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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?





90 Comments, Comment or Ping

  1. 1. Mike

    Why can’t the new graduate start a non-registered investment to ‘take advantage of the compounding’. Once they get into higher tax brackets they can use this $$ to make contributions.

  2. Mike: Great question. A new graduate, with a new job, say $35k – 45k / year, can certain start a non-reg portfolio. However, it would be more efficient for the new grad to contribute to the RRSP and pay down debt, IMO. Even at $35k /year, the new grad will be subject to capital gains and dividend taxes (except BC). Why not start the portfolio in a tax efficient manner? Not only that, the new grad can withdraw from the rrsp towards the down payment of their first home.

    If the new grad doesn’t have much contribution room, max out the RRSP, and use any money left over to pay down debt. Non-reg portfolio should be used last, UNLESS, the new grad expects to stay in a low tax bracket for his career (unlikely).

    FT

  3. The only problem I have with keeping all your investments in an RRSP is when it’s time for you to purchase a home, one can only withdraw up to 20K otherwise one will be subject to RRSP withdrawl fees.

    I’m trying to save up to purchase a home in about 5 years and want to maximize my savings but don’t want to over contribute to my RRSP if I can’t use it all for my downpayment. Just my two cents :)

    http://canadiandollars.blogspot.com

  4. Hi CD,

    Why not max out your contributions to keep some growth in your RRSP when you withdraw a portion of the funds for the down payment?

    FT

  5. 5. Mike

    I think that maybe not everyone has enough $$ to max out their rrsp and save for a house. I’m not saying one is better than the other but sometimes you have to make a choice and go with it (for a while).

    As far as the new graduate goes – I would suggest that depending on how much $$ they make, if they put $$ into an rrsp – they could be looking at withdrawing the money later at a higher tax bracket. Now if they make $35k or more then maybe that shouldn’t be a big factor – I was thinking more of my own history where I made around $27k to $32 for the first three years (about 12 years ago) – at that time I would have been better off just paying any dividends/cap gains (at a low rate) on a non-reg account and then used the money to make contributions once I started making more $$ OR buy a house.

  6. the only problem with maxing out my contribution (which I can do) is that I’ll be contributing a lot to my RRSP but then my downpayment for a house won’t be very much.

    As I am living in the Greater Toronto Area, I am looking at probably purchasing a 400K+ home. I would like to put down a decent down payment. Unfortunately maximizing my RRSP won’t allow me to do that. I’ll need to explore more options.

  7. 7. Mike

    CD – I have a $225k rsp and a $220k mortgage – guess which one keeps me up at night? I’ll give you a clue – it’s not the rrsp or lack-thereof. If I could make both disappear and then start over with the rsp I would do it in a second.

    My advice to you is make sure you have enough in the rrsp for the home buyers but everything else keep outside and make the downpayment as big as possible – just make sure you can handle the mortgage (which I didn’t!).

    Mike

  8. 8. Kevin

    Hi,

    I’m a little concerned about the last point (permanent low income earners). Who are these people and why would they resign themselves to being low income earners for their entire careers? Why would they *plan* on having a low income at retirement so that they can take advantage of government benefits?

    A caveat — I’m from South of the border (Seattle, WA), so I might be viewing this from a different angle. Is this a common “strategy” up North?

    –Kevin

  9. Hey There,

    I’m 22 right now, have been contributing to an RRSP for just over 1 year through the company I work for. They offer the ability to have RRSP funds taken out automatically and stuck into an RRSP. Right now, all I’ve been able to afford it $100 a month, as I only make $40k/year, so I’m only managed to build up $1200 in my RRSP and my max contribution is something like $9k.

    My question is, is it worth trying to take out a loan to max out my RRSP’s. How does that kind of thing work and what would I be in store for? Also, do you happen to know what tax bracket I fall into?

    Thanks!

  10. Kevin: When I saw permanent low income earners, I don’t mean that people intentionally do this. This is more of a consequence of lack of education etc. This is an issue in both Canada AND the United States.

    Soultrance: If I were in your situation, I wouldn’t even consider getting an RRSP loan UNLESS your refund would pay off the loan completely. Note that RRSP loans are non tax deductible. You’re a young fella, if you have consumer debt, pay that down ASAP, then worry about the RRSP.

