What Should I Do With My RRSP?
I was 19 or 20 when I first began contributing to my RRSP. I worked in the private sector for 10 years and took advantage of an employer matching program during the last 5 years while in a senior management position. My contributions were modest, but over time they added up to about $30,000 worth of blue-chip dividend stocks.
Fast forward 2 years later and I have switched careers, moving into the public sector where I contribute nearly 11% of my salary towards a defined benefit pension. I put my RRSP contributions on hold, figuring there was little point adding more to that account when I already contribute so much towards my pension plan.
I haven’t completely ignored my RRSP; my dividend income accumulates in a cash account and when it reaches a certain amount I will add to my existing positions, or purchase a new dividend growth stock. My RRSP has now grown to $40,000 and generates about $1,775 per year in dividends (4.40%). I’m at the point now where I’m wondering, what should I do with my RRSP?
Stay The Course
Financial experts are always preaching the benefits of investing at an early age by showing the chart of 20-year old Johnny contributing a certain amount per year for 10 years and then stopping his contributions, versus 30-year old Sue contributing at a higher rate all the way until she’s 65. Johnny seems to always come out ahead due to the benefits of compounding interest over time.
That’s the approach I’ve been taking with my RRSP. My plan was just to stay the course, not add any new money, re-invest the dividends every so often, and just continue growing the portfolio. Assuming a 6% annual return, my $40,000 RRSP account could be worth $123,000 by the time I turn 50, and could reach $233,000 by the age of 60.
Take A Passive Approach
Since I’m basically ignoring this portfolio for the next 20+ years, perhaps the smarter decision would be to take a true passive approach and simply index my RRSP. I could sell all of my stocks and set-up a low cost, diversified portfolio of ETF’s that covers Canadian, U.S. and international equities, bonds and real estate. Since I love dividends so much, maybe I’d even include a Canadian dividend ETF. Either way, the goal is to set-up a broad portfolio that tries to capture all of the market returns for a low fee.
I wouldn’t actually be ignoring my portfolio with this approach, since I would still be re-balancing to my proper asset allocation each year. Essentially I would be doing the same amount of work with either portfolio, so it comes down to what approach will be the easiest to manage while delivering the best returns.
Start Contributing Again
I’ve put my RRSP contributions on hold because of my new employment situation and large pension contributions. But I still have unused contribution room, plus an additional $2,000 or $3,000 in new contribution room each year. I could start maxing out my RRSP and build this portfolio up to a substantial amount by the time I reach retirement. By having two large portfolios and potential income streams I could have a great opportunity to really live it up in retirement. Of course, this scenario will leave me with a hefty tax burden as well.
Retirement Dilemma
The most difficult decision, in my view, is what to do with my RRSP once I get closer to retirement age. My pension income should be relatively high, which means that any RRSP withdrawals will be taxed at the highest rate. We could look at pension income splitting, where I can transfer up to one-half of my pension income to my wife. This income splitting could apply to RRIF withdrawals as well.
The other option that I’ve considered is to retire early and use my bridge benefit (the payment made to pension plan members who retire before age 65 on an early pension) while drawing down my RRSP before I reach 65.
It’s tough to predict what the landscape might look like 20-30 years from now. Tax laws can change, my employment situation may change, and our financial needs as a family may change. When faced with uncertainty, often times it’s best to just wait and see what happens rather than making a rushed decision.
What do you think I should do with my RRSP?
From what you describe, it seems to me it would make sense to max out your TFSA before maxing out your RRSP (given you goal of reducing income tax during retirement). It it were me, I would certainly be interested in the early retirement option and would make the additional contributions if I could. But if you don’t have that goal or another goal where the contributions can help achieve it, it might not make sense to make them, especially not if they would be deterring from another goal you do have, like paying off a mortgage early or something like that.
@Dee
Thanks for your comments. It’s a tough balancing act, for sure. Between the pension, RRSP, TFSA, RESP and extra mortgage contributions, it doesn’t seem like there’s enough to go around.
Depending on your salary and tax bracket, you could always contribute to RRSP and then use your income tax refund to pay a lump sum on your mortgage.
