Many financial planners, myself included, have been talking about the benefits of a Registered Retirement Savings Plan (RRSP) and how important it is to have one. But, just like many other things in the financial planning spectrum, the RRSP is not a one-stop solution and is not for everyone.
So, should people not invest in an RRSP at all? There may be those who are in fact better off skipping RRSP’s all together and focusing on Tax Free Savings Account (TFSA) and other tax efficient non-registered investment options instead.
These people will generally fall into one of the following categories:
Low Income – While the annual income amount considered to be “low enough” will vary based on a number of other factors, those that live on a low income level now and expect to also do so in retirement will typically be better investing the small amount they can afford to put away into a TFSA.
In addition to getting little value from the tax credits for making RRSP contributions, if you plan to live largely on only CPP and OAS benefits in retirement, avoiding the RRSP program should allow you to qualify for the Guaranteed Income Supplement as well in retirement.
Close to Retirement – If you’re within a few years of your retirement date and you haven’t made any RRSP contributions at all, the benefits of the program may not be worth it. This will depend on your current income and the tax credits that you would receive but generally if you’re only able to save a small amount and haven’t started yet, there is a lot less time to take advantage of the tax deferral benefits.
Having said that, there are some situations where large RRSP contributions in the last few years of working will also make more sense so again every situation is different and should be evaluated properly.
Low Tax Rate – By investing in an RRSP, you get a tax credit that is applied against earned income. If you’re paying a low marginal tax rate now, claiming this RRSP deduction will provide a smaller refund against taxes owed. Down the road in later working years or in retirement, you could end up paying higher taxes when you pull the RRSP money back out if your tax rate at the time is expected to be higher.
Young people who are currently in a lower tax bracket but expect their earnings to increase over time should generally still utilize some of their RRSP room now, though they may want to also save some for later years when they are earning more money.
In addition, instead of using the full deduction in the year it’s made, you may elect to hold onto some of your RRPS contribution credits and apply it in subsequent years when your income level has risen.
Large Pension Plan – For those fortunate enough to have a significant work pension building up, the RRSP program may not be the best choice. Your pension may provide a substantial income amount during your retirement that will be fully taxable and adding taxable RRSP income on top could push you to a higher tax bracket and/or cause your OAS to be clawed back.
If your pension is going to make up the majority of your retirement nest egg, it might be best to diversify your personal contributions into other options so that your tax situation in retirement is more manageable.
Roughly half of those who can contribute to an RRSP will in a given year and it’s sad to see all of this RRSP contribution room being wasted, often due to misconceptions about how the program actually works. Canadians are falling farther behind in their retirement planning and the benefits associated with the RRSP program can go a long way to helping most people reach their goals.
I still strongly advocate the use of RRSPs for most people, but if you fall into one of the four categories above make sure you discuss your situation with a Certified Financial Planner professional to see what contribution plans make the most sense for you.
This column is written by Michelle Weisheit CFP, IG Wealth Management and presents general information only and is not a solicitation to buy or sell any investments. Please contact your own advisor for specific advice about your situation.