Much is made of the rewards of taking full advantage of registered retirement savings plans during working years. Indeed, it pays to contribute as much as possible -- ideally, to the maximum extent allowed -- to an RRSP each year. And the younger you are when you set up a plan, the better.
But what about people in their 60s, with retirement on the minds of many and RRSPs' end date only a few years away? Does it remain a priority to make full use of an RRSP, or is it time to consider alternative places for your savings?
Given today's generally longer life expectancy, 60-something investors still need to save and invest. "Most of us can expect to live to our mid-80s or longer, so your money needs to grow," says Robert Kerr, chairman of Kerr Financial Group Inc. in Montreal. "It should be invested for moderate risk and growth, and the longer time horizon and good diversification will reduce the risks of losses in the market."
However, how and where we can make that happen varies tremendously, depending on your specific circumstances.
An RRSP is a powerful tool that can help you accumulate significant retirement savings over the long term. You get to invest pre-tax dollars and have that money grow free of immediate tax within your plan. This happens because you claim a tax deduction for an RRSP contribution, and you don't report the income earned on that money while it is within the plan.
When the time comes to use those savings to fund your retirement, the amount withdrawn is fully taxable. This means you are paying tax on your original capital as well as on the income earned by that investment within the plan. Ideally, not only do you gain from the tax-free compounded investment over time, in theory you will have lower income after retirement and thus pay less tax when you withdraw those savings via a registered retirement income fund (RRIF) or a registered annuity.
There's no denying the advantage of having money you'd otherwise have had to pay tax on if you hadn't put it into your RRSP, and having it grow on a tax-deferred basis for many years. What's more, that deferral continues once the money has been converted to a RRIF, although only to the extent funds haven't been withdrawn.
But over a relatively short period, the tax deferral is less compelling. Moreover, should your income remain high after age 71 (when you are compelled to begin receiving RRSP income through a RRIF or annuity) those savings will be taxed at a hefty rate, perhaps even higher than when the original contributions were made.
"If your personal tax rate will drop from 50% to say 30% in retirement, then it might be worth it to contribute to an RRSP," Kerr says of people in their 60s. Moreover, he adds, depending on your income in the year a contribution is made, you can opt to delay claiming a deduction for a contribution to a future year in which your income might be higher, although you must do so while your RRSP is still intact.
However, income can remain high after you begin receiving RRIF or annuity income if you are still working (for example, as a consultant). Your post-retirement income also could be high if you sell your home or receive an inheritance. This new investment capital is likely to generate significant income, and push you into a higher tax bracket.
It's worth noting that assets received via an inheritance usually are not taxable in the recipient's hands because an estate normally pays tax on its assets prior to distribution to heirs. And the cash from the sale of a principal residence is not taxable either.
The sale of a cottage or other second home will generate taxable capital gains, unless it makes sense to declare it as your principal residence instead of another home in the city or elsewhere. The tax rules allow you to identify specific periods of time during which a home can be considered a principal residence, as long as it is "ordinarily used" by you.
If you are considering taking an inheritance as an "in-kind" transfer of stocks and other securities, be aware that there is no tax advantage to doing so because the securities are deemed to have been "sold" upon death to the deceased's estate, and taxes on any gains or income from those assets are payable as of that date.
It usually makes sense to take an inheritance as cash and invest it according to your own needs and goals, Kerr says. "Don't get stuck holding Dad's old portfolio. Make changes to suit your investment objectives."
If you expect your income to be lower when RRIF withdrawals are made, "contributing to an RRSP during your 60s may be useful," Kerr says. "But if that isn't the case, it may be preferable to pay down debt, so it won't loom over you in retirement, or invest in a tax-free savings account if you have some contribution room." (TFSAs recently became more of a factor in retirement savings when the federal government increased the maximum annual contribution to $10,000 from $5,500.)
Making this decision means you need to do some planning now. "Retirement planning involves making projections to see what tax rates you will be subject to and how you can best manage your cash flow," Kerr says.
A key goal for those who are married (or living common law) is to maximize post-retirement income splitting. If you have already been doing so, contribute to a spousal RRSP so that your two income streams can be as equal as possible, which may reduce your combined tax paid during retirement. "While the current tax system allows the splitting of retirement incomes up to 50% of such income received, a spousal RRSP may provide more opportunity to reach the coveted target of equal taxable incomes in retirement," Kerr says.
There's also the prospect of governments increasing taxes in the future, Kerr warns. "You can assume current levels of taxation to continue. You may think that, given an aging population, politicians will try to keep tax rates on seniors as low as possible. But given the need to replace aging infrastructures, it is likely taxes will continue to rise."
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