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) 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 if withdraws occur:

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)

  • 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  RRSPs must be converted to a RRIF, an annuity or investments need to be sold and monies withdrawn.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.

11 Responses to "Why we optimize, do not maximize our RRSPs"

  1. Long term I feel that one of the best attributes of the TFSA will actually become its biggest downfall, if we are speaking to the large majority of Canadians.

    A few commenters have made reference to it. There are many demands on a person’s financial resources over the years. There are numerous times in a person’s life when cash is short and people will want to withdraw from their savings. There is a tax impact if they withdraw from the RRSP. However, there is this very tempting pot of money in the TFSA and guess what, there is absolutely nothing to prevent a withdrawl. Now that is fine if the funds were contributed for this purpose.
    However, many people are advising the investing masses in the middle tax brackets that to save for retirement the TFSA is the preferred vehicle. I think this is a little dangerous. I contend that people have a much smaller chance of accumulating retirement funds in a TFSA …….. it is just way too accessible.

    1. @Brian,

      Thanks for your detailed comment.

      Certainly the TFSA, has no tax consequences and makes the money very tempting to “get at”. Sometimes, the greatest strength of something is its greatest weakness. Those savers and investors that can avoid dipping into their TFSA over the long-haul, will tbe rewarded.

      On the bigger scale, I don’t see how this temptation is any different than dipping into available, cheap credit right now. In the end, there is no substitute for financial discipline.

      What are your thoughts on that?

  2. I personally like having more ‘control’ over my own money later on in my life so I way prefer the TFSA over RRSP. I don’t like the idea of having someone else (the government in this case) when and how much I need to withdraw the money. With this said, I am also not in the income bracket for the RRSP tax advantage to benefit me significantly at this time.

    1. Thanks for your comment!

      I’m with you, with the TFSA you have more control over RRSP, for sure. Does that mean I should be more safe with my investments, in it? Meaning, indexed products vs. dividend-stocks in TFSA? Even more conservative investments? Thoughts?

  3. I tend to think of RRSP tax refunds as a kind of rejection of part of the contribution. If you contribute $10,000 and get a $4000 refund, then the $10,000 in the RRSP is split between $6000 of your money and $4000 of the government’s money. As long as you stay at the same tax rate (40% in this example), this way of thinking about it works well.

    One advantage that RRSPs have over TFSAs is downside protection. If at some point in the future your income drops significantly for any reason (health, skills out of date, etc.), your tax rate drops and you get to keep part of the RRSP money that used to belong to the government.

    1. That’s a good perspective Michael, and you’ve hit the point I’ve tried to drive home as well – the refund is government money.

      This can be advantageous at a time when really need to get at your money, in a life-altering crisis.

  4. This post is Stellar! I have a second post coming up on BankNerd and/or the Ninja where I focus on RRSP maximizing strategies. However…

    I still feel very strongly however, that the TFSA is the best option for most Canadians. The fact is simple, you do not get taxed when you withdraw money from the TFSA 😉 If your saving for retirement, the TFSA makes the most sense.

    I also think most Canadians are in the position where they cannnot even begin to maximize either plan, so go with the TFSA for sure!

    The Dividend Ninja

    1. Thanks very much Ninja. I’ve been over to the BankNerd site recently, and your post was great as well. Will be tweeting and promoting that post in the days to come.

      The TFSA is a great gift from our government. Take advantage of it everyone!


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