Minutes before sitting down for an interview for this article, Kevin Cahill, a certified financial planner from Guelph, Ont., had to give a client some bad news. The man’s father had passed away, and after picking through the estate finances, Mr. Cahill discovered there would be a $70,000 tax bill to pay.
“The son just crumpled. He said, ‘Wow, I can’t believe that’s actually possible,’” says Mr. Cahill now.
The issue, it turned out, was that the elderly man had dutifully squirrelled away a small fortune in his registered retirement savings plan (RRSP) over the years. But before he was able to fully enjoy the fruits of his scrimping and saving, he died, resulting in the remaining money being taxed within the highest bracket.
Mr. Cahill says he thinks many Canadians don’t fully understand the implications of contributing to an RRSP. Although it can be a fantastic financial tool for some, it’s not for everyone at every stage of life. Handled poorly, it can even become a big waste of money.
“It’s amazing. There are all these ads and people go into this robot, drone-like mindset that they have to contribute. But there are no ads that talk about what’s going to happen on the other side,” he says. “I’m not saying don’t contribute, but you do need to think about why you’re doing it.”
It’s enough to make Harley Lockhart, a certified financial planner with Quail Ridge Financial Services in Kelowna, B.C., shake his head. He admits he gave up on RRSP season long ago once he noticed some of his clients he’d inherited were paying more in tax upon retirement than they did while they were working.
In one case, after considering the clawbacks to government benefits and Old Age Security, the person’s marginal tax bracket was the equivalent of a whopping 75 per cent.
“What’s more important is to develop a strategy that will produce tax effective income over a lifetime,” he says. “Sometimes it’s better to pay tax than it is to defer it.”
Steven Metallo, a chartered accountant at Zeifmans LLP Chartered Accountants in Toronto, agrees that tax planning shouldn’t only be about putting off paying tax today. It’s about finding ways to maximize savings over the course of a lifetime.
“All the advertisements say, ‘Come get your RSPs,’ but what is the true cost to the taxpayer? They use the word ‘defer,’ but what does defer really mean? It just means paying later,” he says.
So who should contribute to an RRSP and who shouldn’t? While everyone’s situation is unique, here are a few issues you’ll want to consider.
You’re probably better off doing something else with your money if:
- You are in a low tax bracket already. People contribute to RRSPs to pay less tax overall. When they’re in a high tax bracket, it makes sense to plunk some money in an RRSP and shelter it from taxation. The theory goes that once a person retires, they fall into a lower tax bracket and will eventually pay lower tax overall on the money. So why contribute to an RRSP if you’re making $40,000 or less and are already paying the least amount of tax you’ll ever pay?
Then there’s also the issue of clawbacks. The more money the person must withdraw from an RRSP, the more the government will take away from their Old Age Security. The upshot: Saving for years only to have the same amount of retirement funds as if they’d done nothing at all. “Especially if you make under $30,000, you shouldn’t have a dime in RSPs. It doesn’t make any sense,” Mr. Cahill says.
If you think you’ll be in a lower tax bracket in retirement, of course, go with an RRSP. If not, a tax-free savings account (TFSA) might make more sense.
One more point to consider: Just because a young person is making peanuts today and is in a low tax bracket, it probably won’t stay that way. Recent grads might want to consider starting an RRSP, but refrain from deferring the taxes on that money for a few years until their salaries are higher and they’re paying more in taxes.
- You’re going to need the money soon anyway. People who are only a few years away from retirement, might want to reconsider before starting an RRSP, especially if the contributions are small or they are in a lower tax bracket already.
- You have a good pension. Although it might feel strange not contributing to a RRSP when everyone else at a dinner party is talking about theirs, if you have a good pension, RRSPs shouldn’t be much of a concern.
Again, a TFSA is a possibility. Or take the money that might normally go into an RRSP and use it to pay down the mortgage faster. Paying off high-interest debt is another good use of the money. No one wants to start retirement drowning in $20,000 worth of consumer debt and paying about $300 in interest each month.
Go ahead and contribute to an RRSP if:
- Your employer offers a program that matches RRSP contributions. These are hard to come by, but if the money is there, it’s one of the best ways to ensure a good rate of return.
- You’re certain you’re going to be in a lower tax bracket in retirement. If you’re in the third or fourth tax bracket and making at least $80,000 today, an RRSP is probably a good idea. But talk to a tax professional first before making a move, Mr. Metallo says. A good accountant or certified financial planner will probably outline possible tax scenarios you might never have thought of. Just don’t expect too much in the way of hand-holding at financial intuitions in the run up to March 1.
“The banks don’t have time to explain all this because right now it’s their busy season. Their objective is to get you in, sign the paper and make the contribution,” he says.