The financial industry has done a great job of promoting the benefits of RRSP contributions for those who don’t have gold-plated pension plans, but sometimes the message investors hear is that RRSPs are the ideal tool for everyone, when in fact this is simply not the case.
For some people, such as employees with mid-range incomes and modest inheritance prospects, RRSPs can be a very good tool for their retirement savings.
However, RRSPs are not ideal in all situations, and if not used wisely, they can result in an investor paying more tax, not less. Low income earners, high income earners, and business owners are three categories of investors for whom an RRSP can be counter-productive.
Your tax rate at the time you make an RRSP contribution equals the tax you get back. When you withdraw money in retirement you pay tax on your contributions plus their growth.
An employee whose tax rate is 40% can benefit by making RRSP contributions if their tax rate is lower in retirement. The reverse is true for a diligent saver who makes contributions early in their career when their tax rate is low. They might only get a 20% benefit on their contributions, but find that they have to pay 40% to get the money out in retirement.
Higher income earners run the risk that RRSP contributions, which eventually need to be withdrawn, will result in having their Old Age Security (OAS) pension clawed back. Currently this amounts to an extra tax of 15% for each dollar earned above $73,756.
Business owners need to be aware that only their T4 income entitles them to RRSP contributions. In many cases, business owners are better off keeping retained earnings in their company, or a related HoldCo, rather than subjecting them to additional personal tax. I often work directly with the accountants of clients who own businesses to craft the right retirement savings strategy. (Continued on back page)