It’s that time of year again. The time when, everywhere you turn, someone is urging you to maximize your RRSP contribution.
March 1 is the last day to put money into an RRSP and still receive a tax refund with your 2016 income tax return.
There is little question that Canadians need to save more for retirement — and RRSPs can be a great way to do so. You can deduct your RRSP contributions from your gross tax, which usually generates a nice tax refund. You can then add that refund to your RRSP savings, which, done every year over the span of three or four decades, can make a significant difference to the size of your nest egg. Also, your RRSP savings aren’t taxed until you withdraw them, which allows your investments to grow faster.
Finally, when you retire and start pulling money out, you’ll normally be in a lower income tax bracket than during your working years, and your withdrawals will be taxed at that lower tax rate.
Still, RRSPs aren’t for everyone.
The fundamental thing to know about RRSPs is that having one is like “being on a seesaw,” Ted Rechtshaffen, president of Toronto-based TriDelta Financial, told Global News. You need to make sure the tax break on every dollar you put in is higher than — or at least as high as — the tax you will have to pay on every dollar you’ll be taking out.
Here are a few scenarios when having an RRSP doesn’t make sense:
You make less than $41,000 a year
If you make less than $41,000 a year, your RRSP refunds are going to be small and you’re likely to be in the same tax bracket before and after retirement. For Canadians in this situation, a TFSA is generally a better fit, Rechtshaffen said.
Having a TFSA is like “sitting on a bench,” he explained: You contribute after-tax dollars and there are no tax consequences when you take the money out.
Also, RRSP withdrawals are considered income, which for low-income retirees could result in a government clawback of benefits such as Old Age Security (OAS) and the Guaranteed Income Supplement (GIS).
TFSA withdrawals, on the other hand, have no effect on OAS and GIS benefits.
In general, if you make up to around $70,000, there is no iron-clad case for an RRSP. A generous pension, rental income or an inheritance might place you in a higher tax bracket in retirement, which would defeat the purpose of an RRSP.
Cash is tight right now but you know your income will grow
Perhaps you’ve been slogging away on a temp contract for $35,000 a year but you’re fairly confident that a permanent job — and a much bigger paycheque — is finally around the corner. If this is you, save your money in a TFSA and accumulate RRSP contribution room for later, Rechtshaffen advised. This strategy would allow you to maximize your tax refund.
Let’s look at the numbers. If you were to use up your RRSP contribution room today, you’d get a refund of around 20 per cent on the dollar in Ontario, according to the EY RRSP calculator. If you make a larger contribution once you start making, say, $75,000 a year, you get nearly 30 per cent back on every dollar you put in.
You can also put money into your RRSP now but wait until your income rises to claim the tax deduction, Rechtshaffen said.
You have a lot of expensive debt
Should I save for retirement or pay down debt? It’s one of the most popular questions of RRSP season, but the answer is simple.
If you’re paying 2-3 per cent on your debt (think: most mortgages) then there’s no hurry to pay it down. Start saving for retirement, Rechtshaffen suggested.
If, on the other hand, the interest rate you’re paying is 5-7 per cent or higher (think: credit card and student loans), then paying down debt becomes the priority.
You might be leaving Canada at some point
Always dreamed of living and working abroad? If there’s a chance you’ll be packing your bags soon and leaving Canada for several years — or for good — you should carefully consider whether to open an RRSP, said Rechtshaffen.
An RRSP can’t come with you across the border. You’ll have to either leave the money in there until you return (if you do), or take it all out and pay a hefty one-time tax bill. A TFSA affords you more flexibility.
It’s important to note, however, that because RRSPs have been around for 60 years, they’re generally covered by international tax treaties. Most other countries recognize them as tax-sheltering tools and won’t try to tax any investment income that accumulates inside them. That’s often not the case for the much younger TFSA. Dividends and other income earned on investments held in a TFSA might get taxed by a foreign jurisdiction.