How to retire rich

Retiring rich is easier than you think. If you make a decent salary, get regular raises and save diligently, you should be able to amble away from work with enough cash to make you wealthier than 90% of Canadians.

But - and you knew there was a "but" coming, didn't you? - you must show some unusual persistence if you truly want to join the ranks of the gold-carded, silver-haired set.

To understand why persistence is so important, it helps to define our goals. Since everyone has a different definition of what being rich means, we'll take the most traditional indicator of wealth - a million bucks - and assume that your goal is to drive home from your retirement party at the age of 65 with a paid-off home and $1 million in your RRSP. To avoid having the issue confused by inflation, we'll make the further stipulation that the million bucks we're shooting for is not going to be a million bucks watered down by future decades of inflation. Nope. We're talking about amassing a million bucks in terms of today's dollars.

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Given those starting points, we've shown what it takes to join the seven-figure elite in Million Dollar Math at the bottom of this article. Our chart demonstrates that many middle-class couples can wind up as millionaires if they simply stick to a disciplined long-range plan and enjoy a little bit of luck.

To arrive at the numbers in Million Dollar Math, we started by figuring that you and your spouse earn a combined total of $40,000 a year when you're both 25. At that point, you begin contributing 12% of your before-tax salaries to your RRSPs. You get regular promotions that grow your pay at three percentage points above inflation each year and you continue to religiously contribute 12% of your salary to your RRSP. (That's where the persistence comes in.) You earn 5% a year on your investments in real terms - that is to say, after inflation is deducted.

If all those assumptions hold true, then you and your beloved should walk away from work at 65 with a cool million dollars (in today's dollars!) tucked away in your RRSPs. You don't have to take huge chances with your investments. You don't have to earn a huge salary. All you have to do is to keep working, save dutifully, and invest intelligently.

The road to riches sounds so simple, in fact, that it raises a big question: why don't more people make it into the millionaire's club? Statistics Canada's most recent data on personal finances come from a survey performed in 1999. It found that Canadian families in which the major earner was 55 or older had a median net worth of less than $275,000. In other words, the typical Canadian family of retirement age was barely a quarter of a way to the magic million-dollar mark. To make matters worse, the net worth figure spanned not only savings, investments and RRSPs, but also homes as well as any employer-sponsored pension plans. Even by the broadest definition, Canadians of retirement age were nowhere close to being millionaires.

Even if we update the numbers and look only at the top 10% of Canadians, people still fall short of millionaire status. Extrapolating the StatsCan figures, we figure that it would take a net worth of about $900,000 for a household to place among the top 10% of Canadian families in 2006 - and that figure spans the value of your home, your RRSP, your company pension plan and any other assets you may happen to have.

You can, of course, define wealth in different ways. It's possible, for instance, that many of us want to retire early more than we want to retire with a million bucks. Look again at the numbers in Million Dollar Math and one observation that leaps out at you is the hefty financial penalty that you pay for quitting work early. By walking away from work at 55 or 60, you miss several years of employment in which your earnings are likely to be near their peak; you also pass up several years in which your accumulated savings could grow into a much larger pile of cash. If the couple in our Million Dollar Math example did everything according to our assumptions, but decided on retiring at 60 rather than 65, they would enter their retirement with only $700,000 - about $300,000 less than if they were to continue working until 65. And if they wanted to retire at 55? Then they would have less than half the retirement funds of a similar couple that kept working until 65. When it comes to retirement, time truly is money.

Given that the average Canadian man retires at 63 and the average Canadian woman at 60, it seems most of us are voting with our feet. We're content to make do with less cash if it means escaping the grind of work early. There's nothing wrong with that. To you, retiring rich may mean retiring with a seven-figure bank account. To me, retiring rich may mean leaving the workforce while I'm still young enough to enjoy hiking in the mountains. You shouldn't get caught up in some arbitrary definition of wealth. What counts is how your retirement plan affects your overall sense of well-being. Here are some tips that can help you make the right decisions for you.

Know where you're going

Retiring with a million bucks is a worthwhile goal, but it doesn't have to be an obsession. Your financial needs in retirement are likely to be far less than your financial needs while you're working. You will no longer have to pay a mortgage, childcare expenses, tuition payments, or work-related expenses. Depending upon your desire for travel and expensive hobbies, you will probably live well on 50% to 70% of what you made while you were working.

