Last week’s post Unrealistic RRSP Contribution Expectations generated quite a few comments. We explored the issue quite thoroughly, and it makes sense to lay out a more realistic plan.
The main problem with examples that assume constant contributions for a lifetime is that they ignore inflation. It makes little sense to assume that the typical young person will make considerably larger contributions (taking into account inflation) than that same person will make later in life. There may be a few people who will follow such a path, but the majority will make large contributions in mid-life.
So, let’s try a different scenario. As some commenters suggested, let’s assume that the contributions increase in size with inflation. Let’s say that a 25-year old starts contributing $500 per month and increases this amount with inflation for 40 years. As before, we’ll assume that inflation is 4% and investment returns are 8%.
The total in the RRSP after 40 years will be about $2.7 million, but it will only have purchasing power of about $560,000 in today’s dollars. The question now is what will happen if we wait until age 35 to begin contributing? The final total in today’s dollars would be about $330,000. So, the first of 4 decades of contributions accounts for a little over 40% of the total.
Even if the contributions from age 25 to 35 are half-sized, the final RRSP holdings of about $445,000 are substantially higher than the $330,000 that would result from making no contributions in the first decade. So, saving when you are young makes a difference.