    FT

  11. 11. Kevin

    Thanks for the response. I definitely agree that this is a problem on both sides of the border. :-) I just bugs me a bit that taxes from our 401ks (US) and RRSPs (Canada) will be going to fund folks with this “plan” (or lack of a plan).

    –Kevin

  12. 12. Soultrance

    Thanks for the info.

    My main problem is my debt, at the moment. It’s not consumer debt though. I’ve got about $4,800 sitting on a credit line and roughly $10,000 sitting in student loans. The credit line I make payments on with every pay check. Since my budget is limited, I only usually put $50 per check/$100 per month on to the principal, and cover the cost of interest separately.

    My student loan, however, I’ve been paying down the same amount for 3 or 4 years and have barely knocked $2k off the loan. Right now 54% of my SL payments go to principal, the remaining 46% goes to interest, which seems rather ridiculous to me.

    Thanks again for the help. If you can make any suggestions regarding the 2 debt points I made above, please let me know.

    Thanks!

  13. FT: Could you do a future article about when one should/shouldn’t contribute to a spousal RRSP? Just curious. I enjoy reading your blog. Thanks.

  14. CD,

    Sure can! Keep an eye out for early next week.

    FT

  15. 16. Zaine

    Mike,

    $225k rsp and $220k mortgage? What about putting the mortgage inside your RRSP?

    http://www.garth.ca/columns/030119.shtml

    ZVP

  16. 17. Mike

    Thanks for the link Zaine, I’ll check it out.

    I’ll admit though, if it’s too much work then I probably won’t bother.

  17. Mike, I’ve done some research on placing your mortgage inside your RRSP before, and the fees involved are prohibitive. Most of the big banks have the information online.

  18. 21. DrewP

    Okay, so… what are the next best investments after you max out your RRSP’s and all carry forward amounts? Should I just start non-registered investments? Explore tax shelters? What do you suggest?

  19. Hey DrewP, there are a couple options if you’ve already maxed out your RRSP. You could start a taxable investment account, or you could go the tax free route and pay down debt/mortgage. Depending on the interest rate on your debt and providing that it’s non deductible, you can almost never go wrong paying it down.

  20. 23. leslie foote

    Haven’t contributed ever to an rrsp…How many years back can you go to make up for all those years I didn’t contribute??or have I lost the entitlement afforded to me for past years and didn’t take advantage of..

  21. Hey Leslie, unused contribution room can be carried forward indefinitely.

  22. 28. Glenn

    I’d like some feedback on the Pro’s & Con’s of dipping into an RRSP to paydown line of credit debt. Interest rate on the line is at 6% but since the market is down and my funds have not performed well we are thinking that we’d be better to cash in and pay of the debt even if we have to pay tax on it rather than loose any more to the down turn in the market. any thoughts?

  23. Glen, you’ll have to consider that when you withdraw from an RRSP, it’s added onto your income for the year and taxed at your marginal rate. On top of that, you will forever lose that contribution room. If it were me, I wouldn’t withdraw from the RRSP, but stop RRSP contributions, increase savings, and pour it all into the LOC.

  24. 30. jen

    Hi,

    I have $15k US student debt (~5.5% interest), $140k Can mortgage, no RRSP and take home ~$32k Can/year. Where is my money best spent? Paying down debt? Paying more on my mortgage (even though we’ll likely sell w/in the next 2-5 years)? Spreading $ all around w/regular payments to each, including an RRSP.

    W/re: to low wage earners, I plan on taking time off to travel periodically throughout my career. This may affect my income bracket significantly. Should I avoid an RRSP?

    Thanks. An answer prior to the RRSP deadline this year would be appreciated.

  25. Jen, depending on which province you’re from, it may be more efficient to pay down your student debt and mortgage first. Then after they are paid off, take the same debt servicing money to aggressively contribute to the RRSP. However, you should consult a financial professional for your particular situation.

  26. “Low income earners who expect to stay in the same tax bracket for their career should NOT contribute to an RRSP.”

    That IS interesting. I haven’t heard anyone say that before!

