It’s coming up on the time of year where banks will start the big push on RRSP’s. RRSP’s aren’t universally a great idea as they would have you believe though. So I’ve put together a few thoughts on them to help you decide if you should be putting your savings in an RRSP or a different savings vehicle.
I like to think of RRSP’s as an umbrella that you can put all sorts of investments under. Putting your investments under this umbrella means that they are treated a certain way for tax purposes. The whole idea behind them is to defer taxes you would pay on that income to when you withdraw them in retirement and are in a lower tax bracket. So if you are working fulltime now making 80k a year and contribute 10k to an RRSP you would get a benefit of only being taxed on 70k for the year, resulting in a refund on your tax return this year. Later in life after you’ve retired and your income is now only 20k a year between CPP and OAS you start to withdraw from the RRSP. This is the time that you get taxed on that income you earned years ago. Benefit being that you are in a much lower tax bracket and therefore pay a lower dollar figure on that 10k than you would have when you were making 80k.
The money you contribute to an RRSP gets deducted from your income for tax purposes in the year you contribute and gets added to your income in the year you withdraw it. You still pay tax on the money, it just gets deferred to a time when that tax rate would be more favorable. The assumption being that you will have a working life where your income is high and then retirement years where your income is low. RRSP’s can help even out your tax bracket and therefore save you money overall.
If you have an income now of 25k and in retirement will be in an income range much the same, you really aren’t winning with this type of investment tax wise (which is the main benefit.) On top of that, if you are low income into retirement years, withdrawing RRSP’s can actually disqualify you from many government programs for low income people and seniors, such as the old age security supplement and associated drug card (this card can represent thousands a year if your health isn’t top notch)
I had one particular client who had over a million in RRSP’s. His financial advisor was still trying to keep his RRSP withdrawals low enough so that he could qualify for the supplement and drug card. At the rate he was choosing to withdraw his RRSP’s (about $1000 a year) meant that he still qualified for those programs, but that he would never actually spend and enjoy that money he had spent his whole life sacrificing to accumulate. He was choosing to live with an income of maybe 18k a year with a million dollars in the bank. This is what his advisor had suggested he do. I’m sure there are really good advisors at banks, but this kind of awful advice makes my heart hurt.
Another scenario is for someone like me. My income is relatively low now. I have chosen for it to be that way. I want to work less hours while my kids are small so I can have more time with them. My income will increase with time. I have plans for rental properties and business that will see me earning more in my retirement years than I do now. So for me, RRSP’s aren’t necessarily a beneficial thing. My income will be higher when it’s time to withdraw them and I will end up paying more on that income than I would now.
So if RRSP’s aren’t always the best option, what other options are there for future savings? There is another umbrella that the government has created that is the TFSA (Tax free savings account.) Investments under this umbrella are treated completely different for tax purposes than RRSP’s. There is no change to your income for tax purposes by contributing or withdrawing from these accounts. The benefit to this type of umbrella is that any interest or dividends earned on your investment is tax free.. forever. So while RRSP’s can be hugely advantageous for some people, TFSA’s are much more universally advantageous. If you have investments that aren’t under the RRSP umbrella, they should be under this umbrella (up to your contribution limit.)
On the topic of contribution limits, both RRSP’s and TFSA’s come with limits to how much you can contribute to each. Your limit can be found on your last year’s Notice of Assessment, or they can be found on your online account with CRA. Going over limit comes with heavy penalties, so it’s important not to go over. I have seen dozens of cases where people got a windfall of money and were advised by their banks to put it all in an RRSP or TFSA without giving consideration to the person’s limit, costing them thousands in penalties.
Another issue I see is people contributing to an RRSP and then withdrawing it a year or two later when their car breaks down, or they are out of work for a couple weeks, or something else pops up. An RRSP is not an emergency fund. I’m gonna say that again.. An RRSP is not an emergency fund. You are shooting yourself in the foot by getting an RRSP if you don’t also have some money in a stash elsewhere for those bumps in the road. You invest one year, save $500. The next year you wind up with a tax bill for $500.. or more depending on if you’ve popped yourself to a new tax bracket with the withdrawal. If you don’t have the cash to pay that $500, you also get interest while you pay it off. Put the money into a TFSA so you can withdraw with no penalty and you don’t have to have your tax returns impacted at all. RRSP’s are designed to stay there until retirement when your income is lower. Taking them out all willy nilly when your income is still higher is not beneficial in any way.
