Customizing Your “MAX your RRSP Strategy” Blueprint

You should now have a basic understanding of ...

  • how the Gross Up strategy can increase RRSP income 25-100%
  • the behavioural benefit of using a comfortable amount of forced savings via Catch Up loans

Most of these concepts are visually organized on this “MAX your RRSP Strategy” storyboard.

With this foundation in place, we can combine these concepts to design a custom blueprint to “MAX your RRSP Strategy.”

As discussed and shown on the storyboard, the vast majority of investors use an ad hoc savings approach and spend their RRSP refunds. For most, simply reinvesting their refunds and starting a “Pay Yourself First and inflate” plan would be a big improvement.

But most can do better. Much better.

Upgrading your RRSP savings strategy to what is optimal for you involves two core principles.

1.

Invest all cash flow available, intended, and needed for retirement. This means ...

  • If you’re behind on your retirement goal and it’s important to you, you need to align your actions with your highest priority. If you don’t want to work longer, you probably need to increase the amount saved, and/or the inflating rate.
  • Contributing the full, before-tax, Grossed Up amount. In other words, pasta that is fully cooked. Not dry pasta where refunds are spent nor partially cooked pasta where refunds are reinvested.
  • Inflating savings to at least keep up with inflation and/or wage increases.

2.

Use the forced savings amount that is behaviourally best for you

  • If you, your lender, or your advisor isn’t financially and emotionally comfortable with you borrowing for RRSPs, you shouldn’t use a Catch Up strategy and this amount is zero.
  • If using a Catch Up loan to invest in equity markets might result in you selling when the market drops, this amount should be zero.
  • If you’re a very disciplined investor and won’t benefit from the locked-in commitment of loan payments, a forced savings approach is not needed.
  • On the other hand, if you’re not a disciplined investor, using a portion of your cash flow for forced savings might help.

Using these principles, the basic process for determining your optimal RRSP contribution strategy is only 4 steps.

  1. MAX your RRSP Strategy Blueprint

  1. Determine the best monthly savings amount for your priorities
  2. Determine the best amount of forced savings and timing
  3. Gross Up remaining cash flow with a Pay Yourself First plan
  4. Determine the rate to inflate automatic savings

Let’s return to Typical Ted and MAXing Mary to illustrate how much this blueprint can improve an RRSP investor’s savings.

MAXing Ted’s RRSP Strategy

Ted earns $75,000 and is deep in a 33% tax bracket. He uses ad hoc savings approach, and like most, spends his RRSP refunds.

Ted recognizes that he’s not the most disciplined saver. He normally adds $6,000 to his RRSP each February, before the deadline. But he’s skipped contributions 2 of the last 10 years.

His hope is that he can retire in 20 years, but he’s growing concerned that won’t be possible. His ever-increasing unused RRSP contribution room gives him the impression that his savings are getting further behind.

Step 1: Determine the best monthly savings amount for your priorities

Years ago, Ted’s financial advisor did a basic analysis of what he needed to save to retire at 65. At the time, his priorities were more on keeping up with everyday expenses and the kids’ educations.

After clarification with his advisor, Ted’s current financial priorities are RESPs, retirement, and paying down the mortgage. Since he couldn’t ramp up his retirement savings much until the kids were done school, Ted decided to leave his base savings amount at $6,000 a year, and upgrade his RRSP contributions using the other blueprint concepts.

Step 2: Determine the best amount of forced savings and timing

Ted has never borrowed to invest before. But when asked, he informed his advisor that he hasn’t missed a mortgage or car payment in his life, even when finances were tight. He is confident that he would benefit from locking in a higher level of discipline by using a forced savings approach.

TIP

After 25 years of researching and educating financial advisors and investors on using investment debt responsibly, I strongly suggest that investors use a maximum of 50% of investable cash flow for forced savings. This is one of the keys to reducing financial and emotional risks.

If interest rates rise or his financial situation changes, using less than half of his cash flow for RRSP loan payments gives Ted a reasonable amount of flexibility to handle it. Ted agrees with this guideline. Wanting to lock in his savings commitment as much as possible, he decides to use half of his $6,000 annual cash flow for forced savings.

Assuming an average cost of borrowing of 7% over 9 years, Ted’s advisor determines that payments of $3,000 a year will allow him to pay off $20,000.

For simplicity and efficiency of understanding, these are the same parameters used to introduce the Catch Up strategy earlier.

He now knows that $20,000 of after-tax money equates to more before-tax dollars in an RRSP. As we saw before, deep in the 33% tax bracket, Ted can do a $30,000 Catch Up strategy.

Step 3: Gross Up remaining cash flow with a PYF plan

Since half of Ted’s $6,000 of investable cash flow will initially be used for forced savings, he has $3,000 left for automatic savings. As we saw, Ted’s after-tax cash flow of $3,000 can be Grossed Up to $4,500.