  27. Michelle, the reason being is that people with low income qualify for low income government benefits like GIS during retirement. RRSP’s are counted as income, thus reducing GIS benefits. That along with equal tax brackets while working and during retirement make RRSP’s not desirable for that situation.

  28. 35. Carlos

    Hello,

    While I am making contributions to my RRSP every year, I found out that is better to declare it (and get the tax refund)every two years. Let me explain, I have a limit per year of $11660, so if a claim at the end of the year what i have contributed ($11660) I will get a refund of $3642 which is 31.23%. But if i wait another year to claim this, then at the end of this second year I will be able to claim $23321 and that will give me a calculated refund of $7994 which is an extra $4352.53 on my second $11660, this is equivalent to a 37.33% return on my second claimed of $11660.
    Now if you factor the fact that by waiting that extra year the Child tax benefit and GST calculation will change for better more than proportionally (I have three kids so is kind of a big deal) it all turns out to be an extra $16000 in a 18 years horizon by following the every other year strategy when you combine the extra tax refund ( %37.33 vs 31.23%= +$8000/18year) and the additional Child tax benefit (+$4000/18years).
    Does anybody agreed with the reasoning and is anybody else doing this? Does it make sense?

  29. 36. kyler

    Mike:

    A friend ran this by me and I don’t have the financial acumen to sort it out.

    I am within a few years of retiring. My wife and I are lucky to be teachers (Ont) and hence access to a sweet pension. We also have about 140K each in RRSPs.

    Since our pension is pretty sweet, i imagine our marg tax rate will be up there, and pulling out our RRs will see a huge chunk of them go to the taxman.

    Would it be feasible to retire but delay the pension for 2 -3 years and instead use the RRs up as income ?

  30. 37. JR

    Kyler, I think that I can add something here to respond to that, giving you a broad brush based on the limited information that you have provided

    Your ages are one important factor, the date when officially take retirement & with you both being teachers it supposes that you will do this before 65, if not, then why are you waiting.

    Other considerations such as your lifestyle and any changes that you plan at retirement and thereafter can and will affect the reasons for an early or the wait till 65 date … will the monthly expenses increase or decrease, are you planning an around the world trip … these things form pat of the retirement money planning and pensions question

    Would you be going into retirement with any debt, if so, then clear it off before the retirement date.

    On the money, no matter when you take the teachers pensions, even if you delay it, the years that its not taken will give you more when you do start to draw on it.

    At retirement pre 65, 60, 55 whatever that date is you could start eating into the RRSP’s early as a bridge to 65. How much do you need and how long will the RRSP’s last .. only you can answer that one

    Assume two things (simple maths) pick the retirement year, calculate how long it would take to use up the RRSP’s before 65. Do not draw CPP early, then at 65 you and your spouse would have approximately in todays money a combined CPP & OAS of about $2300 … is that enough?

    At some point 1, 2, 3 years into full retirement post 65 you can then start collecting the teachers pension

    There are other factors such as lifestyle changes, children, grandkids, relocation, health and how long you will live

    Have you thought about one of you retiring a few years before the other?

    Are you planning to leave an inheritance, if so then the RRSP stay intact, dont touch and leave those to whoever as benificary, then at 65 start drawing the teachers pension along with the government pension

    Hope this helps

  31. Kyle, do add to what JR said, does your teachers pension include CPP when you retire as most provincial pensions do?

    But yes, you are right, with a good pension, all RRSP withdrawals will be taxed at a higher rate. If it is possible to delay the pension income, then using the RRSP portfolio to live on for a few years would be a tax efficient means of drawing down the account.

  32. 39. kyler

    Thanks guys for the advice. Here might be some key data:

    – set to retire @ 58, same year as wife. Savers, no debts. Daughter will have finished degree. No round world trip but some travel ( eg month in florida in winter ?) … inheritance will be house, health for both of us strong ( knock on wood). May get some inheritance from folks ( modest 5 figures ) to serve as emerg fund.

    So, to spend RRSP early ( thereby keeping a bit more from gov’t) or hold ?

  33. 40. JR

    Kyler:

    Only you can say when you will pull the plug.

    Once you’ve made the mental decision to do it, then IMO the earliest date that you can op-out … just do it. .

