With the RRSP deadline very quickly approaching (March 2nd) many people have been asking whether or not it makes sense for them to use this traditional retirement savings plan. It’s a fair question to ask because RRSP accounts are not necessarily for everyone and there have been some that have been caught up in making RRSP contributions which did not work out for them because they didn’t understand all of the details. With that being said, let me just cover the basics of RRSP contributions with the following example:
Investor: Lucy Age: 30
Income: $120,000/ yr
Marginal Tax rate (MB): 43.4%
RRSP Contribution: $10,000
New Taxable Income: $110,000
Tax savings from RRSP contribution: $4,340
In Lucy’s case she will get the immediate benefit of paying less tax today but as an added bonus, she will enjoy tax free growth on her RRSP investment between now and her retirement age when she plans to start drawing from her RRSP account for income. If she plans to retire at age 55 then she will enjoy 25 years of tax deferrals, which she will receive compounded growth on. So, what happens in retirement?
Income: $70,000 / year
RRSP/RRIF withdrawals: $10,000
Marginal tax rate: 37.90%
Tax paid on RRSP/RRIF withdrawal: $3,790
In this example an RRSP plan makes sense for Lucy’s goals. If you are considering an RRSP contribution for yourself here are a few things to consider:
1) Will your income be lower in retirement than it is today?
- If the answer is yes, similarly to Lucy above, then an RRSP plan can add significant value to your retirement income plan
2) When time is on your side – If you are like Lucy and have a number of years before your retirement then contributing to an RRSP can help you to build significant wealth faster through receiving growth on money that would have otherwise been paid in taxes in other accounts. As an additional bonus if you reinvest your tax savings from the original contribution (from a tax refund) then this can further enhance this plan.
3) Do you have a company pension?
- If you don’t have a company pension than an RRSP plan can become a substantial pillar that makes up part of your retirement income. Income drawn out of this account will be taxable but if your only other income sources are government funded benefits then you can take advantage of a low tax bracket in retirement.
4) If you want to contribute now but claim later – If you are in a lower tax bracket now but want to enjoy tax deferred growth you can claim your contribution at a later time when you are in a higher tax bracket. Sometimes we recommend using Tax Free Savings Accounts in a similar fashion where you make TFSA contributions today, earn tax free growth and then move money from your TFSA to an RRSP at a later time. Either strategy could work depending on your situation.
For any individuals who would like to make RRSP contribution but find themselves without the liquid cash to do so, we often recommend looking at RRSP contribution loans. For example, let’s look at Lucy’s situation again:
Income: $120,000/ yr
Marginal Tax rate (MB): 43.4%
RRSP Loan (1-year term) - $10,000
RRSP Loan (90-day term) - $7,000
New taxable income: $103,000
Tax savings from contributions: $7,378
The first loan will be paid back over the course of 12 months with a payment of $849.22/month (3.5% interest). The total cost of the loan including interest is $10,190.64. The second loan is paid back within 90 days using the proceeds of the tax return from the RRSP contribution, with the total repayment being $7,165.17 approx. By using the RRSP loan, you are able to add significant savings far earlier than otherwise possible and utilize your refund to reduce the debt immediately leaving you in a net benefit position.
RRSP’s are not necessarily for everyone, but they can add significant value for the right individuals as I have outlined above. With time running out it’s worth while taking a closer look at your own situation.
-Grant White, CIM, CFP®
Grant White is a Portfolio Manager/Investment Advisor at Endeavour Wealth Management with Industrial Alliance Securities Inc, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.
This information has been prepared by Grant White who is a Portfolio Manager for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Portfolio Manager can open accounts only in the provinces in which they are registered.