Again, this is easily confirmed without a calculator. If $4,500 of before-tax RRSP dollars are cashed in, a third or $1,500 would be lost to taxes. Thus, in a 33% tax bracket, $3,000 after tax equates to $4,500 before tax in an RRSP.

So the second part of Ted’s blueprint is to start a monthly PYF plan, automatically investing $4,500 a year, or $375 a month. 

Step 4: Determine the rate to inflate

For the most part, Ted’s salary has been keeping up with inflation, which has been averaging about 2%. While maintaining his RESP funding, he wants to improve his retirement savings without his current lifestyle taking a big hit.

So instead of making a big increase in his saving amount, he decides to “lean into it” and inflate his savings each year by 5%. This approach moves his savings in the direction he wants in an almost unnoticeable way, especially when it happens automatically. 

Note that to get the full benefits of inflating, Ted should inflate the total amount he invests each year, not just the amount left over for automatic savings.

Since half of his investable cash flow will be used for forced savings, only half of his savings will be inflated. This is because with amortized loans, you make the same payment amount each month. Perhaps some day, a progressive lender will allow loan payments to automatically inflate each year. This would allow borrowers to benefit from inflating in the same way that savers are starting to be able to.

If Ted wanted the full benefits of inflating, he could increase the amount that his automatic savings are inflated until the Catch Up loan is paid off, perhaps doubling it to 10%, and then resume his intended inflate rate of 5%.

Of course, this minor difference does not exist for those who don’t use forced savings, as all of their investable cash flow will be used for automatic savings and inflated.

Projected Benefits

When the loan is paid off, Ted can repeat the Catch Up strategy if he prefers the behavioural benefits of forced savings. In comparing his current savings plan to his MAX plan, we’ll assume that after the Catch Up loan is paid off, he simply Grosses Up and inflates all of his cash flow.

So Ted’s “MAX your RRSP Strategy” Blueprint is to initially use half of his cash flow for forced savings with a $30,000 Catch Up loan. The remaining $3,000 a year is Grossed Up to annual RRSP contributions of $4,500, fueling an automatic PYF investment plan that is inflated by 5% each year. When his loan is paid off, all of Ted’s cash flow is Grossed Up with automatic savings and inflated.

Using the “MAX your RRSP Strategy” software and assuming 5% returns, Ted’s financial advisor shows that his current strategy would add about $162,000 to his RRSP over the next 20 years.

But this new combination of forced savings and inflated automatic savings should add $440,000 to his RRSP.

Invest $6,000/yr after tax, inflate 5%

As shown in the chart, this means that the “MAX your RRSP Strategy” Blueprint should increase Typical Ted’s RRSP by about $278,000 — more than 2.5X his current approach!

While this is a significant difference, it’s worth acknowledging that the actual improvement would probably be less than projected. Even though Ted isn’t the most diligent saver, it’s not likely that his current savings amount would stay at the same level indefinitely, especially when the time horizon is decades. As he gets closer to retirement, we can hope that Ted would eventually increase his savings amount.

But there’s a big difference between hoping his savings increase later and following through on a plan that’s on autopilot. Newton’s law of inertia still applies to everything, including your retirement savings.

And the “MAX your RRSP Strategy” upgrade doesn’t just significantly improve Ted’s projected RRSP value. By understanding and ACTing on more powerful RRSP strategies that are mathematically and behaviourally best for him, Ted is more confident than ever about his retirement, and much more likely to stick to the plan.

For many, the emotional and behavioural benefits of the “MAX your RRSP Strategy” Blueprint are more important than the significant financial gains.

Ted is guaranteed to end up with a larger retirement fund by …

  • upgrading from ad hoc savings to automatic savings
  • removing the behavioural risk of skipping contributions
  • Grossing Up his refunds instead of spending them
  • inflating his savings by 5% instead of nothing
  • getting his savings and refunds growing earlier by investing monthly instead of waiting until the end of the year
    As mentioned, equity investors get an additional benefit from dollar cost averaging when they invest monthly.

And as a result, he is certain to have more peace of mind about his short- and long-term financial security.

Of course, no one knows in advance what Ted’s RRSP returns will be. And the actual return achieved is more important when you’re borrowing to invest with a Catch Up strategy.

If Ted averaged only 2% returns, less than a third of the 7% interest rate on his Catch Up loan, he would add $331,000 with the MAX strategy compared to $118,000 with his current approach.

Invest $6,000/yr after tax, inflate 5%

So even with very low returns, the “MAX Your RRSP Strategy” Blueprint improves Typical Ted’s retirement fund by more than $213,000, an increase of 181% compared to his current approach.

MAXing Mary’s RRSP Strategy

Compared to Typical Ted, MAXing Mary is a very disciplined saver.

She learned how the magic of compound interest combined with a Pay Yourself First plan was the easy way to fund the retirement she wanted.

