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Monday, March 27, 2017

The RRSP Debate

Posted by Tim Stobbs on January 21, 2011

Well yesterday’s post had an interesting debate in regards should you use an RRSP.  Some comments were saying you should never use them while others thought they made an excellent choice.  So who is right? Why both of them of course!

I’ve said this before, but it is worth repeating.  Personal finance is personal.  You will do want works for your giving talents and way of thinking.  It doesn’t mean people are wrong or right but rather the situation will drive the decision just as much as any data set you present.

So what I was finding missing from the debate yesterday was some numbers, at what point of income would you not contribute to an RRSP?  Also what is your marginal tax rate if you do contribute?  For me, my marginal rate is 39% so it’s for me an RRSP is a obvious choice for some of my cash to get that refund since I know my tax rate will be lower in retirement.  I would personally stop contributing to an RRSP around $41,000 in income.  Why? At that point the marginal rate is significantly less (26%) and dividend income and TFSA are a better bet.  So where is your threshold for contributing to an RRSP?

Comments

16 Responses to “The RRSP Debate”
  1. I would like to figure out how to know in advance how much to contribute to an RRSP for the year. I usually make my contributions at the beginning of the year, because I want to get it in the stock market as early as possible.

    Any thoughts on this?

  2. Kiester says:

    You’re absolutely right in saying that ‘it depends’.

    Some look at the study and see implied effects. They are implied because of what society has learned from the past (and the present i.e. boomers). What the study doesn’t show, is how people’s lives are different today than before.

    The biggest thing that has changed is the requirement for post-secondary education. Before, people got married after high school and worked. Now the general trend is to go back to school after high school, and for many, to then go to work to pay for that education until they are at least 30. Then again, we’re living longer, maybe its expected to retire later as well.

    Second, the study doesn’t show how many of this group have alternative retirement plans. As an example, the public service is the largest employer in our country today. Those in that line of work, have a retirement plan set out for them (as do many other industries), and it makes absolutely no sense for them to use an RRSP, as delaying that income would likely cause the income to be taxed at a higher bracket than it is today (you’ll likely make more money later and therefore in retirement than you will today).

    So yes, it depends. But also, times have changed.

    I think there is a lot of debate about today’s young generations, because the fears regarding the retiring generation. Reacting toward today’s young generation due to the retiring generation will not achieve the effects we believe. More understanding of the environment is necessary to make educated argument.

  3. Traciatim says:

    I contribute to an RRSP because I get a full match on 6% on my income. It’s easy to hit a good return number when you start with twice the amount you put in.

    I was actually thinking last night that RRSPs are kind of like the “Benefit Now, Pay Later” finance plans. A kind of borrowing from your future if you will. While the TFSA is more about paying up front and benefit later. Do you think if it was marketed this way that TFSA usage would increase?

    I haven’t had the cash flow to do much more than just participate in the company RRSP plan. I sure wish I was able to get in to a TSFA as well, and beef up my emergency fund (things just keep coming up that drain it). At least so far I haven’t gone in the whole and needed to borrow on my credit cards to pay for anything, so having the emergency fund really helps.

  4. Guillaume says:

    @Kiester:
    “Second, the study doesn’t show how many of this group have alternative retirement plans. As an example, the public service is the largest employer in our country today. Those in that line of work, have a retirement plan set out for them (as do many other industries), and it makes absolutely no sense for them to use an RRSP, as delaying that income would likely cause the income to be taxed at a higher bracket than it is today (you’ll likely make more money later and therefore in retirement than you will today).”

    I have to disagree with the statement that it make no sense for public servants to contribute to an RRSP.

    As you say, this depends! Granted, most public servants will likely work until they get full pension benefits. for them, it might not make a whole lot of sense to pour lots and lots of money into RRSP when other vehicles might be better (TSFA).

