Are RRSPs Right For Me?

It is RRSP season, and financial advertisements are everywhere telling us to contribute before the March 2 deadline. RRSPs are a very -useful tool. However, it is important to understand how they work, their benefits and limitations, and whether they are right for you.

RRSP 101:

·        Contribute Up To 18% of Your Income
RRSPs are savings and investing accounts designed to help you save for retirement. The government allows you to contribute up to 18% of your income (up to a maximum of $24,270 for 2014) each year. You can also catch up on unused contribution room from previous years. To know what your contribution room is for 2014, look at the bottom of your 2013 Notice of Assessment, or call CRA at 1-800-959-8281.

·        Contribute up to 60 days into the following calendar year
If you have not contributed or maxed your RRSPs in a given calendar year, you can still contribute in the first 60 days of the following year. You can contribute for the 2014 calendar year up to March 2, 2015.

·        Receive a Tax Deduction on Contributions
When you contribute to an RRSP, you receive a tax deduction at your highest marginal tax rate. A BC resident in the top tax bracket (earning more than $150,000) will receive a tax deduction at the highest tax rate of 45.8%. Therefore, a $10,000 contribution will attract a $4,580 tax refund. A BC resident earning $75,000 per year is in a marginal tax bracket of 29.7%. Therefore, a $10,000 RRSP contribution will attract a $2,970 tax refund. The higher your income, the higher the tax benefit you will receive from an RRSP contribution.

·        You can contribute in your spouse’s name
If one spouse in your home earns more than the other, the higher-earning spouse can contribute to a “Spousal RRSP” in the name of the lower-earning spouse. This creates a tax deduction at the higher earner’s tax rate, but builds up retirement savings in the lower earner’s name. The goal is to build up roughly equal amounts of retirement savings in each spouse’s name, so that future retirement income will be roughly equal and therefore tax will be minimized. Utilizing spousal RRSPs is a great way to work towards this.  

·        Not Limited to Savings Accounts
The name “Registered Retired Savings Plan” suggests that RRSPs are “savings accounts”. However, RRSPs can also be invested into an investment portfolio. One of the benefits of investing inside of your RRSP is that the potential for return is greater, giving your RRSP a better opportunity to beat inflation and grow for your retirement. Consider investing in a well-diversified investment portfolio within your RRSP.  

·        RRSPs are Tax Deferred, but Withdrawals are Taxed as Income
Any gains earned in the RRSP are not taxed while they are inside the RRSP. However, they are taxed as income when you withdraw. Ideally, you will have contributed while in a high tax bracket (highest income earning years) and will withdraw when in a lower tax bracket (such as retirement). Below are some questions to help you determine whether RRSPs are right for you.

Determining if RRSPs are Right for You:

1.       Do I have surplus income?
To contribute to RRSPs, it is generally wise to contribute out of your savings as opposed to borrowing to do so (although in some cases it might make sense to borrow). If you have savings, or the ability to set aside money each month for savings, RRSPs are a good option.

2.       Am I in my high-income earning years?
As mentioned above, the more money you earn, the more tax you will get back when making an RRSP contribution. It therefore makes sense to contribute to RRSPs in your highest income-earning years (note that unused RRSP contributions in low-income years can be used in future years). For clients just starting out in their career, or working less in later life, we often recommend contributing to TFSAs instead of, or as a priority over, RRSPs. If you expect your income to grow significantly in the future, consider deferring RRSP contributions until those higher income-earning years.

3.       Will my income be lower in retirement?
Remember that while you receive a tax deduction for contributing to an RRSP, you are taxed when you take money out. If you expect your income to be lower in retirement than during your working years (as is the case for most people), then RRSPs can be highly advantageous. You receive a large tax deduction, the money grows tax deferred and it is withdrawn at a lower rate. However, if you anticipate high income in retirement, such as income from a very large pension, a family business or royalties, then RRSPs may not be the best choice. Other options, such as a TFSA, non-registered account or investing in your corporate Holding Company should be considered in consultation with your financial advisor.

 

The Power of Regularly Contributing to your RRSP:

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Contributing regularly to your RRSP (or other investment account, such as a TFSA) is a powerful thing. Here is a simple illustration. If you started an RRSP with $10,000 at age 30, and contributed $500 per month until age 65, with the investment portfolio growing at an average annual rate of 7.5%, you would have $1.1 million dollars at retirement (see graph below illustrating this growth). You would also have received several thousand dollars in tax benefit from your contributions over the years. This is a significant pool of money that otherwise would not be there if you hadn’t planned ahead and started contributing regularly.

Graph source: Mackenzie Investment & Regular Deposit Calculator

If you work backwards from where you want to be at retirement in order to live the lifestyle you want, you can start planning how much you should contribute to RRSPs and other investment tools in order to get there.

Make sure you know which accounts you should be contributing to at this stage of your life. Feel free to give us a call on 1-866-960-1025 or drop us a line at tycuda@3macs.com to discuss your specific circumstances.