She also learned the benefit of starting now.

So she immediately began saving 10% of her $50,000 income on a monthly basis a decade ago, and barely noticed the difference. She took advantage of the tax savings of sheltering her investments in an RRSP. And unlike most, she diligently reinvested all of her refunds back into her RRSP each year.

Mary was doing a lot of things right.

But she didn’t realize how much better she could be doing.

After learning the “MAX your RRSP Strategy” Blueprint, Mary’s advisor walks her through the process.

Step 1: Determine the best monthly savings amount for your priorities

When Mary was reading the short “Simple Ideas to Boost Your Retirement Savings” PDF referenced earlier, she recognized that her initial PYF 10% plan had fallen behind.

She was now earning $60,000, and always intended to save 10% of her income. To get it back on plan, Mary agreed to adjust her savings from $5,000 a year to $6,000 a year, or $500 a month.

Step 2: Determine the best forced savings amount and timing

Mary had never considered borrowing to increase her retirement savings. Like many, her thinking was that debt is a negative to be avoided and minimized as much as possible.

And because she was already very disciplined with her automatic PYF savings approach, she didn’t need the behavioural benefits of forced savings.

So appropriately, Mary wouldn’t have borrowed at all to Catch Up on some of her unused RRSP contribution room.

Until she learned about the “Buy More Low” versions of the Catch Up strategy.

She always suspected that the rich knew more powerful wealth strategies, and wanted to use them to increase her wealth. The idea of continuing her PYF automatic savings, patiently waiting for the stock market to drop, and only then borrowing to invest more, made sense to her.

Because she wasn’t comfortable borrowing a large amount, Mary decided on a “Buy More Low Lite” Catch Up strategy which could be paid off within 3 years, and then she would resume investing all of her cash flow using automatic savings.

Step 3: Gross Up remaining cash flow with a PYF plan

In the 33% tax bracket, contributing $6,000 to her RRSP would produce refunds of a third of $6,000 or $2,000. By having the discipline to reinvest the $2,000, her RRSP deposits would be $8,000 a year. This is a meaningful 33% improvement compared to Typical Ted’s $6,000 contributions, where the refunds are spent.

But now Mary knows about after-tax versus before-tax dollars and the 5 RRSP Refund Strategies. She knows she was putting partially cooked pasta in her RRSP.

Mary’s advisor determines that her $6,000 of after-tax cash flow equates to $9,000 before tax. This means that Mary could and should Gross Up her RRSP contributions to $9,000 a year.

This is an extra $1,000 every year going into her retirement savings, compared to reinvesting her refunds.

So until the stock market drops, Mary’s plan is to continue with her monthly PYF plan, after adjusting it to $9,000 a year, or $750 a month.

Her advisor helps her do this Gross Up by adjusting her withholding taxes with her employer, so she doesn’t get a refund.

Step 4: Determine the rate to inflate

Mary already knows that if she doesn’t inflate her PYF savings each year, she gradually falls behind her goal to save 10% of her income as she gets cost-of-living increases.

Her advisor shows her how much more she would have in retirement by simply inflating her savings by the average inflation rate of 2% instead of nothing.

Then he shows her what she could have by inflating a tiny bit more, by 4% instead of 2%.

Mary has already experienced the negligible change to her lifestyle when she first started saving 10% of her income. And she really valued how easy it was for a one-time decision to produce long-term benefits automatically, without any additional thought or effort.

So she decided to inflate her Grossed Up PYF savings by 4% a year. She saw this as a stealthy, unnoticeable way to boost her retirement fund.

Projected Benefits

Since Mary was initially saving all of her investable cash flow into her RRSP, and reinvesting all of her refunds every year, she thought she was already maximizing her RRSP savings.

But even MAXing Mary was able to improve her RRSP strategy by …

  • adjusting her PYF plan back to her initial intent to save 10% of her income, boosting her after-tax savings from $5,000 to $6,000
  • Grossing Up her contributions instead of reinvesting her refunds, increasing her annual contributions from $8,000 to $9,000
  • automatically inflating her PYF plan by 4% each year instead of 0%
  • using a “Buy More Low Lite” Catch Up strategy to invest 3 years of contributions when the market goes “on sale”

Assuming 5% returns, over the next 25 years, Mary’s original plan would add $325,000 to her RRSP. With the “MAX your RRSP Strategy” Blueprint, her RRSP is on track to grow by $663,000. That’s an extra $338,000, more than doubling her retirement fund.

Invest $6,000/yr after tax, inflate 4%

So for Mary, who is already a very disciplined saver, the combination of these ideas more than doubles her RRSP.

And this does not include the boost that should occur when Mary implements the “Buy More Low Lite” Catch Up strategy when the stock market drops. 

Noting how much her RRSP strategy was improved, Mary wonders what else she could learn to MAX her wealth in other areas.