A time to save, a time to spend

Early working years

When you're fresh out of university or college, you are probably experiencing lots of demands on your modest paycheque. The idea of using some of your limited income to save for a distant retirement probably has zero appeal. Generally, it's fine to ignore saving for retirement for now, provided you do other prudent things. And you probably want to spend money to enjoy life a little also, which is okay within reason.

In many cases, the top financial priority will be paying off student debts, before worrying about building up savings. When your finances are back in the black, it's time to save, but generally for a more immediate objective than retirement. Many people will want to start saving for the down payment on a home, but other objectives like furthering your education can also make sense.

If you have a specific objective, that can help motivate you to save for it. But if you don't have a clear objective in mind, it's okay to just save and keep your options open.

With a limited paycheque, you may not be able to make maximum contributions to both RRSPs and TFSAs, so you may have to choose between them. TFSAs offer great flexibility and are well suited to saving for short- and medium-term goals. While TFSAs don't give you a tax rebate, there are no tax implications when you take the money out. You can also re-contribute the amount later (starting the following year) so you don't permanently lose contribution room.

RRSPs offer less flexibility and are more problematic when saving for short-term and medium-term goals. Of course you get a tax rebate, but that is limited if your paycheque is modest and you're in a fairly low tax bracket. Withdrawals are normally fully taxed, so they generally trigger a significant tax bill. Also, contribution room is permanently used up, so the money you withdraw cannot be recontributed later.

However, there are two key exceptions where withdrawing RRSP money for short- and medium-term objectives can make more sense. You can withdraw up to $25,000 per person without tax implications for a first-time home purchase under the Home Buyers' Plan (HBP), or up to $20,000 per person for education under the Lifelong Learning Plan (LLP). Still, you have to recontribute the money to your RRSP within a rigid timetable (15 years for HBP, 10 years for LLP) or the funds become immediately taxable.

It's a good idea at this stage in life to get your finances in good shape, since that can make a big difference a few years later when finances usually tighten up. "You sort of have these Death Valley days ahead," says Malcolm Hamilton, a retired actuary and fellow with the C.D. Howe Institute. "You want to go into that with as much money as you can."

The "crunch years"

After you buy a home and have children, chances are your finances will become very tight. This period is often called the "crunch years" for good reason.

At this stage of life, it's usually all you can do to keep your head financially above water. It's important to be realistic and focus on that without trying to do too much. With child-care and housing costs generally being so expensive, there usually isn't the capacity to also save for a distant retirement. The priority should be to try to live within your means and avoid pricey consumer and credit-card debt.

If you try to do too much, it's easy for your finances to get out of control. Sheila Walkington, a financial planner and co-founder of Money Coaches Canada, says she sees many examples of people trying hard to save for retirement but who are then also forced to rack up expensive credit-card debt. "It just doesn't make sense to run up you credit card at 19% (interest rate), in order to save in your RRSP."

A financial plan can help you see the light at the end of the tunnel. "It's easy to get caught up in the short term and extrapolate and think that's how it's going to be for the next 20 years," says Walkington. "It helps if you can look ahead and see your cash flow and see 'these things are going to change in the next three to five years and then you can start saving.' It's huge to have a plan because it reduces anxiety, but it also tells people what they should be focusing on at that time."

While usually this is not the right time to make it a priority to save for retirement, there are exceptions. If your employer matches your voluntary contribution to a pension or group RRSP, then the free money from your employer might make it worthwhile, despite the challenges of finding the cash. Also, if you don't buy a home or have kids, then you should generally be saving for retirement now. There is no good reason to defer.

Fortunately the peak of the crunch period usually lasts only a few years as your mortgage gradually gets paid off, child-care costs diminish and your salary grows.

The saving years

When the crunch years start to ease, you should take full advantage of the opportunity. "This is when you need to start saving," says Walkington.

While saving for retirement is usually a high priority at this point, you may also need to work in other financial goals, like saving for your children's education. The important thing is to find the right balance so that you can save toward other goals without jeopardizing the longer-term goal of saving for retirement.

Both RRSPs and TFSAs can be good vehicles for retirement saving, although each has their particular strengths. Saving for retirement in an RRSP makes the most sense if you're in a high tax bracket now and expect to be in a lower tax bracket in retirement, as is often the case. Saving for retirement in a TFSA has a particular advantage if you'd like to keep the option open of tapping funds while you're still working (and therefore still in a high tax bracket), or if you don't expect to be in a lower tax bracket when you retire.

While generally saving for retirement should be a priority at this stage, there are exceptions. If you have a generous defined-benefit pension plan (typical in the public sector but increasingly rare in the private sector), you won't necessarily need to save anything outside the plan. Often these plans require substantial employee contributions, so you may in essence have been building up "forced savings" through your contributions in a form which isn't readily apparent.

Concluding thoughts

The important thing to realize is that while it is important to save for retirement, you have to find the right timing that works for you. A lot of conventional advice tells people to make it a priority to save steadily for retirement and then fit their life around that, says Hamilton. But "it should be completely the opposite," he says. "Have a life plan and fit savings around it, not a savings plan and fit life around it."