It’s that time of year in Canada where we are inundated with advertisements and reminders to make your RRSP (Registered Retirement Savings Plan) contributions. But is making an RRSP contribution the right thing for you? While saving for tomorrow is always a good idea, depending on your personal circumstances, saving into your RRSP may not be the best (or only) place to save.
In the book Bank on Yourself – Why Every Woman Should Plan Financially to be Single, Even if She’s Not we addressed this very issue and wrote:
“When it comes to tax, we have all been conditioned to “defer, defer, defer” and to believe that the RRSP is the ideal vehicle for doing that. After all, an RRSP allows you to reduce your taxable income to pay less tax now, and possibly even receive a tax refund; save in an account that lets your money grow tax-free; and then pay the tax way down the road, in retirement. For some people, this strategy can work out well if your tax rate is lower rate in retirement than it is in your working years. However, for others who have planned for and achieved a more comfortable retirement, that deferred taxation can bring a nasty surprise. You arrive on the doorstop of retirement with lots of savings in your “retirement” account and you start to withdraw the income you’d planned for, then you do your taxes in the first year and say, “oh wow, I have to pay how much? But I’m retired!” Not only that, but as you go through retirement you are forced to take more and more out and, therefore, have to pay more and more tax on those withdrawals, which are taxed as the highest tax type: Income…. If you aren’t in retirement yet, take note: Just because the word “retirement” is in the name, it doesn’t make the RRSP your only choice of account for retirement savings. If you are going to have the ability to have a tax-efficient income in retirement, your RRSP may be one of those accounts you choose to invest in, but it shouldn’t be the only account.”
In retirement there is less consequence to having too much in your RRSP for two person households given the ability to pension income. However, for a single person, or in the event you become single again in retirement, too much in the RRSP (or RRIF – what your RRSP converts to when taking retirement income) can have a significant negative impact on your tax bill and your government benefits. In retirement, a one personal household pays more tax than a two person household for the same level of household income because they can’t split pension income. Not only does too much money in that type of account result in high tax burdens, but it also can result in losing out on some or all of your government retirement benefits, namely Old Age Security (OAS). The OAS Claw Back is the equivalent of an extra 15% tax.
Saving is always important. The RRSP gives us highly beneficial tax breaks during our working years and makes it a very important account to use while saving. But it isn’t the only account. Tax Free Savings Accounts (TFSA) are every Canadian’s most valuable account providing both tax free growth and income, and investing in a Non-Registered Account can also provide a more tax-efficient income in retirement. Finding the right balance between using these different types of accounts can make all the difference to your ability to achieve a lifetime of financial independence by managing what is most Canadian’s biggest expense: Tax.
As always, consult with your accountant and your financial advisor about what account, or mix of accounts, is best for you to save and invest using given your personal circumstances. With the proper planning you can find the right balance between accounts for saving today and income for tomorrow.