If you’re self-employed, you know that the many perks of entrepreneurship come with some challenges unique to being your own boss. A big part of the puzzle is figuring out how to do things on your own—and understanding how to save for retirement when self-employed is an incredibly important piece.
Over 2.6 million Canadians are self-employed and, if you’re among that number, saving for retirement should be an ongoing practice. The unpredictable income stream that often comes with entrepreneurship can make planning for the future a little bit more difficult, but even small contributions add up in the long run. The earlier you start planning and saving for retirement, the better positioned you’ll be to enjoy comfort and security later on in life.
How to build your own retirement plan
To come up with a retirement plan, it helps to first understand all the different potential income sources for retired Canadians. These are Old Age Security (OAS), the Canadian Pension Plan (CPP), employer pension plans, and personal savings.
OAS won’t differ much between employed and self-employed retirees, and the current maximum payout per month is $642.25, which counts as taxable income. This benefit is helpful and you can include it in your retirement plan, but it’s not enough to live off of on its own.
For employees of companies, CPP contributions are made by both the employee and employer each month. The total contribution, which is currently 11.4 per cent of pensionable earnings, is divided evenly between the employee and the employer. If you’re self-employed, you’re unfortunately on the hook for the total contribution, which is typically calculated at the same time as your income taxes.
The way this works will depend on your business structure. If you have a sole proprietorship, your pensionable earnings are your business revenue after expenses. For corporations, the calculation will be a bit different, since your income will depend on the salary you draw each year.
The amount of CPP you’re able to draw in retirement depends on your total contributions and age of retirement. The current average monthly amount paid out in CPP benefits is $702.77, while the maximum is $1253.59.
Employer Pension Plans
Obviously, this type of pension doesn’t apply to the self-employed. However, if you previously paid into an employer pension plan before starting your own business, you may be eligible for some pension payout when you retire, which you can factor into your retirement plan.
This is where you can really make an impact on your retirement savings. OAS and CPP are helpful, but generally too small to cover the increasingly high cost of living in most of Canada. By taking advantage of retirement savings accounts that grow over time, you can end up with a comfortable sum to draw from in your golden years. The sooner you start contributing, the more interest can compound to grow your savings.
The two main savings accounts to use when preparing for retirement are the tax-free savings account (TFSA) and registered retirement savings plans (RRSPs). Now, let’s examine the differences between these two types of savings accounts:
Any investment you hold in your TFSA can grow tax-free. You can hold stocks, exchange-traded funds, mutual funds, and many other types of qualified investments in your TFSA. The capital gains on your investments and on any dividends or interest earned in your TFSA account are tax-free. That means that when you do choose to draw money from your TFSA, you won’t have to pay income tax on your earnings.
The tax-free nature of a TFSA makes it an attractive choice for self-employed people planning for their retirement, but it’s also nice to know you can withdraw from this account at any time without paying a penalty. This means that, if an emergency does come up, you can rest assured your TFSA funds are available if you need them.
The limit to how much you can contribute to your TFSA can vary from one year to the next. In 2021 it was $6000, but the limit gets rolled forward if you don’t use it. This means that if you’ve never contributed to a TFSA since the program’s inception, you have $75,500 worth of contribution room available.
RRSPs have a major benefit that TFSAs do not: they can be deducted from your taxable income. This can be really beneficial, since you can defer paying tax on those contributions until a time when you’re in a lower tax bracket. It can take some financial planning to figure out the best amount to contribute to your RRSP and your TFSA, so it’s worthwhile to set up a meeting with a financial advisor at your bank to come up with a contribution plan that works for you.
Even if you can only contribute a small amount per month, the nature of compounding interest means that your contribution can grow significantly over several decades.
Individual Pension Plans (IPPs) and Personal Pension Plans (PPPs)
If you’ve maxed out your contributions to both your TFSA and RRSPs, it may be worth starting an IPP or PPP. These are more complicated to set up, and you will need an investment manager and actuary to help manage your account. If you are just starting planning your retirement savings, a TFSA and RRSP are the best accounts to begin with.
How much should you save?
The exact amount you should save depends on your specific financial situation, but a good target to aim for is putting 20-25 per cent of your income toward your retirement savings. If that just isn’t feasible based on the other expenses in your life, a smaller contribution is still better than no contribution at all.
For example, if you have expensive debt such as credit card debt, paying off balances subject to high interest rates should be a higher priority than contributing to your TFSA or RRSP. If you have “good” debt which has a much lower interest rate, such as a mortgage, this shouldn’t deter you from beginning to save for retirement as well.
How can you successfully manage your small business while planning for retirement?
Managing a business can feel like more than a full-time job. You’re never really off the clock, and everything that comes up in the business is ultimately your responsibility. Planning for retirement is probably the last thing on your to-do list most days, because you have so many other more urgent concerns.
In order to avoid a situation where you neglect your retirement for too long and find yourself having to keep working when you’d like to retire, it’s important to create a system that takes thinking about your retirement off your plate. Here’s how:
Leave it to the experts
Like many other aspects of business, it’s helpful to know when to dedicate tasks to others so that you can focus on your strengths. Speaking to an accountant and financial advisor can help you come up with a plan that makes the most sense for your financial situation. Then, set up a reminder for a meeting one year later to check in and see if you should change anything about your savings strategy.
Automate your contributions
If you can set up automatic monthly contributions to your savings account, you can take your mind off of your retirement completely most of the time, while knowing you’re still doing the responsible thing. If automatic contributions aren’t available, create a monthly calendar reminder for yourself and take a few minutes to pay into your accounts. The more you can automate tasks in your business, the more mental space you can free up.
Pitfalls to avoid
Aside from ignoring the importance of saving for retirement altogether, there are a number of other common pitfalls that regularly hurt self-employed Canadians when it comes to their retirement.
Not factoring in taxes
Make sure you understand how your various streams of retirement income will be taxed. For example, many don’t realize their CPP payouts are taxable. TFSA withdrawals, on the other hand, are tax-free.
Not getting insurance
Unexpected expenses you don’t have proper coverage for can cause you to draw from your retirement savings long before you planned to. For example, an unexpected disability can restrict your ability to work and earn an income. Health insurance and disability insurance are well worth considering.
Re-investing all profits into your business
It’s tempting to invest as much of your income back into your business as possible, especially when you’re just starting out and trying to grow your business. When business is going well, it can feel like a better investment to grow the business rather than contribute to a retirement savings account you won’t get to use for years. However, the future is always uncertain, and even very successful businesses can take a turn. Don’t fall into the common pitfall of expecting to be able to live off of your business profits forever.
Make retirement savings a priority
Saving for retirement requires a little extra planning as an entrepreneur, but by setting up a plan, you can enjoy peace of mind about the future while focusing on growing your business today. Compound interest is powerful and the sooner you can start contributing, the more your investment will ultimately grow.