    However, in the context of early retirement, it makes perfect sense to do so. If you want to retire early and not take such a big hit on your benefits, you can defer the start of your pension so as to limit the penalty (where I work it is 5% penalty per year with no penalty at 60). In principle, I can bridge the gap between when I stop working and when I start getting benefits by drawing on my RRSP. In combination with a fat TSFA account, this can provide for a very decent income with little to no taxes paid.

    I guess my point is that you should stop and think about what you want in retirement and plan accordinlgy. Why would I work until I am 60 if I can reach my goal by 45 (or earlier) and be happy with my spending level?

  5. Canadian Dream says:

    Eclectic Indulgence,

    I’m not sure what exactly you are getting at in your question. Yet if you want to know how much RRSP room you have for 2011 you have a few options: 1) file your taxes as early as possible and then make your contribution right after you know your 18% limit from 2010 or 2) estimate your contribution rate right now at slightly less than 18% to give yourself a little wiggle room in case you got it wrong and then contribute.

    Kiester,

    Good points. I would argue that today the younger generation is slightly overwhelmed with the choices in front of them (for example ETF are still mostly new and confuse a lot of people). This leads to investment paralysis and that feeds an excuse not to save.

    Traciatim,

    Mmm, I’m not sure if that change in marketing would help people understand TFSA’s better or not. While the concept of pre-paid tax account is common enough in the American situation we Canadians just aren’t used to thinking that way. So it will take a few years of these accounts for them to start to be obvious on why they are useful. From my point of view I tend to keep explaining to people that what you are doing if permanently sheltering the growth in a TFSA and allowing tax free compounding. In an RRSP you get tax fee compounding, but you pay tax at the end. In a TFSA, you get tax free compounding but pay the tax up front. Both are useful, but you have to plan to make the most of both accounts.

    Tim

  6. sarahhiggs says:

    My husband and I have debated him having an RRSP. With his pension (which will be 40G + a year) and a combined RRSP (which will also be high due to the fact that we’re starting so young at 24) will cause him to be in a high tax bracket even after he retires. Not ideal when you want to get at that money in your RRSP. We’ve done some math though, and contributing to an RRSP will give him significant tax breaks in the present. So we’re not really sure what we should be doing at this point. Thoughts?

  7. Guillaume says:

    @Sarah
    You can use the tax break to invest in a TSFA. That way, you can enjoy tax free coumpounding of your refund without a tax liability at the end.

    Depending on your situation, if you feel comfortable with leverage, you may want to investigate the RRSP meltdown strategy.

  8. Dave T says:

    My feeling is you have to do what you feel most comfortable with.

    As background, both my wife and I make over $80k per year, have good company pension plans and two kids.

    In my case, I am only putting a minimal amount in RRSP to pay back what I took out for my home, only 2 years left for this.

    In the meantime all of my money is going to pay down my mortgage now instead of later when rates are higher.

    Good or bad, I have not yet started a TFSA, but once the mortgage is paid off (my only debt), my wife and I will have a good $15-20k each to put in within the first year. Once this is max’d, then I will think about RRSP’s again, but I believe they are not my best option.

    The kids also have RESP’s.

  9. sarah says:

    I’ll look into the RRSP Meltdown Strategy. Thanks.

    @Dave-
    We have thought about doing what you do.. put all our savings towards your mortgage principle and save RRSP until the mortgage is paid off. At this point, we would have our house paid off in 10 years(will be 34) with our current plan and we are still able to put away 10% into our various investments. Lots of thinking to do if we minimize our savings and increase our mortgage payments. Hmm
    I think about all the compounding that we’ll loose on on if we deferred investing into our RRSP for another 10 years.. but as my husband points out, and so do you Dave, we’ll have so much to put into the RRSP and TFSA once we have no mortgage payments (our mortgage is also our only debt).

    Anyways, thanks for the advice.. lots of things to think about.

