When is an RRSP right for you?
“You invest in an RRSP not because of the tax deduction but because you are investing in your future self,” says Michael Deepwell (Getty Images)
To use an RRSP or not to use one: that’s a question that Michael Deepwell, CPA, CA, CFP, CLU, principal with Lamp Financial, hears a lot in his practice.
“Clients are always asking whether they should open an RRSP account,” he says. “The short answer is yes. It’s better to save something than nothing at all.”
If you are giving an RRSP some serious consideration, there are some guiding principles that can help you tell whether it’s right for you.
WHEN DOES AN RRSP MAKE SENSE?
1. When you expect to have lower taxable income when you withdraw the funds, compared to when you claimed the RRSP contribution.
While you are working, RRSP contributions lower your taxable income. As Deepwell explains, if you earned $80,000 per year and claimed $10,000 as an RRSP contribution, then your taxable income would be reduced by $10,000 and result in tax savings of approximately 31 per cent or $3,100. The percentage depends on your marginal tax rate. The higher your taxable income, the higher the marginal tax rates, and thus the more beneficial the RRSP deduction becomes.
It’s important to note that when you withdraw from your RRSP, the full withdrawal is included in your taxable income along with other sources of income, such as government and employer pensions. So it’s important to consider all sources of income, not just RRSP contributions and withdrawals, in planning for retirement.
2. When you want to make time work for you.
As Deepwell explains, you can start contributing to an RRSP the year after you have declared earned income on your tax return. That can be as early as the year after your first paycheque (although parents will need to retain signing authority until the child reaches the age of majority).
“Since you can keep contributing until age 71, that can give you 55 years or so of tax-free compounding,” he says. [See Time to set the record straight about these 5 RRSP myths]
3. When you have minimal or no employer pension.
Retirement funding, as Deepwell explains, is based on three pillars: government plans such as Canada Pension Plan or Quebec Pension Plan benefits, as well as Old Age Security, employer pension plans and personal funds.
If you are self-employed, your employer plan is minimal, or you’ve decided not to join your employer plan, you will have to make up the difference to support your lifestyle through other means—such as an RRSP, TFSA, equity in a home, investment savings accounts or other assets.
4. When you want to contribute now and claim later.
This might be the case for students who land their first job, says Deepwell.
“You might work only part of the year, so you will be in a low tax bracket,” he says. “But you know you’re going to be in a higher bracket in two or three years (or longer). So you can contribute this year, report the RRSP contribution for tax purposes, but not claim the RRSP contribution—RRSP contributions can be carried forward indefinitely. This allows the underlying investment to grow. When you are in a higher tax bracket, you can claim the RRSP contribution that was made years ago.”
WHEN DOES AN RRSP NOT MAKE SENSE?
1. When you expect to be in a higher tax bracket when you withdraw the funds.
As Deepwell explains, this is the opposite of No. 1 above.
“If you have higher taxable income when you withdraw the funds, then you could be paying a higher rate of tax,” he says.
Until you review your retirement plans, you might not realize how the various income sources integrate. For example, RRSP withdrawals combined with an employer pension and government benefits could push you over the Old Age Security (OAS) clawback threshold, which means you might potentially end up paying a higher tax rate, but also losing out on a portion of OAS benefits.
2. When you have a sizeable employer plan or other taxable income sources.
If your employer offers matching contributions or if you have a defined benefit plan that is going to pay out, say, $5,000 a month, you might not need an RRSP to fund your retirement lifestyle, says Deepwell. “If you have your government pillar and a substantial employer plan, it makes sense to max those out,” he says.
And if you have other sources of income, you may have less need for an RRSP, depending on your lifestyle needs. You will want to bring in a professional to balance your various sources of retirement income with your lifestyle choices. In any case, it’s important that you consult with your tax accountant before implementing any plans.
Ultimately, the decision to invest in an RRSP will be a very personal one based on your unique financial situation. But even so, Deepwell says he keeps coming back to the inherent value of saving for saving’s sake.
“In the end, you invest in an RRSP not because of the tax deduction but because you are investing in your future self,” he says.
GET MORE ADVICE ON RRSPS
To learn about RRSPs and how they compare to other retirement savings vehicles, see CPA Canada’s Understanding RRSPs and TFSAs and The Procrastinator’s Guide to Retirement. To plan a financial literacy session in your community, see Planning for retirement.