    It does not appear in your case there a need to keep wealth building for retirement.

    I have taken some assumptions using the following example:

    How much will you need (I shall pick the number for you) its $36k per year … $3000/mth (leave out inflation increases)

    You said each you have banked $140k in RRSP’s ($280k total). The RRSP money is invested in basic growith @ 5% per year . Should you begin today to withdraw a total of $36k per year from the RRSP (each draws 18K minmizes tax) the balance in the combined RRSP continues to grow at 5%, then the RRSP fund would be depleted in 7.5 years.

    Based on those numbers, knowing the RRSP’s will be over and done in 7.5 years, you now have some idea of the earliest retirement date. You said that you have other available resources to chew into, in your case, the assumption again is that its a combination of life savings and the RRSP would carry you through to 65 before you start thinking about collecting the pensions available to you.

    At this stage do you really need to continue on working and keep building the RRSP’s (me thinks not)

    That said, again based on assumptions, is that you have both retired earlier than expected, have used life savings and RRSP to carry you through till 65 when the other guaranteed income (pensions) should be adequate to sustain you for the rest of your lives

    At 65, you have a couple of choices

    1. Collecting or delay collecting government pensions
    2. Collecting or delay collecting the teachers pension

    Would you need both at 65 or only one of them. Will the pensions be enough to keep you going through to 85 or 100 years of age?

    I always to folks, “remember the government will encourage you to collect as much income from investments and pensions as possible so they get their biggest tax bang from you”

    My suggestion would be for you & your spouse to calculate how much money you will need at the earliest retirement date to chew up the RRSP’s and any savings prior to collecting Teachers & government pensions, as well as calculate any expenditures along the way, to also factor in what-if’s.

    Post retirement, in this case 65, how much will you need?

    Will you need a combination of the teachers pensions and government pensions at 65, would it be only one or both of them .. only you can answer that

    Other factors.

    Now, assuming at some point in the retirement years the need arises along the way for a big expenditure, such as paying for your daughters wedding, or you always wanted that classic car, a yacht maybe, the condo in florida … then unless there is a considerable amount of other money that is taxable (stocks, bonds, interest bearing certificates etc) and you’ve not mentioned any investments here or their value, it would be the time to look at other options such as the downsizing idea in selling the family home to pay for the big needs.

    If part of your plan is not to downsize and take equity out of the family home, then of course, use the taxable investments that you have for any purpose that there is a need for those additinal expenitures.

    Do not go into any bad debt in your retirement years.

    The idea in retirement is just that … retire for the fun of it, not because you need to, or someone made you do it. Plan to do it with as little stress as possible and without worrying about money and having to pay tax (sorry minimal tax)

    Has any thought been given to how you will spend your time in the golden years?

    Closing comment:

    Do not (I say this all the time) leave yourself short just for the sake of leaving it to someone else, especially the taxman

  34. I personally don’t see anyway around paying taxes on the rrsp money – once you get to a point where you are eligible for a pension, then delaying it will just cost you money.

    Best advice I have is to spread out the withdrawals to reduce the taxes (a bit). Don’t forget, you never paid taxes on that money so it’s not like you are really losing anything.

    I have to say that rrsps are not a very good deal for teachers or anyone else with a good defined benefit pension.

    Mike

  35. 42. JR

    Four Pillars, exactly …

    If Kyler is at the point in life to retire early the tax would be negligible on any RRSP melt down of $18K per year each of them.

    The example I used was based on the $280k they have in combined RRSP’s now, it would take approximately 7.5 years to get it to zero and my rough estimate the tax would be nothing to cry about

    Per year each individual draws $18k – less personal deduction … how much tax would they pay on the balance … ALMOST ZERO

    So go for it Kyler 58 or sooner is the best approach, based on the information that you’ve provided.

    For those that do not have luxurious company pensions, who may need be more than whats available from the fed’s. Those that live in any major city in Canada living off of CPP & OAS with GIS top up, wont take you very far … below the poverty line in fact.

