RRSPs are our friends ... or are they?

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Ted Rechtshaffen is president and CEO of TriDelta Financial Partners, a firm that provides independent financial planning advice. He was vice-president of business strategy at a major Canadian brokerage firm and found that the interests of the client were often not aligned with the interests of the adviser or the interests of the company.

This is part four in a series that looks inside the financial services industry at what advisers tell their clients and - more importantly - what they don't.

"Maximize your RRSP" - does that really make sense for you?

The mutual fund industry has a clear opinion: Based on their commercials, registered retirement savings plans are the best friends Canadians (and the mutual fund industry) have ever had.

The reality is that, often, RRSPs are great friends of investors, but when it comes to paying the piper in retirement, or at estate time, there is a down side.

The down side is that our friendly government taxes RRSP/RRIF assets upon "second death," as if it was income earned that year.

This means that if there is an 85-year-old couple with $500,000 in each of their registered retirement income funds, and the husband passes away, his RRIF merely rolls over to his wife. This leaves her with a $1-million RRIF. If she passes away two years later, the $1-million is taxed as if it were income earned in one year, and will take a tax hit of roughly $445,000! Suddenly, the RRIF is looking more like a foe than a friend.

To be fair, the RRSP and its next of kin, the RRIF (which is what an RRSP will become by the individual's 72nd year), are more positive than not, but here are the three key questions to ask before putting more money into them:

1) What is the tax refund I will receive on each dollar of RRSP contribution? This will be dependent on your taxable income. Your refund could range from 0 cents on the dollar to 46 cents in Ontario.

2) What will my tax bill be when I take money out of my RRSP or RRIF? In a very low-income year, the tax bill could essentially be $0, or like the estate example, in the 44-per cent range or higher.

3) How much time will the investment be able to grow tax free?

If you are getting 46 cents back on the dollar (in Ontario, this means that after your RRSP contribution, your taxable income is still over roughly $127,000), then an RRSP contribution is most likely a good choice.

If you think your tax rate on this year's contribution is going to be lower than what it will likely be when you take funds out, then an RRSP contribution likely does not make sense for you. The only way to really answer this question is if you are 50 or older and have a good financial plan.

In general, after looking at the first two questions, the younger you are (assuming a decent income), the more you will benefit from tax-free growth. However, the TFSA may be the better starting point - especially when income is under $40,000.

A good financial planner will be able to show you how to strategically use tax rates to help you determine how much, if any, to contribute to RSPs, and also how much you may want to withdraw.

The TriDelta Retirement 100 tool, found at tridelta.ca, helps you to see your likelihood of running out of money, and if you won't likely run out of money, it shows your likely estate size and lifetime tax bill. By playing with RSP numbers, you can see the effect on your lifetime tax bill and estate.

Unfortunately, as with most financial questions, whether an RRSP contribution is a friend or foe depends on your personal situation in any particular year.