Dee, great article!… I’m using my TFSA the way you are using your RRSP account. The only difference is my TFSA is my plan,my RRSP is my back up plan. Not sure if that makes any sense to you?
I love dividend paying stocks also. I use my TFSA for ETF’s and riskier dividend paying stocks. I use my RRSP for solid blue chip dividend paying stocks. If my TFSA is a hit ill be laughing all the way to the bank when Im 60 or 65, if it flops I always have my safe burden RRSP to take care of me. I figure when Im that old Ill only need about 20k a year to survive.
Seems like you are doing the right thing with your RRSP.
If you end up doing an early retirement, you could always extra contributions before you go in order to benefit from the tax arbitrage.
@Mike
Good point, and I guess I have a few years to wait and see 😉
I would max out the TFSA. I would then contribute lesser amounts to my RRSP.
When you start to withdraw from your RRSP at a later date you will be surprised (even shocked!) at the amount of tax you have to pay.
@Peter
That’s what worries me about building up a large RRSP portfolio. When withdrawn in addition to my pension, the tax bill might be pretty hefty.
Why choose a dividend ETF? Just buy the companies directly that have the biggest holdings within all of the best ETFs.
@My University Money
That’s pretty much how I have my RRSP set-up now, I was just speculating if I decided to dump the stocks and index the portfolio.
You could contribute to a Spousal RRSP and your wife could withdraw the funds in retirement on a tax free basis depending on how much she takes out per year. This is a good way to income split.
Hi Mom, I’ve considered a spousal RRSP but I need to look further into pension splitting in retirement to determine if it would be worthwhile.
So many choices….
I think since you have a pension, you should only optimize your RRSP, and instead, try to maximize your TFSA and RESP.
If you can paydown your mortage with lump-sum payments, even better, but you really don’t need a paid-off home until you are closer to retirement. Why do I say that? Because aggressively paying off your mortgage, while nice, you are foregoing all the compounding your friend Johnny is taking advantage of 🙂
Time is an investors best friend.
Unless you have an uber large salary, I think the TFSA contributions should trump the RRSP; especially if you have a pension.
I personally want to avoid as much tax in retirement as possible. I pay enough now and who knows how, if, when the tax rules will change over time. I’m guessing it is not going to get any easier for our government to collect revenues.
I’d be curious to see Part 2 of this post, what your short-term decision is.
Cheers!
Hi Mark, I’ll definitely post a part 2 with an update on my decision. I hear what you are saying with the mortgage, however since we just upgraded our house and have a fairly big mortgage, I’d like to focus on paying that down aggressively over the next 5 years.
An excellent question Echo, and in my view, it’s not an easy one to decide upon because it’s such a subjective area of discussion. Your situation is even more complex than some of the more straight-forward scenarios.
The good news is that you’re tucking away >10% of your salary towards your pension and now you’re simply seeking to maximize your additional hard-earned dollars.
If you’re anything like me, paying down debt would be a high priority and you may wish to consider lump sum payments on your mortgage.
If you prefer a mixed approach, I would focus on the mortgage and maximizing your TFSA for the time being, as Mark advises.
You’re right in that having a ‘too-large’ of an RRSP nest egg can cause further tax-related scenarios to deal with, and I think taxable accounts are something investors should also consider as part of their overall investment strategy.
Hope this helps.
TWC
@TWC
Thanks for your comments! I like the mixed approach with the mortgage and TFSA.
I’d also be interested in calculating what an early retirement might look like where I can draw down my RRSP for a few years and then take my pension. It’s tricky because the earlier you retire the more your pension benefit is reduced.
True. And if you think you will accumulate enough savings to retire earlier than expected (and hence earn less pensions benefits), your approach to RRSPs may change as a result of it.
I’m a novice investor – recently widowed, sold my house – paid off all debts and breathing easier, but need to generate retirement income over coming 2-3 years – have approx 100,000 to invest but only for short term investing. Have limited RRSP thru bank and small corporate matched plan as well – what are my best options?