    And should you have RRSP’s that would provide you with supplemental income in your retirement, the fed’s have that one figured, simply by just taxing the hell out of you for withdrawing from the RRSP at the same time taking away any supplements (GIS or Allowances)

  36. 43. JR

    So meltdown the RRSP early, pay off debt or use the RRSP against interest on loans and if you have enough time plonk it in one of those new fancy TFSA (said somewhere else)

    If you are at least 10-years away from retirement consider melting down any RRSP’s, get rid of all of that bad debt and retire early.

    At 65 try to make sure the fed’s cannot get their hands on your hard earned and saved money by way of undeserving taxes and also try to maximize on the pension and supplement offerings available from them

  37. 44. ChrisB

    I’ve got a question on RRSP’s myself. I’m 22 and have no experience in investing. I paid off all my debt shortly after college, I make 52k/yr and have 18k in savings… I’m trying to learn more about finance and investing, the thing that seems to make most sense to me is to put in at least 20k into RRSP’s for when I do buy a house, that would help a bit with the down payment.

    Does this seem like a good idea, or is there some other types of investments I should look into instead? And if investing into the RRSP is a good idea, once I hit the 20k mark, should I continue, or look to other non-registered investments?

    Thanks!

  38. ChrisB, congrats on the big savings at such a young age, you are off to a fine start. Your plan sounds like it makes sense providing that you pay back the HBP aggressively after you use it. Do you have $18k in contribution room?

  39. 46. ChrisB

    Thanks! I believe so, I’ve only ever gotten a 1k RRSP a year or two ago, so assuming I get to use all the credits from previous years, yes? I’m not really sure.

    I’ve been reading more and more on financial blogs, a lot on this one :D I’m still confused as to what investments might be good for me, but I’m hoping with a lot more reading I’ll begin understanding the terms and ideas behind them.

    I’m open to any suggestions ;)

  40. Chris, I would suggest that you do some research on indexing with a more aggressive stance as you have a longer time line.

    This might be helpful:
    http://www.milliondollarjourney.com/just-starting-out-with-rrsps.htm

  41. 48. ChrisB

    Thanks, I actually just read that about 30 min ago, very good article.

    Last questions:

    Am I correct that your previous unused rrsp contribution room moves forward?

    If it does and I put in 10k later this year, would that result in a tax return of (my tax bracket) * 20,000 ? Which I could invest back into the rrsp.

  42. Chris, yes you are correct, any unused contribution room will carry forward. Your calculation is “close”, but not completely accurate. You see, if you contribute a large sum like $20k, you’ll most likely drop tax brackets. You can only multiply your RRSP contribution by the amount of your tax bracket. Once you drop tax brackets due to your contribution, the remainder of your contribution will need to be multiplied by the new tax rate. An ex:
    http://www.milliondollarjourney.com/reader-mail-rrsp-loan-yes-or-no.htm

  43. 50. RJ

    I am young and just learning about RRSPs….

    When I read about people considering RRSP contributions, I mostly notice that they are talking about their current tax brackets compared to the future….but I want to know why dont they consider at least contributing just to go to a lower tax bracket.

    For example if you are making about $38,000 (taxed @ 22%), shouldn’t you definitely contribute $1,000 to reduce your income to about $37,000 (taxed at 15%)?….am I missing something here, or is this so obvious and that is why it is not often discussed?

    Also, if this is the case, if I am making 25,000 as a grad student, should I consider contributing enough so that I move into the 0% tax bracket?

    Thanks in advance!

  44. RJ, the strategy that you suggest is what a lot of readers here do. That is, contribute enough to drop to the next bracket.

    The problem with contributing while in a lower tax bracket is that you’ll be contributing at a tax rate that may be lower than when you withdraw during retirement. The RRSP strategy works best when your tax rate during contributing years are higher than during retirement years.

    Ofcourse, the way around it is to contribute now and carry forward the tax deduction for when you obtain a higher salary.

  45. 52. pierre

    Hi,

    I am 26 years old, just out of grad school and have recently started a career with the federal government. I am currently making around 50K and have approximately 15K in student loans to payoff. I was wondering if I should begin contributing to an RRSP or concentrate solely on debt reduction until it is paid in complete.

