Gen Y, you need to choose: Get a good start on retirement saving, or buy a house.
A lot of 20- and 30-somethings can't have both. They need to accept it, and start thinking about what really matters to them as a financial goal.
Home ownership vs. retirement saving: Now, there's a topic you don't hear talked about much in registered retirement savings season. Maybe it's because the people selling investments and advice for retirement also make a lot of money from mortgages. It's in their interest to keep up the fiction that it's no problem to do it all.
As part of Finance February here at The Globe and Mail, we're presenting information on investing and retirement matters of interest to all ages. Let's dig into what could be the most important financial consideration a young adult will make: Start saving for retirement, or for a house down payment.
Retirement could be 40 to 50 years ahead when you're in your early 20s, but you can't ignore it. Pensions aren't as good or available as they used to be in many jobs. Many Gen Y members aren't getting a sniff of a pension because employers will only hire them for contracts, not for full-time positions. And, our aging population will strain government finances in the years ahead.
Home buying is something you want to do in your 30s, which means you have to start preparing in your 20s by saving for a down payment. You'll need $25,000 to $30,000 to cover a 5-per-cent down payment on the average-priced resale home in Canada and closing costs. In cities like Vancouver, Calgary or Toronto, you'll need to save $5,000 to $15,000 more than that.
If you earn $40,000 gross as a 20-something employee, you might conceivably have $32,000 to take home after taxes and other deductions. If you saved 15 per cent of that much annually and used a high-interest savings account paying 1.5 per cent, you'd roughly need five to 10 years to get your down payment.
Let's back up a little to the point at which a young adult graduates from college or university. The top priority at this point is to pay off any student debt, not save for retirement or a house. Yes, the returns from investing might be higher than the rate on your student debt, currently 5.5 per cent for floating rate government loans and 8 per cent for fixed rate loans. (There's a 15-per-cent federal tax credit on government student loan interest, so your net cost on these loans is actually lower.)
But paying off your student debt isn't just about math. It also allows you to focus your full financial resources on your next goal. This is the point where you need to think about how home ownership fits into your future plans.
There's a trick for buying a first house and saving for retirement at the same time. You put money in a registered retirement savings plan, and withdraw up to $25,000 of it later on using the Home Buyers' Plan. This federal government program requires you to pay the money back into your RRSP, but those repayments can last for 15 years and may limit your resources for making any new contributions.
The HBP has been used more than 2.6 million times since it was introduced in 1992, which tells you that young people have long tilted toward home buying over retirement saving. With RRSPs being used to buy houses, no wonder there's so much concern today about whether people are putting enough away for retirement.
Dead set on buying a home as soon as possible and saving for retirement later? It can be done, but you'll need to really apply yourself once your kids are out of the expensive daycare years and you reach the prime earnings stage of your career. Forget about moving up to a bigger house and leasing a couple of SUVs – there won't be money for that if you want to backfill your RRSP.
Now, consider a radical alternative. You rent indefinitely, and build up a fat and happy RRSP with the money you're saving because you don't own a house. Maybe you turn your attention at some point to a house down payment, or maybe you don't. The one thing you know for sure is that you've nailed your retirement savings obligations by creating a pool of money that will benefit from decades of compounding.
Most people will go for Door No. 1, the house. No biggie. They just need to be ready to crank up the retirement savings later. Don't just nod your head that you will. You have to do it.
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Gen Y retirement primer
Recent books:
The Moolala Guide to Rockin' Your RRSP, by Bruce Sellery
RRSPs – The Ultimate Wealth Builder, by Gordon Pape
Trusty websites:
The Globe and Mail's Retirement & RRSPs page
The GetSmarterAboutMoney.ca website's RRSP page:
Investopedia's RRSP page
The Retire Happy blog RRSP guide
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Follow me on Twitter @rcarrick
Rob Carrick