  10. Dave T says:

    @Sarah… For me I only have 2-3 years left on the mortgage at the current pace, so I see the end in sight and it can not come soon enough. But even when we decide this was our path many years ago, the main factor was to take advantage of the low interest rates now when we can because we do not know where they will be in 2, 5 or even 10 years. I hate paying interest and the thought that I could be in a mortgage at 7+% increasing the length on my mortgage did not sit well.

  11. Chris L. says:

    If you are self employed, like I am then it really doesn’t make a lot of sense to put into an RRSP. I write off my expenses throughout the year and so putting into an RRSP will only help reduce my taxable income even more, which is unnecessary. Any surplus money just goes into paying down my principle on my rentals. They’ll be paid for in 2 years. Thus RRSP’s would put me in a higher bracket. If you have rentals and plan to pay them off, it makes no sense to put into RRSP’s because you’ll be in a higher tax bracket. I don’t see planning to earn less money in the future as a great way to see retirement. There are ways to enjoy retirement now such as duplexing your house or having a granny flat. Downsizing to a smaller house, building your own house on cheap land, etc. If you really want to do plan to make less in retirement, you should really start doing things today.

    I know a lot of people say they wont have mortgage payments in retirement, won’t have work related expenses, etc. But all these sorts of things can be cut now…if that’s your long term plan, start reducing your expenses today and live your retirement now.

    Here is an excellent blog to discover just how to do this: http://earlyretirementextreme.com/

  12. I made the mistake of maxing out my RRSP when I was young. Now I make the top tax bracket and I could benefit much more from the room.

    RRSP shines due to the fact that you get the instant tax refund, and the growth is tax free. This tax-free growth is worth much more than the initial tax rebate over 30 or 40 years.

    For young people who expect to have their salary rise quickly: Don’t contribute to your RRSP until you’re near the top bracket. But do invest after-tax, either by repaying debt or saving. When you hit a high tax bracket then move your money into an RRSP to benefit from another 40 or 50% windfall and tax-free growth.

  13. @Dave: You said this: “In the meantime all of my money is going to pay down my mortgage now instead of later when rates are higher.”

    If you expect mortgage rates to go higher in the future then maybe you should pay them off in the future?

    Run the numbers: If you mortgage now is 5% and you think it will go to 10%, and you can make 8% investing then your best bet is to leave the mortgage, invest in TFSA to get 8% growth tax free, then when rates do rise past 8% you withdraw from TFSA to pay the mortgage in a lump sum.

    You’d be ahead by about $750 in 5 yrs if you did this with your $15,000 TFSA contribution room.

    When interest rates are low you borrow to invest, when they are high you sell investments to pay debts.

  14. Guillaume says:

    @Perfecting

    I agree, in principle.

    The problem is, there is no way to guarantee that you will beat or match 8% with your investments. It all depends on the assumptions of the model you use. One can cater a specific situation where paying debt first wins in the long run versus investments or vice-versa simply by changing the parameters(unknowns).

    My personal take on this is not to put all my eggs in the same basket. That is, you can focus a large part of the money on mortgage payments but still keep a significant amount of free cashflow to benefit from investment opportunities (ie : CD rates raise to 10% tomorrow morning, interesting stock prices, etc) shall they arise.

  15. Dave T says:

    @perfecting

    You are correct and I did run some numbers, but do I know where mortgage rates are going for sure, well no I don’t, but I feel they will go up. On the other side could I expect a good return on my TSFA, say like 8%, well I can not guarantee that either. If I could you are right that is the way to do it. Do I know if I will have a job in three years times, again I do not now for sure.

    This is why l always do what makes me feel comfortable with and lets me sleep at night, and paying off the mortgage does both for me, but everyone is different.

  16. LJR says:

    You don’t have to claim your RRSP deduction in the same year that you made the contribution. It can be carried forward (using Schedule 7)and deducted in a future year. This would be beneficial for anyone who expects to be in a higher tax bracket in future years. I did this throughout my 20s. My strategy was to claim only as much as was necessary to take me down a tax bracket; the rest I would carry forward to be used in a future year. Works great and its very easy to do.

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