    Furthermore, I was wondering if I would be a candidate for the TFSA instead of RRSP. If I continue my career with the feds and therefore increase my salary along with a decent pension, would it make more sense to go with TFSA where I wouldn’t be taxed upon withdrawal? From reading above it seems like careers with a decent pension and decent salary earning may be a recipe for paying higher taxes when withdrawing RRSP contribution. Could a solution be the TFSA or am I missing something??

    Any help is much appreciated!

  46. Pierre, if you plan on staying with the federal government for the rest of your career, then the RRSP contribution limit will be very limited due to the defined benefit plan. Even if you had more contribution room, the defined benefit plan is so good that I would focus on paying down debt before contributing. By the looks of how the TFSA will play out, people in your situation would be best to contribute to the TFSA before using your RRSP contribution room. TFSA withdrawals during retirement will be tax free whereas RRSP withdrawals will be taxed at a fairly high rate due to the high pension income.

  47. 54. DAvid

    Pierre,
    Many folks with a Defined Benefit Plan accumulate RRSP contribution room to use in time of short term high income (bonus of windfall), or to move them down a tax bracket, lowering their taxes overall. In your situation, I suggest waiting until your income increases before claiming any contributions. In the meantime, as FT suggests, pay your debts first. You may also wish to speak to a financial advisor for future planning.

    DAvid

  48. 55. MORTIIS

    Is there any reason to contribute to my RRSP if I do not plan to stay in Canada(maybe move to US in next 3 4 years)?

  49. MORTIIS, here’s what you can do to minimize the taxation on your RRSP account when you move:
    http://www.milliondollarjourney.com/leaving-canada-what-about-rrsps.htm

  50. 57. stuart

    totally confused.

    about Gis I have been encouriging my wife to open an rrsp account which she did hooray she makes around $36,000 per year before taxes
    am I corect from what I am reading that while she is working hard to accumalate for a retirment she would forgo the gis while someone who never really worked or accumalted anything would have a gis there waiting for themself guarenteed so whats the point of going to work working hard saving and stil finishing the same off as someone who never financed school or worked hard. Can you make it black or white should she have an rrsp or not?

    also does joint income affect the gis would I lose mine I have 45,000
    in rrsp and have been dedicated to saving for retirment should I withdraw the money so I would get the gis I am 48 my wife is 35

    thanks

  51. 58. DAvid

    Stuart,
    Unless you plan to have a joint retirement income of considerably less than $20,000 or so in today’s dollars, the GIS will be of little benefit to you. It is likely that the income from the CPP you are already contributing will create retirement income that will reduce your GIS to or near 0. It would appear that you and your wife have a family income in excess of the Canadian average, and as such, it should be to your benefit for each of you to contribute to an RRSP.

    There is lots of information on the ‘net about CPP, OASP, and GIS. Have a look to learn more for yourself.

    DAvid

  52. 59. Mark the Foster Advocate

    Hi All,

    For me, I think the rules for who and when to contribute to an RRSP are simple:

    Step 1) Contribute to an RRSP only after you have eliminated most of your high-interest debt (no credit card payments, no car payments, no student loans, etc).
    Step 2) When you have no high-interest debt (say, only the mortage and bills to pay each month), contribute to an RRSP to reduce your taxable income
    Step 3) Keep contributing until you get tax refund(s) from the federal gov’t for a few years (i.e., you are slowly building your wealth)
    Step 4) Keep contributing, modestly, to the RRSPs but start using the tax refunds or the new tax-free savings accounts as a means to start buying dividend-paying stocks
    Step 5) Keep modest contributions to the RRSP but slowly transition most of your monies to buy dividend-paying stocks to fund your retirement

    So far, I’ve completed steps 1-3, I’m working on step #4.

  53. 62. Bob

    The correct answer was: “Everybody”.

  54. 63. uberben

    Hey FT (and fellow readers),

    I am completely new to investing and RRSPs and the whole shebang as I am still in school, but I would like to get a jump start on my financial future. Reading through a bunch of Can. finance blogs and other resources, I think I have a good grasp on how everything works, but there are a few things I just want to clarify.

