealthsimple account and complete your profile, you will see an option to “transfer existing accounts” on the funding section of your account. You can easily set this up yourself online, or you can reach out to their support team and they would be happy to help get things set up for you.
We also cover the account transfer fees that your other institution may charge so long as the account you are moving over has a $5,000+ value. Michael says.
Investing for retirement has never been easier or cheaper.
You don’t need to be fully knowledgeable about asset allocation or rebalancing to take advantage of lower investment fees.
A robo-advisor like Wealthsimple does all the work automatically behind the scenes and you can rest easy knowing that compounding interest is working on your behalf to grow your retirement savings.
Also, you don’t need to wait until you have a big chunk of cash to invest. A robo-advisor can invest whatever you have available…including your spare change!
Readers of Savvy New Canadians can invest up to $10,000 free for one year when they open a Wealthsimple account.