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Who should contribute to an RRSP?

Hopefully, most of you know what an RRSP is. For those who don’t, RRSP stands for Registered Retirement Savings Plan and it’s one of the only tax (and largest) deduction/deferral tools that employed Canadians have. The RRSP account can be opened at any of the big banks along with some online brokerages, and allows your investment growth to compound TAX FREE. On top of that, all contributions for last year, up to March 1 of this year can be deducted from your income. This will equate to a tax return of the sum of your contributions x your marginal tax rate.

For example, if I contributed $6000 to my RRSP for 2006 (up to March 1, 2007) with a marginal tax rate of 38%, I would get a tax return of $2280 ($6000 x 38%). The tax return is free money right? Not so fast, RRSP’s are a tax DEFERRAL tool where you are taxed at your marginal rates when you WITHDRAW. So when it comes time for you to retire, hopefully you’ll be in a lower tax bracket than when you were working.

Now that we’ve gotten some of the formalities out of the way, the question that this article is going to try to answer is, who should contribute to an RRSP?

The simple answer is, anyone who is employed and expects to be in a lower tax bracket when they retire. The real power of RRSP’s though is the ability to let your investments compound TAX FREE. For example, if you were to contribute $200/month to your RRSP at the age of 20, you’d have almost $650,000 in your RRSP at the age of 60 (assuming 8% growth). If you wait until you’re 30 before you contribute, you would have $284,000 at 60. The power of time cannot be understated.

How about a new graduate from University in a low tax bracket?

Even though you are in a low tax bracket, I believe that your RRSP should be “started”. Any deductions can be carried forward to a future year when you reach a higher tax bracket. You young folks out there, take advantage of the power of time and compounding. You can also withdraw from your RRSP in the near future towards the down payment of your first home (HBP).

How about those permanent low income earners?

Low income earners who expect to stay in the same tax bracket for their career should NOT contribute to an RRSP. Reason being is that being in the lowest tax bracket will provide little tax benefits. On top of that, upon retirement, government benefits like GIS (guaranteed income supplement) may be clawed back if you have an RRSP that exceeds the maximum income requirement.

That’s all for now, comments?

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FrugalTrader About the author: FrugalTrader is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 81 comments… add one }

  • Andrew June 29, 2009, 8:52 pm

    Thanks FT. I just think it’s important to use more specific information rather than vague terms like “low income”. Especially when you are in fact referring to millions of “average” Canadians who are earning less than $40K and probably will for much of their lives. How many people really see huge increases in their income after a certain age? A lot of us are happy if we can see consistent cost of living increases.

    Someone earning $35-40K knows they’re not rich, but they may not think of themselves as “low income” either, so when reading an article like this, it’s easy to say: “He’s not talking about me. So I’m going to continue to follow the advice of the person at the bank who sold me that RRSP.”

    Thanks for the link to the other article. I’ll check it out, because I’m still not sure if dividend income in retirement is any different than RRSP withdrawals for “low-income earners”?

    Cheers,

    Andrew

  • FrugalTrader FrugalTrader June 29, 2009, 9:39 pm

    Andrew, you are absolutely right, I should have been more specific in the article. I will make the appropriate changes.

    Dividend income in a non-reg account gets preferable tax treatment, regardless if it’s during retirement or not. Check out my article on how dividend income is taxed:
    http://www.milliondollarjourney.com/how-investing-taxes-work-part-2-dividends-and-interest.htm

  • Andrew June 30, 2009, 1:03 pm

    In the article linked above you say “if you are over 65 the high dividend gross up may negatively affect your OAS payouts”. So it sounds like the only “investment” for retirement that really makes much sense for people in the lowest tax bracket is to pay off a home. At least then you have somewhere cheap to live after retirement, and if you have any money left over it should go into a TFSA. However, I have to wonder if there are any guarantees that the rules regarding TFSAs won’t change in the next 20 or 30 years.

    Cheers.

  • YYC27 July 14, 2009, 8:28 pm

    I think, unless you expect to be on GIS in retirement, it’s almost always a good idea to invest in an RRSP.

    Here in Alberta, the lowest combined Federal/Provincial tax bracket is 25%. Even at that rate, you can boost your investments by 1/3 ($133.33 pre-tax = $100.00 after-tax). That extra initial investment is still going to make a huge difference compounding over a working-life.

    —-

    There’s one thing I’m trying to decide for myself, right now.

    I’m about to purchase a home. I’m going to be using HBP withdrawals for part of the down payment.

