Should I have an RRSP?
A Registered Retirement Savings Plan, or RRSP, is a type of investment account for Canadians that is tax sheltered until you draw on the funds in your retirement when you have stopped your working career.
For most people, it is not a question of if you “should I have an RRSP”, but rather “how much should I contribute to avoid paying income tax from my job”. In this case, you want to determine how to contribute an amount that will lower your personal income tax bracket and outright defer paying tax on that amount of money you made that year. But, RRSPs simply may not be for everyone when it comes down to the math. We will dive into why that is the case.
Your contributions in an RRSP will be a deduction of your income that you declare to the tax man. This is massively beneficial to keep more of your hard-earned money. That being said RRSP contributions are not black and white and a simple answer for every single person’s situation. Eventually, you will be paying tax when you need that money and hopefully it is when you are making less money than right now. You will pay the full tax rate of the income tax brackets in Canada of the amount you withdraw from your RRSP exactly like you pay tax on your personal income.
RRSPs May Not be The Best Option for Everyone
Is there such a thing as too much money in an RRSP? Yes!
Let’s use an example:
Bob has been great at saving money from his job over his middle management role at his company. He managed to grow his investment portfolio to 2.5 million dollars after his 42 year working career. When you are 72, you must roll your account over into an account called a RRIF. The government forces this to happen and you must withdraw at least 5.3% of the funds annually. Bob turns 72 and his RRSP is forced to roll over into a RRIF.
Bob’s 2.5 million dollar portfolio requires him to withdraw over $130,000 a year with his newly rolled over RRIF. Withdrawing 130K annually, Bob is now in a high-income tax bracket and paying half of his money to the government! Oh no.
Situations where RRSPs are not ideal:
If you will be receiving a pension or another type of continued payout in retirement
Have passive income from a business you own OR income generating real estate assets
These situations will ensure retirement income and you will be tax inefficient with your investment portfolio when you need to withdraw it.
But don’t stress, there are other options if you are not a good RRSP candidate.
Other Good Options:
Maximizing TFSA contributions. This is tax free growth and has no further tax implications when withdrawing. I am a believer that this should be the number one goal of all Canadians regardless due to the liquidity of a TFSA. If you need it during your career for some reason, you won’t throw yourself in a higher taxation bracket. TFSAs are especially great when you are a young investor and you are already in a low bracket.
Using a taxable account that you pay capital gains on. This tax will be lower than your income tax bracket if you underestimate your income later in retirement.
The Bottom Line
RRSPs are great for most Canadians, however they are simply not for everyone when it comes down to the math. They are not ideal for people with pensions, passive income from their business and/or many real estate income generating properties. They are great to defer personal income tax from your job and potentially lower your tax bracket if done correctly. However, they may not be your best option if you will find yourself in a high tax bracket when you require it. TFSAs are a fantastic option and sometimes even a taxable account can be more tax efficient with capital gains tax rather than a high-income tax bracket in your retirement.