Canada Pension Plan (CPP) and Old Age Security (OAS) will cover many of your basic expenses. Both programs are on solid financial footing and will deliver benefits as far as the eye can see. If you've worked in Canada all your life, CPP and OAS combined can pay you as much as $16,000 a year. Benefits will be reduced if you start collecting benefits before 65 or haven't worked for long periods: the typical payout to a retired Canadian works out to about $11,000 a year.

If you work for a company, you should factor the value of your corporate pension plan into your retirement planning. (Your employer's human resources department should be able to tell you what your plan is worth now.) A good pension can be worth a surprising amount and may put you closer to millionaire status than you realize. Combined with CPP and OAS, it may provide you with all the retirement income you need.

Do it now

We know, we know - you've heard this tip before. Still, it's worthwhile repeating: it pays to start young. If you're old enough to remember hearing the Internet referred to as the information superhighway, or listening to the debut of Eminem's first album, or waiting for the final episode of Seinfeld, you're old enough to be saving for your retirement. People who start contributing to their RRSP in their twenties wind up far ahead of those who start in their thirties, because their early contributions have more time to grow. Remember the couple in Million Dollar Math? If they were to put off contributing to their RRSPs until they were 35, they would have to put away 20% of their incomes to merely keep pace with the couple that starts saving 12% of their salaries at 25.

Of course, you have to be realistic. Many young couples find it impossible to contribute much to their RRSP during those difficult years when they're raising kids and paying off a home. So don't beat yourself up if you fail to stick to some overly ambitious savings goal that leaves you wretched. Do what you can, and think about your RRSP contributions as an opportunity. You have a great chance when you're young to make time work for you. In fact, every dollar you set aside before you're 30 is likely to be worth a two-dollar contribution you make after 40.

Invest smart

In Million Dollar Math, we assumed you would earn a 5% annual return on your money after inflation. While that may seem a relatively modest ambition, it's not. DALBAR, a Boston research group, tracked the behavior of U.S. investors fro 1984 through 2000, a time when the S&P 500 was surging upward by an average of 16% a year. Despite the sizzling stock market, the average investor in a stock fund earned only 5% a year, including inflation. Once you subtract inflation, the average stock fund investor made less than 2% in real terms. What caused this dismal performance? High fees and investors' habit of jumping into hot areas just as they were about to cool off.

To get the most out of your savings, look for low-cost ways to invest and stick to a disciplined asset allocation plan rather than chasing hot trends. The MoneySense Couch Potato portfolio is one good approach to investing. A good low-cost balanced mutual fund is another.

Play catch up

Just about all of us find ourselves behind the game at some point because of student loans, child-rearing, divorce, job loss or simple inattention. Don't fret. No matter what your age, you can do a lot in a few years to build up the funds for a good retirement.

The simplest and best plan is to increase your RRSP contributions to as high a level as you can sustain. If that still doesn't do the job, consider working a bit longer. Earlier, we saw that you pay a big financial penalty for retiring early. The good news is that you earn just as big a financial reward for putting off your retirement for a few years. In extreme cases, you may even want to consider working part time after 65. Not only does parttime employment keep you physically and intellectually active, it can be a tonic for your retirement portfolio.

Keep the faith

It's all too easy to get discouraged if the market happens to be going the wrong way or if you don't seem to be amassing wealth as quickly as you hoped. Remember, though, that many of your gains are going to come later in life.

Even in the steady-state, perfect world of Million Dollar Math, our hypothetical couple has an RRSP of only about $239,000 in their mid-forties. But as this amount multiplies, and as they continue to make contributions, their net worth zooms upward in their fifties and sixties until they hit the magic million mark at 65.

As our chart demonstrates, a steady habit of saving, a disciplined investing strategy and the willingness to work until 65 are more important than making a huge salary or cashing in on a windfall profit from a lucky stock pick. Keep that in mind as you plan your own path to a rich retirement.

Million Dollar Math

It's more straightforward than you may think to retire rich. We've calculated what it would take for a couple aged 25 to amass a million bucks in their RRSPs at 65. We've assumed they make a combined total of $40,000 a year at 25, get raises that boost their salaries by three percentage points a year above inflation, contribute 12% a year of their before-tax incomes to their RRSPs, and earn 5% a year in after-inflation dollars on their investments. All amounts are in 2006 dollars.

Age of
coupleCombined
salariesRRSP Contribution
(12% of salaries)Value of
RRSP

25$40,000$4,800$4,800
30$46,371$5,564$36,801
35$53,757$6,451$85,617
40$62,319$7,478$150,085
45$72,244$8,669$238,868
50$83,751$10,050$359,714
55$97,090$11,651$522,693
60$112,554$13,506$740,818
65$130,482$15,658$1,030,959