RRSP facts and guidance for this season

With “RRSP season” now in full swing I thought I would remind you about some RRSP facts, why the RRSP is a powerful savings vehicle, why you might want to take advantage of it (or not), what to avoid when it comes to this account, and share what our longer term game plan for this account is.

First up, RRSP facts this year

  • The RRSP contribution deadline for the 2015 tax year is coming up – February 29th.
  • Contributions to an RRSP are tax deductible, so you can use these tax deductions to reduce your taxable income.
  • There is no minimum age requirement to have an RRSP; a minor can set one up thanks to their parent or legal guardian.
  • Contribution limits are based on the contributor’s earned income and can be found on his/her tax notice of assessment. The contribution room to this account is based on 18% of your earned income from the previous year up to a maximum of $24,930 for the 2015 tax year. (That’s a good chunk of change to sock away for your financial future).  If you belong to a company pension plan, this amount will be less.
  • If you did not use all of your RRSP contribution room from some previous years you can carry forward the unused room indefinitely. Check out your current Notice of Assessment to learn about your contribution room.
  • You can contribute to your RRSP until the end of the year you turn age 71.
  • Inside an RRSP you can hold a variety of investments including Guaranteed Investment Certificates (GICs), mutual funds, Exchange Traded Funds (ETFs), stocks, bonds, and other securities.
  • An RRSP is an account, not a mutual fund or an investment itself.
  • There are penalties if you over-contribute to your RRSP although a small exemption exists.
  • All money inside this account including the money you earn on your investments is tax deferred.
  • A common type of RRSP is an individual RRSP, registered in the name of the person contributing to it.  There are also spousal RRSPs and group RRSPs.
  • RRSPs can be managed by a professional money manager but you can do-it-yourself (self-directed).

RRSP Guidance

When should you contribute to an RRSP?

It depends.  Some articles I read blindly tell you to contribute to this account.  Don’t follow that advice.  As referenced above, there are two great tax benefits RRSPs provide Canadian investors:

  1. a tax deduction from your contribution, and
  2. Tax deferred growth.

With your tax deduction, you can reduce the taxes you pay today.  With tax deferred growth, investments in your RRSP can compound over time without being taxed as long as money made stays in the account.

For most Canadians, to reap the benefits of this tax deferred account they should maximize their contributions when it makes sense (based on their earned income) and keep the fees associated with their investments inside the account as low as possible for as long as possible.  This means RRSPs are highly effective for Canadians who will be in a lower tax bracket in retirement versus their contribution years. This is because you’re not as rich as you think:  when you take money out of the account, you have to pay the tax on the money withdrawn.

If you’re in a low tax bracket today or you’re just starting your working career*, you might want to think about maxing out your Tax Free Savings Account (TFSA) first, killing off all personal debt, creating an emergency fund or a combination of all three before you contribute to an RRSP.

*One caveat I’ll add to my guidance above is if you work for an organization that offers an RRSP matching program – then by all means take the free money offered by your company who will contribute to your RRSP and get the investments you choose inside this account working for you.

Should I use the RRSP for the Home Buyers’ Plan?

Probably not but that’s up to you. The Home Buyers’ Plan (HBP) is a program that allows you to withdraw up to $25,000 in a calendar year from your registered retirement savings plans (RRSPs) to buy or build a qualifying home for yourself or for a related person with a disability. There are a few conditions to take advantage of this plan.  You can read more about the HBP from our government’s website here.

In a nutshell you can repay the amount withdrawn within 15 years and you can repay the full amount back into your RRSP at any time. I personally don’t think the HBP is a great deal:

  • Problem #1 – You’ve received a tax refund on the money contributed to the RRSP. You will not receive another tax refund when you put the money back.
  • Problem #2 – While you have up to 15 years to pay back the loan, you might be in a higher tax/income bracket when you do. Effectively you are in conflict with a couple of core benefits of the RRSP account: long-term, untouched, tax deferred growth, and withdrawals that should occur when your income is lower than the income you contributed (i.e., when you’re not working).

