Should You Make RRSP Contributions If You Have A Pension?
A few weeks ago I was chatting about retirement planning with a teacher who was about to leave work next year with a fully funded defined benefit pension. He mentioned the recent market correction and was wondering if he should just withdraw all of his investments from his RRSP before the next crisis hits.
I tried my best to calm his fears by suggesting that even though he’s reached the standard retirement age, he was still in good health and should take a long term view of his investments rather than over-react to what the market is doing now.
What really struck me during this conversation was the fact that someone with a generous defined benefit plan was still making significant RRSP contributions. Before I moved into the public sector I was making RRSP contributions for ten years, but now I haven’t contributed for the last two years.
Should you contribute to your RRSP if you have a defined benefit or defined contribution plan?
Pension Adjustment (PA)
The primary reason for limiting your RRSP contributions when you have a pension plan is that you simply won’t have as much room to contribute. Your annual RRSP deduction limit will be reduced by the pension adjustment, or PA. This is a complex formula for defined benefit plan holders, but the end result is a significant reduction in your available RRSP contribution room each year.
Alberta teachers contribute 9.1 percent of their salary, up to the Year’s Maximum Pensionable Earnings ($48,300), and then contribute 13 percent on pensionable salary over the YMPE. So a teacher with an $80,000 annual salary would be contributing $8,516.30 each year towards their pension, or just over $700 per month.
Using the pension adjustment formula, the teacher would have their RRSP deduction limit reduced by $10,591.80 next year.
RRSP Contribution Room
Even though the pension adjustment significantly reduces your RRSP deduction limit, there is still a decent amount of RRSP contribution room left over. A salary of $80,000 would allow an RRSP deduction limit of $14,400 (18 percent). Subtracting the pension adjustment of $10,591.80 will leave this teacher with a potential RRSP contribution of $3,808.20.
The question is; should you take advantage of this contribution room each year, knowing that your retirement planning includes the luxury of a gold-plated pension?
Retirement Planning: What Are Your Options?
There are many factors to consider when planning your retirement. With a defined benefit pension you have the peace of mind knowing that you’ll be receiving 40 to 60 percent of your working salary in retirement. Whether or not you will require more income depends on the type of lifestyle you want to have in retirement.
If you also have investments within your RRSP, you will need to begin withdrawals in the year you turn 72. It’s possible that you will be earning more income in retirement than you were during your working years, meaning that you could be paying more in taxes as well.
In this case, you should consider contributing to your tax free savings account rather than maxing out your RRSP. The TFSA will give you the ability to top up your savings during your working years, and the flexibility to withdraw your investments on your own terms during retirement, tax free.
Good article – I like how you discuss the DBP’s regularly here. We’re all about TFSA over RRSP as Mrs. SPF and I both have DBP’s (hopefully, someday). After the ~ 9% that we each put into the DBP we work on TFSA and after that focus on debt instead of the RRSPs.
The one thing i’ve been curious about is whether our DBPs act like RRSPs (as in reducing your taxable income). If not, one use of RRSPs would be to make a smaller contribution in order to reduce your taxable income – the contribution may pay for itself on your CRA return.
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@SPF – I think it’s wise to focus on debt and TFSA contributions as well. Yes, your pension contributions will reduce your taxable income.
Thanks Echo. Do the DBP contributions lower the taxable income dollar for dollar the way RRSPs do? Just want to make sure I file properly next spring!
Yes, it’s dollar for dollar, just like an RRSP.
You shouldn’t have to do anything special when you file, your employer will include your Registered Pension Plan deduction (your total contributions) in box 20 on your T4 slip. You then enter that amount on line 207 of your tax return.
By “special” I meant how I pay attention to my RRSP contributions and how far the DBP takes me below my marginal tax rate. If it makes sense to put a few thousand into an RRSP to drop my tax bracket, I want to be aware of such situations.
Good article.
One small correction – mandatory withdrawals from your RRIF starts the year you turn 72. The RRSP has to be converted to a RRIF by the end of the year you turn 71.
Thanks Mike, I corrected the post.
I hope your article gets really wide circulation. Marketers of RRSPs are very persuasive, but RRSPs aren’t right for everyone and even more so now that TFSAs are an option. I stopped about 10 years ago after struggling to maximize contributions yearly – sure wish I’d figured this out sooner and used that money to do more with the kids. I retire next year with a DB and will attempt to withdraw my RRSPs in a tax efficient way (and put them in TFSAs) before I start collecting CPP and OAS and risk clawbacks and needlessly higher tax brackets. Thanks for writing about this!
Thanks Patricia, I hope so too 😉
I don’t want to sound like I’m bashing RRSP’s, there was enough of that going around this past tax season.
They are still a very valuable investment tool, however those of us with a DBP should be aware of all our options and the TFSA will be much more beneficial so we can withdraw money tax free in retirement without triggering those clawbacks.
Great post.
So many factors, yes, but for the most part I would think the majority of folks who have a DB plan, should not maximize their RRSP. I think the RRSP makes sense if you’re in a high-tax bracket, but otherwise, don’t contribute the max if you have a DB plan. We’re not in a high-tax bracket and we tend to optimize our RRSP contributions instead, because I have a DB plan. Also, because of that reason, I’d much rather maximize my TFSA.
If I maxed out my RRSP for years on end, and have my DB plan to retire on in another 20 years, I might be earning more income in retirement than my working years; which doesn’t really make a great deal of sense other than you are very wealthy and pay lots of taxes to show for it.
I’d rather minimize my tax burden in my senior years. I won’t have the brainpower to deal with all the tax issues then. Not that I have any brains now… 😉
Cheers,
Mark
Hi Mark, I was thinking the same thing…if we continued to max out my RRSP then we would be making as much (if not more) in retirement than when I was working.
