When should you start contributing to your RRSP?

The longer you allow the money in an RRSP to accumulate, the better it is, experts say (Getty Images/PhotoAlto/Eric Audras)

The annual deadline for contributing to a registered retirement savings plan (RRSP) is coming up (March 2, 2020)—a time of year when many Canadians consider if they should add to their plan, how much and when.

For many, contributing to an RRSP is a no-brainer—the sum is deductible from total income, which can reduce taxes in the year its claimed. What’s more, income earned in an RRSP, such as interest, dividends and capital gains, grows tax-free until it’s withdrawn. The idea is to contribute to an RRSP earlier in life to benefit from compound growth over time for retirement.

“The longer you allow the money to accumulate, the better it is,” says CPA Jamie Golombek, managing director of tax and estate planning with CIBC. 

Funds in an RRSP can also be used to buy a home through the Home Buyers’ Plan, or go back to school using the Lifelong Learning Plan, says Golombek. 

RRSP OR TFSA?

How much and when to contribute to an RRSP is a conundrum for many Canadians, particularly those who need to choose between an RRSP and the tax-free savings account (TFSA). There is no income deduction when you contribute to a TFSA, but the assets inside grow tax-free and aren’t taxed when withdrawn.

If you can’t contribute to both an RRSP and a TFSA in a given year, Golombek says that, generally speaking, Canadians in a higher income bracket should pick an RRSP over a TFSA to take advantage of the deduction today and withdraw at a lower tax rate in retirement.

On the flip side, those earning less money might choose to pay tax on their income now, at lower rates, and contribute the after-tax amount to their TFSA first. They could then contribute to an RRSP later if their income and tax rate is higher. For those unsure about whether the money can remain invested long-term, a TFSA is better suited for short-term investments.

“There’s no right answer for everyone. It really depends on your tax rate, your financial plan, your goals and what you're trying to achieve over what time horizon,” says Golombek.

TIMING AN RRSP CONTRIBUTION

When to make an RRSP contribution for a particular year is another consideration for Canadians. Golombek recommends making smaller contributions throughout the year, if possible, instead of in a lump sum before the deadline.

“You should do so as soon as you have the money,” he says, noting that there’s no requirement to invest the money when contributing. It can sit in a savings account until a decision is made on how to invest, “but don’t forget and just leave the money sitting around earning minimal interest for years,” says Golombek.

He also discourages investors from trying to time when to buy investments, such as stocks and bonds, based on headlines or recent market activity.

“If your theory is that you’re investing money for the long term and you think over time markets are supposed to go up, why would you second guess the timing?” he says. “As soon as you have the money put it into the RRSP, let it grow tax-free as soon as possible. It's out of sight, out of mind, and you don’t spend it.”

RRSP CONTRIBUTION STRATEGIES

Canadians can also contribute to an RRSP in one year, and deduct that amount in a future year, says CPA Tannis Dawson, vice-president of high-net-worth and business succession planning at TD Wealth Advisory Services.

Dawson says the strategy can sometimes work for people in a lower income-tax bracket, who know they will earn more in the future, such as a student just starting their career or someone on maternal or paternal leave.

“As long as you have contribution room, you can put money in, but then choose when you take the deduction,” Dawson says.

Some Canadians may also want to borrow money to contribute to an RRSP, but Dawson doesn’t recommend this strategy. “Unless you can pay back in a year, borrowing for an RRSP is usually not a good idea because the interest isn’t deductible,” she says.

Spousal RRSPs are also an option for married or common-law couples, Dawson notes. In this case, the higher-income spouse contributes to the spousal RRSP and receives the tax break, which then reduces the couple’s overall taxes paid. 

Dawson says the contribution affects the higher-earning spouse’s RRSP deduction limit, while the lower-income person’s limit is unaffected. But there are rules to how long the money has to stay in the RRSP before it is taken out by the spouse, so contributing earlier is better, she says.

It’s one of a handful of strategies Canadians can consider when contributing to RRSP, Dawson says, adding: “There are many options of where you can put your savings, which has made the decisions more complicated.” 

Both Dawson and Golombek recommend Canadians consult a financial adviser to help make decisions based on their personal goals and circumstances.

LEARN MORE ABOUT RRSPS

For advice on 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.