Can you have too much money in your RRSP?
Earlier this year the Registered Retirement Savings Plan (RRSP) celebrated yet another birthday. This means for decades Canadians have had a great opportunity to defer taxes and growth their retirement nest egg using the RRSP. But can you have too much money in your RRSP? I’ll provide my answer in a bit.
History of the RRSP
The RRSP was created in 1957. Back then I read that contribution limits were 10% of the previous year’s income to a $2,500 maximum. If Canadians did not contribute to this account in any given year, that year’s contribution room was gone – forever. The rules have obviously changed over time, for the better. Canadians can now grow/maintain their contribution room over many years. The change happened in the early 1990s – contribution limits changed to 18% of the previous year’s income and account holders then could carry-forward contribution room. Indefinite carry-forward contribution room was established in the mid-1990s and remains this way thankfully.
Why the RRSP rocks
The RRSP is a kick a$$ retirement account for these two main reasons:
- There is a tax deduction for your contribution, and
- There is tax deferred growth.
With your tax deduction you can reduce the taxes you pay today. (We took advantage of this feature this year for us.)
With tax deferred growth investments can grow over time without being taxed as long as the money made stays in the account. (We take advantage of this every year since we don’t dare touch our investments.)
For most Canadians, to reap the benefits of this tax deferred account, this means they should maximize their contributions in their highest income earning years and have a plan in place to withdraw monies inside the account when they are in their lowest income earning years (likely retirement). This is because you’re not as rich as you think: when you take money out of the RRSP you have to pay the tax on the money withdrawn.
Not just a tool for the wealthy – the RRSP can make you wealthy
While the RRSP has heavy competition now in the form of the TFSA – the basics for all Canadians are outlined here – the RRSP remains one of the best retirement saving options available. Here are other benefits you might not have considered:
- Free money might be available. Although employer-sponsored pension plans (defined benefit and defined contribution) are becoming extinct, many employers still offer some sort of Group RRSP including plans that provide matching. This is essentially free money. Take advantage of it. Join your RRSP matching plan if you have one at work.
- It encourages a behaviour of long-term savings. There is withholding tax associated with this account; given RRSP withdrawals must show up as income on your tax return. Knowing this I believe this is a disincentive to use any RRSP money for short-term needs. In my opinion short-term money needs are not the same as investing. Investing is a long-term, multi-year plan.
|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)|
- Most Canadians are likely to retire with a lower income (than their working years). For this reason, there is a net tax savings if you use this account.
- U.S. tax reporting exemptions. The Canada-U.S. tax treaty recognizes RRSPs as tax-deferred accounts for U.S. tax purposes. This means there is little worry about foreign income reporting.
How can the RRSP make you wealthy?
Using the super simple RRSP calculator from this page a 30-year-old who contributes $5,000 per year into their RRSP, for 30 dedicated years, earning 6% on average over that timeframe will own over $420,000 in their account at age 60. Assuming couples can do this, that’s approaching $1 million combined at time of retirement.
$1 million invested wisely in low-cost ETFs is likely to churn out at least $30,000 per year for life starting at age 60. Combine that with Canada Pension Plan (CPP) and (Old Age Security) government benefits and it’s not a stretch for many Canadian couples to earn $50,000-$60,000 per year in retirement without a workplace pension.
To do this however you would need to 1) save early 2) save often and 3) mind your money management fees.
Now to the question: can you have too much money in your RRSP?
However, this is an excellent problem to have.
Instead of a cash flow issue in retirement you have a tax issue.
In my opinion the latter associated with managing taxes in retirement would be a great problem to have. Your ability to earn an income in retirement may be compromised or non-existent for many reasons, maybe your health. If you have a healthy retirement nest egg you’ve eliminated the income problem.
I’ve read a number of articles and case studies about seniors complaining about the tax-hit on RRSP withdrawals. I suspect these seniors didn’t realize the RRSP account structure very well. I can’t necessarily fault them – there’s lots of information (and heavy marketing) about contributing to RRSPs. There is very little information about asset decumulation.
Common questions about asset decumulation I read about go something like this:
- What registered accounts do I draw down first?
- How much income will my investments generate?
- Do I have any idea how long this income might last?
- What amount of taxes will my RRSP withdrawals incur?
- When should I take my workplace pension (if you have one)?
- Is it more beneficial to draw down non-registered money before RRSPs and TFSAs?
- And much, much more…
Through this blog I’ll tackle all these questions and many, many more at some point for us because these are very important questions for us to answer too!
In our 40s now, our future approach is to:
- draw down RRSPs before non-registered investments.
- spend all RRSP assets before CPP and OAS
- spend the majority of our RRSP assets before taking any workplace pension income in our 60s
- use up non-registered investments before TFSAs in our 60s or 70s; and finally…
- leave government benefits (CPP and OAS) and TFSAs until “the end”.
I haven’t done all the math on this yet but this is a high-level plan. Your approach and situation may vary.
At the end of the day, having a nest egg in your 50s and 60s that forces you to navigate the tax implications of your RRSP decisions is a great problem to have.
This will only occur if you contribute to this account early and often.
The RRSP became a senior by turning 60 recently. You can benefit from this account now and for decades to come if you know the rules and use them to your advantage.
What do you think? Can you have too much money in your RRSP? Is this a good or bad problem to have?