Since we’re a single income family I’ve thought about contributing to a spousal RRSP, but with pension splitting available in retirement it’s probably not that beneficial anymore.
Great article! With the pension adjustment factored in, my RRSP contribution limit is typically $800-$850. That’s not much at all.
I have about $15k left to repay to my RRSP through the homebuyer’s plan, but outside of that, I’m turning my attention to my TFSA instead, other than contributing what I can to the RRSP simply for the tax refund.
Thanks! It sounds like you have a well thought out plan. I don’t have much annual contribution room after the PA either, but I do still have quite a bit of unused contribution room.
The spousal RRSP might be an idea. You can’t split income with a spouse until you are 65, so that is a long way off.
If her income remains low, it might be worthwhile to make sp rrsp contributions and then withdraw at a very low tax rate and then put that money into a TFSA or even non-reg account.
Of course there are rules about withdrawing (have to wait 3 years etc), but it’s something to consider.
within that context, anyone with a DB pension can estimate the value of the fixed income portfolio that would have to underlie it and take that into consideration when building their portfolio. effectively, if a DB pension is most of your retirement plan, you already have a very substantial allocation to “fixed income” – meaning that any further investments you make (in either your RRSP or TFSA) should be equities in order to keep your overall allocation closer to optimal.
Since this article focuses on DBPs 9as do the examples), and I have a generous DCP (100% funded my employer at rate of 9%), what are the thoughts on contributing to RRSPs if you have a DCP? Or is is the same as what’s listed in the article? Thanks.
help I need some advise? Doing my husband’s tax return for the first time and discovered he has an over contribution on his RRSP of 20,000 which has accumulated each year from 2008 when he began teaching. He automatically contributes through pay deduction to teachers pension with a PA of approx 9000 and was contributing same or more to RRSP. I have read the government’s request to pay 1% interest and considering getting permission to withdraw amount from rrsp so not to incur the interest penalty. Is there any other suggestions for me out there? He only has about 3000 that he can contribute over PA amount each year. What do I do? Signed worried and desperate.
Mary, I just went through the same thing last year. There was no way to get out of it. I wrote letters, I called, I begged. In the end, I had to withdraw $10,000 from my RRSP, which counted as income, plus I had to pay taxes, fines, and interest.
The worst part is that I was given advice to keep buying more RRSPs by two tax accountants and my bank. No one ever told me that I was overcontributing and I misunderstood my Notice of Assessment. I made the same mistake every year for 6 years, compounding the problem. Horrible mess, I feel bad for you.
Sorry, but I’m going to give a different perspective on this topic. I am close to retirement and am extremely thankful that I have contributed the PA adjusted maximum amount since I was 22 years old- 34 years in total. My contribution amount has ranged from $1800 to $2600/year. This isn’t a lot of money so my current RRSP total is significantly less than I had hoped it would be after all these years.
Low returns haven’t helped. Projections made over the years are meaningless as no one imagined that the world as it is today would exist. TFSAs weren’t an option until recently.
My provincial government DBP is NOT guaranteed to increase with inflation and my professional salary has not increased over the years nearly as much as salaries for teachers and nurses. When I started working in the late 70’s we all earned the same.
Although I have had to adjust my retirement plans and was not able to retire at 55 years, I am still much closer to retiring than most of my friends in the same profession who did not save. The funds in my RRSP will be used to top-up my pension income so that I will be able to enjoy inflation protection.
As well, like many others, I do not have a spouse so I will not be able to benefit from two incomes to pay for basic expenses such as property taxes, home insurance etc. Travel will require paying a single supplement. Therefore, not only will RRSP income provide me with inflation protection but it should also allow me to enjoy a similar comfortable standard of living as couples enjoy in retirement.
Thanks for the interesting analysis on the effects of PA on RRSPs and DBP.
This is a really valuable resource as both my wife and I are enrolled in DBPs through our employers.
The funny thing is, without going into much detail with the math, we both firmly decided that for now, we will only be contributing into our TFSAs and will wait to do a more indepth analysis of contributing into our RRSPs in the future.
Thanks for the great post, it’ll get me thinking some more on RRSPs and DBPs!
I’m having trouble finding out more about whether RRSP’s are right for someone with a DBP. Everyone talks about RRSP vs TFSA, but what if your TFSA is already maxed and will continue to be maxed out every year? Does it make more sense to put money into RRSP or non-registered? A total of 25k was already contributed to RRSP for the home buyer’s plan, which will be topped back up to 25k in just over a year by putting away 20% of my pre-tax towards it (to grow tax-deferred rather than just in non-registered).
I’d like to know the answer to this too. I have a DBP, and my TFSA is already maxed out. Also have over 120k+ available RRSP room left. Constant struggle to decide if I should invest the RRSP or just focus on paying extra off on the mortgage.
I’m also in a similar situation where I have a DBP, maxed out TFSA each year, and have some contribution room in RRSP. What I have started to do is at the end of each year, I transfer money from my TFSA into my RRSP up to the amount enough to put me below the next lower tax bracket. In doing so, it gives me more room to contribute to my TFSA the following year plus decreasing my income taxes via RRSP contributions. I’m thinking I may do the opposite when I retire, taking money out of my RRSP and putting it into my TFSA. Is anyone else in a similar situation? I wonder if my method is good or not.
I live in Ontario and here’s a link to a chart for combined federal and provincial income tax rate: http://www.ey.com/Publication/vwLUAssets/Tax-Rates-Ontario-2016/$FILE/Tax-Rates-Ontario-2016.pdf