    What I’m not sure about is where to direct surplus money — mortgage prepayments or HBP repayments (over and above what’s required). My RRSP contributions will already have been maxed, so I won’t be able to take a tax deduction for any payments into the RRSP (they’ll just come off as HBP repayments and go back to growing tax-free until retirement).

    So, whether it’s mortgage payments or HBP repayments, it’ll end up being after-tax money. I would get a better return within the RRSP, but the mortgage savings are guaranteed.

  • Bill October 11, 2009, 8:43 pm

    Thanks FT.
    I have a family of 4. My wife and my 2 children. I am the only one working (35k/yr). At the moment I have neither a RRSP nor any saving account. I have 10k in my normal bank account and I would like to know what to do with the money? What would be the better option? a RRSP, Saving Bonds or a bank saving account?

    Thanks a lot!

    Bill

  • Stacy January 27, 2010, 11:29 pm

    Hi all,

    I’m 24 years old and I’ve been contributing my max allowed every year since I started working, I now have about $16,000+ in RRSPs. This year I made around $80k and I have $25k just lying around in my bank (already contributed my RRSPs). I have no school debts (paid off), I paid off my car in full, insurance – everything. I just pay what I need to live (rent, food, internet (lol), etc.) My question is.. where should I put this extra money? I’m scared to do anything in the stock markets and where I live I don’t have enough money to buy even an apartment. Oh, I also have $10k in a tax-free savings account (contributed my max $5k last year and $5k this year)

    Any ideas? I’m a very hard worker and I spend my money very wisely. My plan is to eventually buy my own place, but I want to be smart about it and not jump into anything just yet.

    I’m also wondering what is the best plan when putting money in RRSPs. I know there’s 2ys, 3yrs etc. I’ve been putting mine in a 3yr rising rate as my bank told me this was the best option for me but I haven’t a clue if this is true.

    Thanks for any advice.

  • David October 24, 2010, 11:54 pm

    Please correct me if I am mistaken.

    As it stated on cra-arc.gc.ca If your RRSPs are not locked in, you can withdraw funds at any time According to the following rates.

    * 10% (5% in Quebec) on amounts up to $5,000;
    * 20% (10% in Quebec) on amounts over $5,000 up to$15,000
    * 30% (15% in Quebec) on amounts over $15,000.

    We do not have to wait until pension. If for example I know that in two years I am going to study I can accumulate approximately 14400cad (contribution room for 2010 for my income) +14400cad(Cont. room for 2011) = 28800cad . If I deduct these 14400cad from my 80000cad income for two years I can save approximately 10000cad in terms of tax.(depends on your provice)
    I know in advance that during my 2 years course my income will be low, lets say 25000cad. So, I am going to withdraw 14400cad yearly from my RRSP.
    Thus, 14400* 20% = 2880

    10000cad -(2880+2880)= 4240cad saved.

    I omitted marginal tax issue to make this article simpler which is not very significant here especially if my income even lower than 25000 .

    The good point in this scenario that I do not need to wait until my pension and my RRSP money will not be eaten by inflation which is about 2%in Canada. 2% multiply by 30 years =60% . I think that because my education is not less important when my pension I have moral right to withdraw my RRSP before pension and of course it is money wise.

  • FrugalTrader FrugalTrader October 25, 2010, 9:43 am

    @David, withdrawing from RRSP prior to pension is a strategy that many use to reduce tax on the RRSP withdrawals. I recommend that you consult a tax pro to verify.

  • Dr. Philosophy December 16, 2010, 7:46 pm

    Two points:
    1)It is misleading to claim “On top of that, upon retirement, government benefits like GIS (guaranteed income supplement) may be clawed back if you have an RRSP that exceeds the maximum income requirement.”
    HOLDING an RRSP regardless of value does not kick in an OAS or GIS clawback. OAS and GIS clawbacks occur based on the year’s income, and RRSP WITHDRAWALS are the only thing that affects that.
    By the way, GIS is worth between $0 and roughly $10000/yr. All but the poorest/chronically un or underemployed/new to Canada get less than the full $10000 just by virtue of their CPP and OAS incomes.
    2) It is foolish to recommend that a person in the lowest tax bracket not contribute to an RRSP. A person in the lowest tax bracket can benefit from tax-sheltered growth in savings just as easily as a person in the highest tax bracket! That the TAX savings on one’s tax returns from year to year won’t be as great for a person in the lowest tax bracket who’s planning to stay there as they would be for a person in a higher tax bracket should not dissuade someone from taking advantage of tax-sheltered growth in savings. Put rhetorically, a person who is of low income would like to be worth approx 650K by retirement just as much as a person who is of high income!

