Why we optimize, do not maximize our RRSPs
No doubt the RRSP deadline is approaching fast. If you don’t already know, the last day to contribute to your RRSP for the 2011 tax year is February 29, 2012.
Here are some quick facts about RRSPs as it relates to the 2011 tax year:
- The maximum contribution limit for 2011 is $22,450. If you did not use all your RRSP contribution room for years 1991-2011, you can carry forward the unused amount to 2011 – so your deduction limit for 2011 could be more than $22,450.
- Your contribution limit should be on your last years’ Notice of Assessment (NOA). If you don’t what this statement is (or where you filed it), contact the Canada Revenue Agency (CRA) here to find out what your limit is.
With those facts out of the way, it’s important to remind ourselves why the RRSP is such an excellent tool. Here is a quick refresher since there is so much information available about this vehicle:
- RRSPs were introduced in 1957 to encourage Canadians to save for retirement.
- Some people borrow from this account to help buy their first home.
- Some people borrow from this account for education purposes.
- You get a tax break when money goes in. You get tax-deferred growth.
- RRSPs have withholding taxes. You can find out more information about RRSP withholding taxes here, but a summary is provided below:
RRSP Withdrawal Amount
|Up to $5,000||
10% (5% in Quebec)
|$5,001 to $15,000||
20% (10% in Quebec)
30% (15% in Quebec)
- You cannot hold your RRSP after age 71. RRSPs must be converted to a RRIF, an annuity or investments need to be sold and monies withdrawn. You can read more about those options here.
Most Canadians are enamoured with RRSPs, for all the great reasons above and more. This tool is also a component in our retirement plan but just one of many. Instead of busting our butts every winter to maximize our RRSPs we choose to optimize our RRSPs instead. That is, we contribute only enough money to our RRSPs to avoid paying any more income taxes. If anything, we might get a small tax return back (which is fine).
Why do we do this?
1) Maximizing the RRSP takes a whack of cash
When you crunch the numbers, maximizing the RRSP contribution is a challenging task. I don’t know about you but saving 18% of our income amongst everything else on the go is a very tall order. I don’t need the stress of worrying about this every year, which leads me to reason # 2.
2) We’ve got competing priorities
A Globe & Mail article a few weeks ago stated “Canadians might want to stop working before the age of 65, but for the many who don’t have enough saved that retirement goal is just a pipe dream.” OK, but as 30-somethings we’ve got more to worry about that just retirement. How about:
- Paying down mortgage debt.
- Paying off credit cards every month.
- Making TFSA contributions.
- Creating an emergency fund, and last but not least,
- Enjoying life.
Saving for retirement is very important and necessary but it doesn’t trump everything else.
3) I don’t like borrowing from the government (too much)
In a recent post, I said RRSPs are excellent because the contribution you make lowers your taxable income and you may get a tax refund because of it. A great formula! Yet I know this refund is really a long-term loan from the government. A refund associated with my RRSP contribution should not be considered a financial windfall but instead, present value money for a future tax payment I’ll be required to make. RRSPs provide tax-deferred (not tax-free) growth. At some point, the tax man will find you (and I) and ask for his refund back in whole or in part.
In closing, I think RRSPs are great. We contribute to them throughout the year, a few thousand dollars in fact but only to optimize our accounts for tax purposes. This way, we don’t need to stress about our financial situation when some bank ads appear this month. By optimizing our RRSPs, we can divert income to other things in life. There’s much more to life than mortgage payments…right?! Lastly, we know these taxes are deferred not free so by contributing moderate sums today, we’ll avoid a considerable tax consequence years down the road.
RRSPs are a great tool and we’ll be using ours for years to come for sure. Before you rush out to maximize your RRSP this month, I think you’d be wise to determine how RRSPs apply to your overall financial plan. Maximizing them may not be the right strategy for you.