With RRSP season gearing up, it's time for the full court press reminding us that the deadline for making a contribution for your 2012 tax year is March 1. And while the introduction of the tax-free savings account made the retirement savings options a bit more confusing, an RRSP was not a slam dunk before its introduction.
There are some people who should avoid RRSPs. What makes it trickier is that those same people might then want to embrace them, but only for about six years. Confusing? You bet.
What's even worse is that this demographic might be hard pressed to get advice from someone who understands this. That's because generally you need lots of money to see experienced financial advisers – and this demographic has just the opposite.
Low-income Canadians approaching retirement do not get as much benefit from an RRSP contribution as those with higher income, yet face stiff reduction of income benefits, namely the Guaranteed Income Supplement (GIS).
Because an RRSP contribution lowers your income, it reduces the tax owing in the year of contribution. But since lower-income earners are in a lower tax bracket, that tax reduction is low. The RRSP contribution then grows on a tax-free basis, which is less beneficial than for someone sheltering investments from a high marginal tax bracket.
Ultimately, the withdrawal is treated as taxable income at the time it is taken out, which can have a devastating effect on a senior's GIS benefit. It is not only subject to tax, it can also reduce GIS at a rate of 50 cents on the dollar. That's like getting a 20 per cent refund when making a contribution but being subject to a 70 per cent tax on withdrawal.
Having said that, the tables turn between ages 65 and 71. A very low-income senior might actually benefit from an RRSP contribution during this stage. So while some low income seniors may want to consider avoiding making RRSP contributions before 65, they may conversely want to consider it for this six-year period after they turn 65.
The GIS is paid if income is below certain thresholds (which vary based on marital status) and since an RRSP contribution is an income deduction, some seniors might be in a position to qualify for GIS only by making an RRSP contribution.
For example, I wrote online last year about this case study in which a 65-year-old senior with an income of $18,000 was able to qualify for $25,000 in GIS by making RRSP contributions. The extra tax and interest for the strategy was minor compared to the benefit.
Since retirement planning for low-income seniors is nuanced, and low income generally means you don't get your financial firm's most experienced adviser helping you, those seeking further advice should read John Stapleton's guide, Planning for Retirement on a Low Income.