    In summary, it is nearly always best to put away in an RRSP. There are circumstances where it doesn’t make any sense. But these are rare, and none of them were mentioned in this article.

  • FrugalTrader FrugalTrader December 16, 2010, 8:01 pm

    True that tax free growth is great, but remember that people MUST dissolve the RRSP at some time. So when a low income earner turns 71, they’ll be forced to pay full income tax PLUS lose their GIS income. Personally, I think the TFSA is a much better vehicle for low income earners.

    http://www.milliondollarjourney.com/tfsa-vs-rrsp-clawbacks-income-tax-on-seniors.htm
    http://www.milliondollarjourney.com/old-age-security-and-the-oas-clawback.htm
    http://www.milliondollarjourney.com/guaranteed-income-supplement-gis-and-gis-clawback.htm

  • Dr. Philosophy December 17, 2010, 2:48 pm

    FT, thanks the for reply. It is only fair to point out that when you wrote this piece TFSAs hadn’t been invented yet, so you couldn’t have mentioned that option. I agree it is a good option for everyone, including low-income earners, to take advantage of. But it is not the best option: I still think you are wrong to think any person with a perennially low income should contribute to an RRSP rather than a TFSA. Let me try to show why.
    Your argument is that low income earners pay little tax on working income before retirement and will lose the GIS if they defer the tax on what little income they have into retirement.
    My response is that (legally) deferring paying taxes is almost always better than paying said taxes now. Let me explain. A low income earner with an RRSP and a TFSA faces the choice of what to do with, say, $200 left at the end of the month. He could slot it into an RRSP and get, at a brute 25% tax rate, an extra $50 on his tax refund at the end of the year. Or he could take the $200, forfeit the $50 tax he must pay on the $200, and slot it into a TFSA. Granted he has a better chance at getting the GIS if he takes the latter route. (I say chance because the rules for GIS may change between now and when he goes to collect OAS. I’m 27–I’m not counting on anything.) But think what he could do with the $50 refund *this year*. If he does choose to reinvest it I daresay the compound interest on the $50 FROM THIS MONTH ALONE will be worth quite a bit when he’s ready to retire, particularly if the low income earner is young at the moment. But even if he just goes and spends it on whatever he still has extra money he otherwise would have lost to CRA in his pocket *now*.

    It’s true that low income earners pay little tax in this country relative to the wealthy. That is a good thing which makes me proud to be Canadian. What I’m suggesting is that almost everyone, including low income earners, take advantage of the even more incredible option of being able to be, in some measure, in control of how much tax we pay in any given year. With RRSPs we are both in control of deferring current income taxes, but also in control, even after conversion of an RRSP to a RRIF, of how much income we want to be taxed on in any given year (besides the variable minimum amount which must be withdrawn from a RRIF yearly.) Deferring paying income tax is almost always better than paying it up front and saving with what’s left, the possibility of losing the GIS notwithstanding.
    Cheers.

  • FrugalTrader FrugalTrader December 17, 2010, 3:47 pm

    @ Dr – Another thing to consider is that if the low income earner, instead, chose to invest in a non-registered account of dividend payers, they would pay very little or not tax on their dividends. Thus, in effect, if they held the portfolio for the long term, it has the same tax deferral benefits of an RRSP. And when they sell, they would only have to pay 50% of the gain, instead of 100% of an RRSP withdrawal. Yes, I agree that there are huge benefits of reinvesting the tax refund, but I’ve read that most people simply spend the refund.

  • josey124 August 2, 2011, 5:50 pm

    I have a problem with my RRSP and I don’t know where else I can post this. I have an account with Questrade (RRSP) and one of my posititons CONVERTED ORGANICS INC (COIN:US) is now declared non-eligible. I purchased the shares in February and now I am forced to transfer them out of the RRSP account or sell them? WTH? I can see that they are non-eligible now and one shouldn’t be able to buy them under the RRSP umbrella but I bought them months ago. How can CRA force me to take a loss?

    Here is an excerpt from the email I got:

    The Canadian Revenue Agency (CRA) determines which securities are eligible to be held in RSPs. All non-eligible securities are taxed at a rate of 1% per month, based upon the value of the security at the time it was acquired.
    Your account currently holds the following non-eligible security (or securities):
    CONVERTED ORGANICS INC

    To remove non-eligible securities from your RSP select one of the following options:
    1. Sell the security.
    2. Transfer the security to a non-registered account.

    Note: transfers from a registered account (except TFSAs) are considered a plan deregistration and are subject to fees and a withholding tax.

    Can anybody let me know what my best option is here? Thanks!