    First, some background. I am 21 with 2 years (3 tops) of school left. I have about 21k in the bank including a maxed out TFSA. As a full time student currently living with the parents, I am making about 11 or 12k/yr. about 5k goes to tuition, 90% of the rest into savings. I have no debt. Shortly after graduation I am looking to buy a house (renting is for suckers!) and quite possibly get married. I will also probably buy a car (in cash, preferably). I wish I could bike year round, but Canadian winters are not so accommodating. In my back-of-a-napkin calculations I have been assuming no finances coming from anyone else (i.e. spouse, parents, inheritances) for any of these major purchases, just to play it safe.

    Now for the questions:

    1. Claiming deductions for RRSP contributions is best done in a higher tax bracket than you will be in upon retirement. As a student, I am currently not paying income taxes but would like to get a jump on compounding savings. How long can I put off deducting contributions?

    2. RRSPs grow tax free, correct? Correct me if I am wrong, but I am assuming that the tax free growth isn’t impacted by not claiming the deductions.

    3. If I were to take advantage of the HBP, can I continue to defer claiming RRSP contributions? I don’t entirely see much point to putting money in an RRSP without claiming it, just to HBP it out again, but I just want to check.

    4. If I do put some funds into an RRSP with the intention of pulling it out via HBP in a couple of years, is that a wise move? The market seems to be in a good place to buy right now, but as a complete novice, I’m not 100% comfortable diving in for the short term.

    5. While on the subject of home purchases, I’ll toss in a question about the Smith Maneuver. Since I will likely be in a low tax bracket when I buy the home, if I do decide to do the SM, it is probably best that I wait a little while for the tax bracket to jump up.

    So, thoughts?

    Ben

  55. Ben,

    To answer some of your questions:
    1. AFAIK, you can carry forward your deductions indefinitely.
    2. Correct
    3. I’m not 100% sure on this one, but I “think” you can continue carrying forward even though you are on HBP.
    4. If you need the money soon (within a few years), I would personally keep the money out of the market. Not unless you are a good market timer, which not many people are.
    5. SM works best for those in higher brackets, just like RRSPs.

  56. 65. uberben

    Thanks FT. Sounds like I am on the right track. Most of my cash has been in what was a high interest savings account until rates took a nose dive. At least I haven’t lost capital. Hopefully rates will start going up again shortly.

  57. 66. Andrew

    I’ve read a few articles like this recently, but most of them don’t define “low income”, which can be a somewhat subjective term. The statscan definition in 2005 was about $20K for individuals in urban centres.

    Even if you’re income is only $20K, I’m assuming you’re going to be earning less when you are retired and not working at all. So wouldn’t that meet your requirements of “anyone who is employed and expects to be in a lower tax bracket when they retire”?

    So if you are earning $25K now, but never expect to make much more than the national average of about $35K, then you’re not really a “low income earner”. So do RRSPs still makes sense? If not, then what kind of income do you need before it makes sense to contribute to an RRSP? Are there better investment options for low income earners who want to save something for retirement? I’ve read that withdrawals from a TFSA won’t involve clawbacks of the Guaranteed Income Supplement, Old Age Security payments, etc.

    What about dividend income? Would that be treated the same as withdrawals from an RRSP in retirement?

    Cheers,

    Andrew

  58. Andrew, people in the lowest tax bracket for all their working years will find that an RRSP isn’t as effective as someone who is in the higher brackets. Like you mentioned, lower income means government benefits during senior years. Here is a more detailed article:

    http://www.milliondollarjourney.com/tfsa-vs-rrsp-clawbacks-income-tax-on-seniors.htm

  59. 68. Andrew

    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

  60. 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

  61. 70. Andrew

    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.

  62. 71. YYC27

    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.

  63. 73. Bill

    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

  64. 74. Stacy

    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.

  65. 75. David

    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.

  66. @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.

  67. 77. Dr. Philosophy

    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.

  68. 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

  69. 79. Dr. Philosophy

    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.

  70. @ 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.

  71. 81. josey124

    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!

  72. 82. Perry

    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!

  73. @Perry, what are the interest rates on the loans?

  74. 84. Perry

    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!!

  75. @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?

  76. 86. Perry

    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!

  77. 87. Mansbridge

    <– 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.

  78. @mansbridge, that’s what I would do.

  79. 89. ImprovisedEconomist

    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.

  80. 90. JC

    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.

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