Now that we’re clear on the intended purpose and benefit of RRSP’s, you may still choose to contribute to an RRSP even if that’s not your situation, but as a means to save for a home or for schooling . The government has two programs called the home buyers plan (HBP) and the lifelong learning plan (LLP.) Both programs work on a similar premise in that you can withdraw from your RRSP to use as a down payment on a home or for school without penalty. You then have a set number of years to repay what you withdrew from your plan, or you can stretch out the taxing of that money over 15 years rather than all in one year. This could be a reason to set up an RRSP that falls outside the general ‘defer taxes until you’re retired and in a lower tax bracket’ reason.
Some employers will match RRSP contributions in lieu of a pension plan. This could be another fantastic reason to contribute to RRSP’s. Free money is free money after all.
You will probably hear some talk about RRSP loans this time of year. Banks will tell you that it’s a good idea because the interest on the loan is a deduction (it is, but you still have to pay the interest on the loan to get the deduction. You just get a tax break of a portion of the interest you paid.) It’s also important to say that the interest you pay on a loan vs. the interest you will earn on the investment are not anywhere near the same. If you do the math on this reason, it really isn’t a mathematical benefit still. Paying 10% on a sum of money to earn 2% on the same sum of money just doesn’t add up even with the small benefit of having interest paid as a deduction.
They will also try and tell you that your RRSP contribution will give you a refund on your tax return. Generally it does, but it certainly doesn’t always. If you spent any time on EI, or have rental income or business income the refund you would have gotten from the contribution will probably be offset. If you owe any money to the government, they may take your refund to pay it. CRA can take tax refunds to pay delinquent student loans, delinquent child support and spousal support payments, fines, money owed to EI Programs, all sorts of things. If you have any of those things you won’t get any cash refund for your contribution, it will go to your government debts. Even if neither of those apply and you did work one job all year and will get a refund, it won’t be the full amount of your contribution. At best it’s about 30% of what you contributed. So unless you have other money sitting around (which if you did you wouldn’t be taking out a loan) you will still be left with another debt and another bill that needs paying. I personally am anti- RRSP loan for that reason.
I hope I didn’t overwhelm you with tax talk on this one. The simplest advice I can give is if you aren’t sure if RRSP’s are right for you, ask an accountant or tax specialist, not someone who’s job is to sell RRSP’s. The job of bank employees is to sell investments and credit (notice how RRSP loans are a double win there.) They are trained in upselling. They aren’t all trained in assessing the full financial picture of a person. They certainly aren’t all trained in taxes. I can tell you as someone who has worked in a financial institution just how little training there is on RRSP’s for tellers. What training was provided didn’t even begin to cover the vast amount of different financial situations, fluctuations in income, and the tax implications of all that, which is the most important piece in deciding if a person should buy them.
I’ve seen people on social assistance or who are claiming a super small net business income buy RRSP’s on advice from their bank teller. There is zero tax benefit what-so-ever to the person, but they were told they’d get a tax refund. Some of these people also screwed themselves out of their OAS supplement or social assistance by taking the RRSP’s out in subsequent years too. I could go on and on about the crappy advice people have gotten around RRSPs, and the general lack of understanding around the tax side of them, but I won’t. I just want you to understand the way they are designed and how to use them to get the most benefit. Bank employees are highly incentivized to sell you RRSP’s so take their advice with a grain of salt. Not every person benefits from RRSP’s.
You will notice also that the sales pitch that generally comes this time of year for RRSP’s is heavily weighted in the tax break you get now. As someone who prepares hundreds of tax returns a year for the last seven years, I can tell you this is only part of the equation. The withdrawing of the RRSP’s is rarely even mentioned in the process of buying RRSP’s. Most people are completely unaware of this half of the transaction and don’t find out until they get their tax bill and it’s too late.
The pitch is also weighted in the idea of saving for your future. RRSP’s are not the only way to save for retirement. TFSA’s are another great umbrella to use that are more universally beneficial. Personally, I keep my long term savings in a TFSA. It’s still retirement savings even though it doesn’t have the title and I have so much more flexibility in contributing and withdrawing that just isn’t there with RRSP’s.
If you have any questions on RRSP’s or TFSA’s please send them along! I know this one is a lot. Taxes are a beast all their own and knowing how what you’re doing with your savings is impacting them can be a tricky thing. Especially when you’re looking at different tax brackets and years. Don’t be afraid to ask a tax professional for help on this decision.
Also, feel free to ignore the pressure from the banks that will be heavy this time of year. Saving for retirement is an all year event that you can start anytime. RRSP contributions run from March 1 to March 1 each year instead of on the calendar year like all your other income and deductions for taxes. They capitalize on this deadline to drive sales. If you have a steady contribution you are doing fantastic. Take the noise they are putting out as an opportunity to learn more and spend some time thinking about how your retirement might look instead of as pressure to take out loans to invest to try and feel like you’re planning.
Dawn
Tax Wise 