  • Perry February 7, 2012, 2:14 pm

    Hi FT!!

    I’m 23, have 20K in student loan debt, and 20K for my car. Making 43K/year. Want to ensure I’m on the right thinking page. Should not make any RRSP contributions until I have paid off my student loan and car?? Or would paying one off ie. student loan be sufficient, then make contributions to RRSP while paying down the car?

    Thanks!

  • Perry February 7, 2012, 2:48 pm

    Hi FT!!

    Ontario Student loan Current Interest Rate: 5.50 % Floating….car loan is at 1.99 %. I’m currently paying $300/month to student loan, and $308/month to car loan. Would you advise me paying more monthly to both debts? I’ve got a couple hundred dollar (aprox $300) wiggle room after other expenses like rent, gas, insurance etc. Thanks so much!!

    • FrugalTrader FrugalTrader February 7, 2012, 3:00 pm

      @Perry, after counting for the student loan tax deduction, you are still paying an after tax rate of around 4.4%. As you are in a low tax bracket, I would personally pay off the student loan first. What is the balance remaining?

  • Perry February 7, 2012, 3:57 pm

    Got it! Will do! I just checked the remaining balance..looks like I
    was slightly off….balance to date is $21,894….not fun. I realized
    if I increase my payments to $400 it won’t make much of a difference.
    I will try for $500/month. At that rate, it would take me aprox 50
    months to pay. I will also try applying for repayment assistance…in
    hopes to get a lower interest rate, or have the interest taken care
    of. Not sure how successful that will go with my current income
    bracket, but definitely worth a shot. Any other advice is greatly appreciated!

  • Mansbridge February 8, 2012, 4:42 pm

    <– govt worker with pension (for now)

    23 yrs old, 51k… no debt. should i max out TSFA then start contributing to a RRSP?

    Thanks in advance.

  • FrugalTrader FrugalTrader February 8, 2012, 7:47 pm

    @mansbridge, that’s what I would do.

  • ImprovisedEconomist September 14, 2012, 11:11 pm

    Having worked through the math, I would say that most people should max out their TFSA contribution before they contribute to their RRSP. RRSPs are useful for income splitting if someone earns much more or less than their spouse, but otherwise if your current income is $60,000+, you’re under age 40, and you save enough for retirement or have a company pension, you are extremely unlikely to end up in a lower tax bracket.

    Most of us should be in the 22% federal + 10% provincial tax bracket in today’s $. If you make more than that, consider squirreling money away in the Cayman Islands or something of that that sort (half-joking of course) … Second, if you move to a cheaper/lower taxed jurisdiction upon retirement, you will still be paying 15% tax minimum in Canada when withdrawing from your RRSP, but nothing on money moved out of a TFSA. Finally, because we have very little competition in the banking/insurance sector (let’s hope that changes eventually) the annuities you can buy in Canada are ripping off savers. Considering all these factors, put your first $5k in a TFSA every year and only the excess of that into your RRSP.

  • JC January 12, 2013, 7:44 pm

    Disclaimer** Do NOT consider any of the following as advice in any way shape or form, as I am not communicating it as such: I’m a Financial Planner and I love how many people think RRSP’s are a big scam and how the “government takes my money!” As stated in the article, you got a tax refund up front, and don’t have to pay back the money until you withdraw… potentially many years later… you’re using the government’s money interest-free for potential profit. Most calculations will show and RRSP is usually ALWAYS better vs. non-registered. A smart move is to take the RRSP refund and pay down debt or contribute to a TFSA. I wouldn’t take a trip, buy a TV, orconsider it free money. Personally, through my employer, 100% of my stock contributions go directly RRSPs. a) I make 50% instantaneously through matching and b) If I have to withdraw it unexpectedly for any reason… well I’m just paying taxes back that I already owed anyway.

    Also, improved economist, I disagree. I think what you’re trying to say is that people with higher tax rates in retirement should contribute to TFSAs. Yes, that makes sense, but flat out saying ALL should contribute to the TFSA first is not necessarily a good recommendation.

  • J B March 17, 2015, 2:10 pm

    Of course people who save are often higher income earners
    And frugality is just as important for them especially if they cannot read the future potential of their earning ability … So my question which is rarely covered in your wonderful site is where does an rrsp fit if
    You hope or plan to have a reasonably high income after 55,70 yes of age ?
    Is an rrsp still a good vehicle ? And how long ? What are alternatives or plan for rrsp/other in ones estate planning when they realize their frugal approach has left them expecting a higher income after 60?
    Can you help here ?
    Thanks

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