RRSPs before 60: Not always a priority

Sometimes it's best to postpone contribution to a future year.

Matthew Elder 30 January, 2018 | 6:00PM
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The registered retirement savings plan is Canadians' main vehicle for long-term savings. The power of the RRSP's tax deferral over many years emphasizes the importance of getting started early in your adult life.

However, Canadians often don't get serious about retirement savings until we're into our 40s. By this stage of life -- with a higher income and retirement age only two or three decades away -- the financial-planning rule of thumb is to make your maximum allowable contribution each year. This includes your unused contribution room as well as the additional amounts added each year to your cumulative limit. Basically, if you don't use it, you don't lose it -- until of course you reach age 71, when contributing to an RRSP becomes a thing of the past.

But there are strategies to consider during those prime contributing years up to around age 60, when retirement draws near and the RRSP may become less of an investment priority. Or, for that matter, you may be ready to begin drawing on your savings.

An RRSP is a tax-deferral arrangement in which you deduct the amount of contributions on your income-tax return, and your investment grows free of tax until withdrawals are made. You pay tax on withdrawals at your top marginal rate, which is presumably at a lower rate than during your working years.

A contribution qualifying for a deduction in a particular year can be made no later than 60 days following the end of that year. The annual contribution limit is 18% of your previous year's earned income, up to an annual dollar limit. For the 2017 taxation year, then, you have until March 1, 2018, to contribute the lesser of 18% of your 2016 income or $26,010. (The annual dollar limit is increased each year based on the inflation rate; for 2018, the cap will be $26,230.) Unused RRSP contributions can be carried forward to future years, thus building contribution room that can be accessed when you have the available funds or can better benefit from the tax deduction.

An RRSP must be converted to a registered retirement income fund (RRIF) or registered annuity by the end of the year in which you turn 71. Your savings remain invested in the RRIF or annuity and taxed as you make withdrawals.

The primary goal for RRSP investors is to save as much money for retirement as possible, aided by the tax deferral. However, there are two elements to keep in mind as you consider how much to contribute to your RRSP each year:

  • Will your tax rate actually be lower after you retire than it is now?
  • Will you be better off using the tax deduction in a later year?

Making maximum RRSP contributions might not be the best route if you expect to have amassed a considerable investment portfolio both within and outside an RRSP by the time you retire. For instance, if you anticipate a sizeable inheritance, you won't necessarily be paying tax on your future RRSP withdrawals at a lower rate than had you invested outside the RRSP. Depending on your specific situation, it might make sense to instead invest outside an RRSP and pay tax on the resulting interest, dividends and/or capital gains each year, since the latter two types of income are taxable at preferential rates.

In such cases, an RRSP might not necessarily be your best after-tax route. "There are tax challenges with RRSPs," says Mohamed Sheibani, a partner with Deloitte Private. "Capital losses will not be recognized, and dividends and capital gains will be taxed at full rates when you take the money out. It really depends on the type of investments that you are making."

But while post-retirement tax rates are a consideration, you must respect the importance of the time value of money and the ability to create two streams of retirement income, or income-splitting, through a spousal RRSP, Sheibani says.

Regardless of your expected future income, it does make sense to make full use of a tax-free savings account. You can invest up to $5,500 a year in a TFSA, and you can save unused contributions for the future. While you cannot deduct these contributions, no tax is payable (on the income or original capital) when you take money out. What's more, the amounts equivalent to these withdrawals are restored to your overall TFSA contribution room in the year following the withdrawal.

If you are a member of an employer-sponsored defined-contribution (or money-purchase) pension plan, you may want to consider this ahead of an RRSP, Sheibani says. "It depends on the limitations of the plan, but if there is any sort of matching, an employer pension would likely be better as there will be more money saved. And note that an employer pension may have negotiated lower fees with its advisors."

When the deduction isn't to your advantage

If your taxable income is less than approximately $45,000, from a tax perspective alone it may be worth foregoing an RRSP contribution and paying tax now at a relatively low rate on the income that otherwise would have been sheltered by the deduction. You also will benefit from lower tax rates for dividends and capital gains. Your tax bill now may well be lower than what you would pay had you put that money into an RRSP and had it fully taxed later at a potentially higher tax rate. However, at a taxable income above $45,000 or so, you will be in a high enough tax bracket to probably come out ahead over the long run from making the RRSP contribution and claiming the resulting deduction.

Another reason to not contribute in a given year is one of practicality: you can't afford it. Particularly in years where your children are expensive due to sports or arts activities and, later, post-secondary education, retirement savings might not be your immediate priority.

Contribute but postpone the deduction

You are allowed to make your maximum contribution, but delay use of the corresponding deduction to a future, higher-income year. So even if you can afford to make a healthy RRSP contribution, it may be to your fiscal advantage to hold off claiming the deduction until a future, higher-income year.

"The (contributed) money can grow tax free in your RRSP, so if you have the cash you can make the contribution and carry forward the deduction," says Sheibani. "This depends on what you think your future income earning potential will be. For example, if you are earning $45,000 and could earn $85,000 in a few years' time, waiting to take the deduction could be a better result in terms of your tax refund."

If you leave the country

In some cases, at this career stage, you might have the opportunity to work in the United States or abroad. While you are unable to make RRSP contributions during a year when you are not a Canadian resident (defined by where you live as of Dec. 31), you can maintain your account with a Canadian financial institution.

"However, from a tax perspective as a non-resident of Canada, winding down the RRSP could get you a better result, since there is flat withholding (by the CRA)," Sheibani says. This flat tax could prove to be considerably lower than the tax payable in the future, when you are back in Canada. "You will need to consider the implications in the country where you will become a resident," he says.

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About Author

Matthew Elder

Matthew Elder  Former Vice President, Content & Editorial of Morningstar Canada, Matthew was previously an editor and columnist at the Financial Post and The Gazette in Montreal.

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