So with RRSP season in full swing and you seeing a least five ads a day to contribute to an RRSP I thought I would point an often forgotten fact about RRSP: do you need one at all? This isn’t to say I suggest you avoid saving something for your retirement, but rather I question who should be investing in what type of account.
In some regards the RRSP program has always been for the rich or upper middle class. As they are the ones getting the most tax savings and most benefit out of the program. After all as you income increases you don’t have to keep spending the extra money, so in becomes easier to save a larger percent of your salary.
As an example, let’s say someone in Saskatchewan is currently earning over $100,000/year. Yet their basic expenses for a family of four are about $35,000 a year. So to max out their RRSP contribution of 18% of last years income ($18,000), it is fairly easy for them. Also they get a tax savings of almost 40% when they contribute to an RRSP, yet when they take those RRSP out in retirement they likely will be in a 26% tax bracket so they will be doing very well with tax savings.
Yet in someone else is earning only $40,000 the RRSP program starts to become less useful. After all their living expenses are likely also around $35,000 to raise their family, so saving 18% of their income ($7200) is going to be fairly damn impossible without cutting back on their spending. Add in the fact the tax savings is only 26% now and even when they pull the money out of their RRSP in retirement, as they will likely still be in the same tax bracket.
So what is a lower income person to do? Simple, skip the RRSP and go straight to the TFSA instead. While tax sheltering only $5000/year for someone earning $100,000 a year isn’t that much (5%), for lower income people of about $40,000 it starts to be a decent percentage of income (12.5%). While you won’t be getting a tax refund for TFSA contribution that is ok. Why? People tend to forget something key about RRSP’s, you have to pay tax on any investment gains you make over the years when you pull that money out. You don’t pay tax now, but you still owe it in the end. Meanwhile the TFSA tax shelters those investment gains forever (as you don’t pay tax on a withdrawal from a TFSA).
So when should you use an RRSP? You should use an RRSP to lower your taxable income into the lowest tax bracket. After that any extra savings should go to the TFSA. So for example, if your lowest tax bracket ends at $42,000 a year and you earned $45,000 a year. Put the first $3000 of your savings into an RRSP to get the tax refund. Then put any additional savings into your TFSA.
So during this RRSP season I would suggest you invest something, but depending on your income don’t assume it should be an RRSP.