Should I raid my RRSP to pay down debt?

Probably not but that’s also up to you.  Generally speaking, unless you have a big emergency on your hands, pulling money out of your RRSP to kill debt is a bad idea for a couple of reasons:

  • Problem #1 – There are withholding taxes charged if you raid this account early, think of it as a penalty charged by your future self.
RRSP Withdrawal Amount Withholding Tax
Up to $5,000 10% (5% in Quebec)
$5,001 to $15,000 20% (10% in Quebec)
$15,001 + 30% (15% in Quebec)
  • Problem #2 – Any money withdrawn must show up as income on your tax return.  Ouch.

What is our RRSP game plan?

Overall I believe this account can be an excellent wealth building tool if used wisely:  the contributions you make today lower your taxable income and you get a tax refund because of it.  A great formula!  However, be reminded once again the RRSP-generated tax refund is really a government loan – at some point you’ll have to pay that money in whole or in part back.

We’ve contributed to our RRSPs for years and will continue to do so.  In recent years, we’ve strived to increase contributions to these accounts as we approach our peak-income earning years.  We also have many other demands for our income that include maxing our TFSAs every year, paying down mortgage debt and last but not least – just living our lives and having some fun.

Ultimately, you need to consider the same thing this RRSP season (and every RRSP season) – how best to use this account as part of your balancing act to secure your family’s financial future.  Choose wisely.

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19 Responses to "RRSP facts and guidance for this season"

  1. Another good summary. I still like to max tfsa then begin adding to the rrsp. Taxes never go down so when looking ahead 20 or thirty years, they’ll be much higher.

    Reply
    1. The income tax rates have gone done for some brackets over the years. We just had a 1.5% reduction take effect Jan 1, 2016. I seem to remember some brackets were higher in the 90’s as well? Theoretically, couldn’t a person make a substantial contribution for the 2015 tax year and get a refund based on the 22% bracket and then take it out in short order and end paying the 20.5% rate effective this year? That’s a 1.5% savings for nothing (as long as there are no fees).

      Reply
      1. I believe you are correct Lloyd, given the tax bracket changes by our friend Mr. Trudeau – making a sizable contribution for the 2015 tax year could help you come out ahead although in the end, tax rates during your working years (as they go up, or come down) get blended over time.

        I believe ultimately the key is to withdraw from this account a) when you need the money and b) in the lowest possible tax rate.

        Reply
  2. I’ve been addicted to RRSPs since I was 19. Love the things. But one thing I never lost sight of was that they are not just for retirement. If a person is intending (or not) to be out of the workforce for some time, RRSPs can be used to fund that period. Ideally, investments are made in RRSPs whilst in a higher tax bracket and removed whilst in a lower tax bracket. Nothing says that a person has to be “retired” to be in that lower tax bracket. I’m thinking a parent who might want to stay at home for a few years to raise a child or two as one example. Or a guy who wants to retire early but defer his workplace pension due to penalties. Sure, there are ramifications of removing funds from an RRSP but there are cases where it works for some people.

    Reply
    1. You raise something I’ve been thinking about myself Lloyd: “a guy who wants to retire early but defer his workplace pension due to penalties.”

      This “guy” is me and that’s my strategy in another 10 years if I keep my job and pension. Thanks for your comments.

      Reply
      1. Also following this plan. Wonder how many workers with pensions are also choosing an RRSP–>Pension retirement path. Also wonder how much that messes with the pension if they have to pay out the max on a high percentage of plans. Perhaps worth a calculation on the reverse: retire into an early pension and then access your RRSP in deep retirement.

        Reply
        1. If you have a pension SST, and you contribute to that for a good 25+ years, with some monies in the TFSA and RRSP – you’ll be in good shape. You know this.

          Our hope is to draw down the RRSP early but no guarantees on that. I doubt many people would do the inverse, retire early with pension and keep RRSP until 70s then into RRIF but I could be wrong. It would seem wise to keep fixed income assets intact for as long as possible, no?

