By Karin Mizgala, Co-Founder and CEO Money Coaches Canada
With the March 2nd RRSP (Registered Retirement Savings Plan) deadline looming, it’s often the only time of year we give retirement savings much thought. March 2nd, 2020 is the deadline for contributing to an RRSP for the 2019 tax year.
Are RRSPs still a good investment? Should you be paying down your mortgage first? Or are Tax-Free Savings Accounts (TFSAs) a better savings strategy? These are some of the questions we hear from our clients who understandably are confused by the many and varied options. And while in general, I tell them investing in RRSPs is a good idea, there’s by no means a one-size-fits-all answer.
While most financial institutions extol the virtues of RRSPs (it is a big part of their business after all), I see more articles and debate about their usefulness.
From RRSP supporters, we hear about the benefits – you can deduct RRSP contributions from income. So, as a result, you pay less tax and the income earned in an RRSP is tax-sheltered.
On the flip side, naysayers argue that RRSPs aren’t really a tax savings vehicle, just a tax deferral because you must pay tax when you withdraw the funds. The drawback is that if you are still in a high tax bracket when you withdraw the money at retirement, you pay tax at that higher rate, and you might also lose your Old Age Security pension benefits. Or, if you still have a large RRSP at death (unless you have a spouse), your estate will be hit hard with tax rates that can lop off 50% or more of the estate value of your hard-earned RRSP savings.
Truthfully, there is so much to consider. But it’s important not to get overwhelmed. Let’s start by painting the portrait of the ideal RRSP investor and then looking at a few other questions we frequently address from would-be RRSP investors.
When Do RRSPs Make the Most Sense for Canadian Investors?
RRSPs almost always make sense if you fit this profile:
- You are under 50 with 10-15 years to retire
- You have less than $200K invested in RRSPs to date
- You are in the highest tax bracket now
- You pay less than 5% on your mortgage
- You have a balanced portfolio of conservative stocks, bonds and cash investments in your RRSP
There are, however, other factors you should consider before determining that an RRSP is the best investment vehicle for your retirement. Here are a few things to consider before making an RRSP investment.
- Are you in the highest income tax bracket? For every dollar you contribute to your RRSP in the highest tax bracket, you reduce your taxable income, in effect getting you a tax refund of $498 for every $1,000 you invest if you live in BC. (Tax rates vary slightly from province to province).
- Do you have less than $200,000 invested in RRSPs? Even if you think you’ll work past 65 and your expenses are modest, you’re still going to need to save and invest for retirement.
- Is your income less than $50,000 a year? If so, you may want to consider investing in a TFSA instead of an RRSP. You can shift the money to an RRSP later if your income increases. You get a tax break for making an RRSP contribution, but you are taxed on every dollar when you start taking money out. So, you’ll want to make sure that you’re getting a high enough tax break on the money you contribute. At $47,000 a year, your tax break is only 24.15% if you are an Ontario resident.
- Is your income likely to be considerably higher in the coming years? Perhaps you’re working part-time, or you’re earning what amounts to a training wage while you work towards credentials that could boost your income. It makes sense to get the largest tax break you can for your RRSP contribution, so as in the case above, put your money into a TFSA and wait until you can get a refund that’s 30% or higher.
- Does your employer benefit plan match RRSP contributions? If your company has any provision for matching RRSP or pension contributions, take advantage of it.
Should You Contribute to Your RRSP or Paydown the Mortgage?
The RRSP dissenters often recommend paying off your mortgage before making an RRSP investment. They argue that the better course is to invest outside of your RRSP, and now, your TFSA (Tax-Free Savings Account) as well.
There are some instances where this makes sense. But usually, it’s best not to wait to save. You may be paying your mortgage for 25 or 30 years (or more). If you wait for the day it’s paid off, there may be little time to catch up on your savings for retirement, and you lose all those years of RRSP growth.
A two-part strategy that grows your RRSP and shrinks your mortgage is to make your RRSP contribution and then take any tax refund you receive to pay down your mortgage. This works best if you’re in a high tax bracket, and the interest rate on your mortgage is more than 4%.
Should You Borrow to Make an RRSP Contribution?
This is another one of those situations where the right answer for one client might be wrong for the next, but generally, I’m not a big fan of RRSP loans.
If you have little or no taxable income, don’t borrow for an RRSP. If you’re in the highest tax bracket, consider borrowing, but only if you don’t owe money on credit cards or other high-interest debt. And, you should only borrow if you’re able to pay off your RRSP loan within one year, using your tax refund to help pay off your RRSP loan.
How to Simplify Paperwork for Better RRSP Decision Making?
Do you receive RRSP statements from multiple companies? All this information, streaming in from multiple financial institutions, can be overwhelming. This is especially so when combined with the barrage of RRSP advertising that inundates us every February. Perhaps it is time this year to do a little financial housekeeping. It is imperative to see what you have in your RRSP accounts, how they are performing, and what fees you are really being charged.
As a starting point, consider consolidating your RRSP accounts to reduce some of the needless paperwork in your life. While putting all your eggs in one basket is generally not a good idea, it is also important to make sure the risk of holding your investment at one financial institution is real and worth the extra paperwork. If you have investments spread all over primarily because of deposit insurance concerns, remember that most financial institutions have several subsidiaries that can each cover $100,000 in deposits.
There is no set standard on how much to hold at different financial institutions, but there can be advantages to hold more of your RRSPs in one company. With a larger account, you will likely get more attention, better service and lower costs.
It’s easy to transfer from one company to another. Do a little extra analysis this year then decide where it is best for you to hold your investments. Your advisor, banker or broker will handle all the paperwork to make the transfers. Be sure to ask about any transfer or redemption charges and make sure you don’t cash out your RRSP, or there will be tax consequences.
One of the most important considerations when choosing a home for your RRSPs is to go with an advisor who has earned your trust, with whom you have a good working relationship or is referred to you by an unbiased and credible professional. Trust matters, above all else, when it comes to your financial well-being.
Where to Go from Here
Who’s right about RRSPs? For most Canadians, I still think that RRSPs are the way to go (and that’s from an advice-only planner who doesn’t sell or earn commissions from RRSPs or any other financial product).
And a big reason I’m in favour of them isn’t financial; it’s behavioural. Most people think twice about withdrawing money from an RRSP before retirement, so there’s a greater chance that you’ll have some savings when you retire even if you do have to pay some tax.
However, RRSPs may not be the best option for you if you’re close to retirement, already have tons saved in your RRSP account, and expect that your retirement income (after any income splitting) will put you in and around the highest tax bracket.
If you have questions or need guidance on how best to prepare for retirement, contact one of our Money Coaches today.