RRSPs were first introduced in 1957. Because of their longevity, they’re the preferred vehicle when it comes to retirement savings. However, there are instances when contributing to an RRSP doesn’t benefit you. In certain cases, it could even do more bad than good.
Let’s examine these.
You’re in a low tax bracket
Meaning you don’t earn much. As a rule of thumb, if your earn under $50K gross per year, you won’t benefit much from an RRSP.
Why? Because you’re in a lower tax bracket. The tax refund triggered by your RRSP contributions is dependent on your tax bracket and your marginal tax rate. If you’re in the 15% bracket (lowest), you won’t benefit as much as someone who is in the 33% bracket -the highest-.
If you’re in this situation, contribute to a TFSA instead. It has many benefits as well.
You’re expected to pay more taxes in retirement
As surprising as it sounds, it can -and does- happen. If you have a pension plan at work, for example. Although a pension plan lowers the amount you can contribute to your RRSP, you need to factor it in when retiring.
Between, CPP, OAS, your pension and RRIF withdrawals or annuity, you may end-up earning more than when you were working! You’ll be taxed accordingly, and it will trigger a claw-back on your OAS.
This also may happen if you retire overseas and are no longer considered as a resident of Canada, fiscally-speaking. RRIF withdrawals and annuities are taxed at a flat 25%, regardless of their amounts.
Depending on the tax treaty with the country you retire to, the rates may be lower. However, it’s not the case, for the most part.
You’re not going to stay in Canada
This in relation to the above-point.
You can’t port your RRSP to another country. You can, however, keep it until you turn 71, should you wish.
You can also liquidate it. Depending on the dollar-value of your RRSP, you may do so when you’re still a resident, or when you become a non-resident.
If the dollar value is less than $ 15K, liquidate it while you’re still a resident. If it’s above $15K, wait until you’re no longer considered a resident. The flat tax rate for non-resident is 25%. The withholding tax for residents is 30% on RRSPs worth $15K or more.
You’re not making ends meet
If you can’t pay your hydro bill, there is no point in stashing cash in an RRSP. Same if you have high-interest debt or large student loans.
This isn’t always related to income levels. You need to figure-out your day-to-day financials first. This is the mistake I made. I contributed to an RRSP when I earned very little and had a lot of debt.
Instead of deferring the contributions at a later time, when I was earning more, I used them right away! 2nd mistake. My tax refund wasn’t as high as if I had waited to earn more to offset them on my tax return.
Final word
RRSPs are still touted as the “best thing ever” for retirement savings. Before you decide it’s the case for you, you need to understand the tax implications of this product.
RRSPs are tax-deferred, not tax-free. Ultimately, you will have to pay taxes on them. Don’t be blind-sided by a potential tax refund.
You also need to figure-out both your current and future tax situation. This is where most people fall short, unfortunately.
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