          Cheers,
          Mark

          Reply
          1. I think mine is the same. Full pension at 65 (which is 20+ years away), if I work that long it’s more than enough to cover retirement expenses without any RRSPs or TFSAs; reduced pension at age 60, which will be a “good retirement” and I’ve projected that income will cover all basic living expenses (food, shelter, clothing) for the rest of our lives; significantly reduced pension at age 55, that might cover housing expenses and maintenance but nothing else. I would need both RRSPs and TFSAs to supplement – so that is the plan.

      2. Hi Mark

        deferring the pension, you mean by quitting your job before 55 and get the pension at 65? I work for the city, and have a defined pension. If I quit @ 50 years old, I’ll be hit with 70% penality. I have the choice to defer the pension at 65 years old. I’m thinking of depleting my RRSPs, and get some TSFA , and some Non-reg to supply my income from 50 –> 65. Is it a good path?

        Thanks.

        Reply
        1. I’m thinking about that Nak. I can defer my pension, I don’t have to take it at age 55, but I might need to for income. We’ll see.

          Yes, this is my thinking, for example:
          -stop working/working at what I’m doing at 55
          -defer pension
          -draw down all RRSP assets, then spend non-reg. dividends for living expenses
          -CPP at 60
          -workplace pension at 65
          -OAS at 67

          Live my life (no RRSP), spend all non-reg. and leave TFSA until ‘the end’ 🙂

          Reply
          1. Hi Mark,

            What a nice plan! I think I will use this path for retirement! LOL leave TSFA until the end hahaha.
            Hope they won’t change the rules about TSFA later on.

          2. Thanks Nak. That’s the plan, it doesn’t mean it will or won’t happen 🙂

            I hope they don’t change the rules either, but it’s government, you never know!!

          3. One thing I would point out is that future governments will always change programs. Sometimes for the better, sometimes for the worse. This is one reason I always maxed my RRSPs contributions in spite of being in a very decent DB pension plan because I felt it would give me more options later in life. Having options is always preferable to being backed into a corner IMO. I had intended to retire at 50, use RRSP funds and defer the pension to 60 to avoid penalties but due to family medical issues I ended up working to 55 anyways. I most often used overtime earnings to contribute to the RRSPs as this would obviously give me the biggest bang for the buck in the reducing taxes game. Now I am removing funds from the RRSP as best I can up to the 44K bracket limit. Might as well get as much as I can out at a lower tax bracket. Won’t get it all out but once again, it’s better to have it and not need it than need it and not have it. I’ll be comfortable paying some higher taxes later if necessary, I don’t sweat that part so much.

          4. You’re a pretty astute investor from what I’ve learned from you Lloyd.

            I’ve maxed my RRSP in spite of the fact I have a decent (but not gold-plated) DB pension at work. I’m almost 15 years into that plan. I figure I need about 20-25 years into it to cover many basic expenses but I can’t touch it until age 55, and with major penalties at that.

            I haven’t thought through everything yet but I will start drawing down the RRSP before OAS for sure, and probably CPP, as to avoid any withholding taxes if things go well with the RRSP assets, TFSA assets and other investments.

            Like you maybe, I don’t mind having a small tax problem in retirement. Worrying about these things, and where to travel to in retirement, is much better than not having enough at all. 🙂

  3. What would you suggest for a public service employee whose severance pay has been paid out? Is it more important to focus on the TFSA than RRSP given our pension?

    Reply
    1. Thanks for your email Y.

      I can’t offer advice on this site for many reasons but when severance is paid out, my understanding is some of it can be eligible for RRSP (some of it may not be). The eligible and non-eligible portions are shown on the T3 or T4 slip given to you. The eligible amount can be directly transferred to your RRSP, without affecting your RRSP deduction limit; basically you have extra RRSP contribution room.

      That means you can transfer all of the eligible portion of the severance pay into your RRSP, even if you have no deduction room left. If you’re in a high tax bracket, that makes good sense since you can take the RRSP-generated refund and use that to fill up your TFSA if you wish.

      You may wish to speak to a tax professional about your specific situation!

      Cheers,
      Mark

      Reply

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