Million-dollar RRSP: Two points

Using a static rate of return for retirement projections comes with significant risks, but enrolling in your employer's pension plan is free money.

Christian Charest 30 August, 2018 | 9:00PM



For Morningstar I'm Christian Charest.

Last week on we published an article titled "What does it take to have a $1-million RRSP?" and that article garnered a lot of attention. The main takeaway was that you don't need to take crazy risks or sacrifice your quality of life during your accumulation phase in order to save a million dollars by retirement age, provided you start early.

The example used in the article showed that someone who has 40 years until retirement and expects an annual rate of return of 6% would need to save around $270 per semi-monthly paycheque in order to get to a million. There were two elements in that article that I'd like to expand on a little bit.

First, let's talk about that 6% average return. While the number itself is a reasonable estimate of what you're likely to see over the next 40 years, there are two important aspects that are not captured when you simply look at an average. One is the variability of returns, and the other is the sequence of returns. As the article pointed out, your portfolio won't earn a steady 6% year after year if you mostly hold stocks or stock funds. Some years will be exceptionally good with returns of 30% or more, while others will see your portfolio go down 10, 20, or even 30% or more, as we saw during the 2008 financial crisis. The magnitude of those variations and the sequence in which they occur can lead to very different results at the end of those 40 years, even if the average return does turn out to be 6%. That's why my colleague Dr. Paul Kaplan, Morningstar Canada's director of research, recommends that investors consider their retirement planning in terms of a range of possible outcomes and the probabilities associated with them, rather than using a static number. He goes into detail on how to do that in an article that's linked below.

The second element I wanted to stress is the importance of participating in your employer's pension plan if that's an option for you. For most employers who offer a defined contribution plan, there are two components to the savings: The employee's contribution and the employer's contribution. Enrollment in a pension plan is usually voluntary in Canada, and for a young person starting out their professional career the benefit may not be obvious. But keep in mind that your employer's contribution is essentially free money, which, combined with the forced savings from your own pension contribution, can make the task of saving for retirement a whole lot easier, particularly if you're a young person with a relatively low salary.

For example, let's say your annual salary is $40,000 and your employer matches your pension contributions up to 5% of your salary. On a semi-monthly paycheque this means you would contribute $83 and your employer would chip in another $83. Since it's withdrawn at the source, you likely won't miss that $83, but that and your company's contribution works out to $4,000 per year, and you essentially get a 100% return on your investment right off the bat, plus whatever the market gives you. That's a pretty good deal.

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Christian Charest

Christian Charest