I don’t invest in my RRSP anymore because I’ll have to pay tax on the withdrawals.” This type of thinking around RRSPs has become increasingly common since the TFSA was introduced in 2009.

The anti-RRSP crowd must come from one of two schools of thought:

  1. They believe their tax rate will be higher in the withdrawal phase than in the contribution phase, or;
  1. They forgot about the deduction they received when they made the contribution in the first place.

No other options prior to TFSA

RRSPs are misunderstood today for several reasons. For one thing, older investors had no other options prior to the TFSA, so they might have contributed to their RRSP in their lower-income earning years without realizing this wasn’t the optimal approach.

Related: The beginner’s guide to RRSPs

RRSPs are meant to work as a tax-deferral strategy, meaning you get a tax-deduction on your contributions today and your investments grow tax-free until it’s time to withdraw the funds in retirement, a time when you’ll hopefully be taxed at a lower rate. So contributing to your RRSP makes more sense during your high-income working years rather than when you’re just starting out in an entry-level position.

Taxing withdrawals

A second reason why RRSPs are misunderstood is because of the concept of taxing withdrawals. The TFSA is easy to understand. Contribute $5,000 today, let your investment grow tax-free, and withdraw the money tax-free whenever you so choose.

With RRSPs you have to consider what is going to benefit you most from a tax perspective. Are you in your highest income earning years today? Will you be in a lower tax bracket in retirement? The same? Higher?

The RRSP and TFSA work out to be the same if you’re in the same tax bracket when you withdraw from your RRSP as you were when you made the contributions. An important caveat is that you have to invest the tax refund for RRSPs to work out as designed.

Future federal tax rates

Another reason why investors might think RRSPs are a bum-deal? They believe federal tax rates are higher today, or will be higher in the future when it’s time to withdraw from their RRSP.

Just for kicks I checked historical federal tax rates from 1998-2000 and compared them to the tax rates for 2015 and 2016.

federal-tax-rates-2015-2016 federal-tax-rate-1998-2000

The charts show that tax rates have decreased significantly for the middle class over the last two decades.

Someone who made $40,000 in 1998 would have paid $6,639 in federal taxes, or 16.6 percent. After adjusting the income for inflation, someone who’s making $56,325 in 2016 will pay $7,335 in federal taxes, or just 13 percent.

Minimum RRIF withdrawals

It became clear over the last decade that the minimum RRIF withdrawal rules needed an overhaul. No one liked being forced to withdraw a certain percentage of their nest egg every year, especially when that percentage didn’t jive with today’s lower return environment and longer lifespans.

In 2015 the federal government made changes to the minimum RRIF withdrawal table, bringing it more in-line with today’s reality:

minimum-rrif-withdrawals

The dreaded OAS clawback

Canadians who receive Old Age Security and have annual income of approximately $75,000 will have all or part of their OAS pension reduced. This clawback is especially concerning for retirees whose minimum RRIF withdrawals push them over the income threshold.

Canada Revenue Agency uses the following example on its website:

The threshold for 2015 is $72,809.

If your income in 2015 was $80,000, then your repayment would be 15 percent of the difference between $80,000 and $72,809:

$80,000 – $72,809 = $7,191

$7,191 x 0.15 = $1,078.65

You would have to repay $1,078.65 for the July 2016 – June 2017 period.

This is a legitimate concern for retirees. No one wants to lose out on benefits that they’re entitled to receive. An advisor or tax accountant can help you determine a strategy that best optimizes your retirement withdrawals.

One such strategy is to make small withdrawals from your RRSP between the ages of 60-70 and delay taking CPP and OAS until age 70. This reduces the size of your RRSP for when you are forced to convert it into an RRIF and make mandatory withdrawals. It also increases your CPP and OAS benefits by 42 percent and 36 percent, respectively.

Final thoughts on RRSPs

RRSPs aren’t a scam; they’re a still a critical tool for Canadians to save for retirement. They’ve just got a bad rap over the last few years because of some misguided thinking around withdrawals, taxes, plus the introduction of a new and seemingly better (re: tax-free) savings vehicle.

RRSP contributions are still a key component of my financial plan. I’ve caught up on all of my unused contribution room and so now my goal each year is to max out my contribution limit (which is reduced by my pension contributions).

Related: Revisiting the tax free savings account

TFSAs are great, and they get filled up next. In fact, now that we’ve paid off our car we’re looking forward to catching up on our unused room and maxing out our TFSAs.

Both accounts are valuable parts of our financial plan and, along with my pension, will make up the bulk of our income in retirement.

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13 Comments

  1. AndrewGr on October 17, 2016 at 6:21 am

    I agree about the benefit of holding off on RRSP contributions until you’re in a higher income bracket. The exception would be if your employer is providing a match to your own contribution from your pay. That gives you an instant 50% gain to your investment. Just a thought.

    Otherwise I would think that savings during those lower income bracket years, and every year should go into maxing out your TFSAs, and ensuring you have a TFSA account that is geared strictly for retirement. These accounts are actually best used for retirement as all withdrawals are tax free mitigating the balancing act you noted above.

  2. Tawcan on October 17, 2016 at 11:14 am

    I’m with Andrew. If your employer has RRSP matching, you should take advantage of this free money instead of holding of RRSP contribution. You can always contribute now and carry forward the deduction to future years. Or deduct enough so you are 1 income level lower to reduce your marginal tax rate.

  3. Wes Philips on October 17, 2016 at 2:18 pm

    Hi Robb,
    I agree with Andrew and Tawcan totally. When I was working, the companies I worked for didn’t provide Defined Benefit Pension Plan but they did offer Group RRSP plans where they ‘matched’ our contributions to the tune of from 2 to 5%. The Group RSP and my own Self Directed Open Investment account for my retirement income. I have converted the GRSP to RIF and withdraw more than the mandatory minimal amounts. I invest the access amount in my TFSA account after all the bills are paid. Come tax time I have to withdraw some funds from it to pay for all the taxes. I still think the RSP is a tax scam in favour of the government. You have to use it carefully somewhere along the line to cut your marginal tax rate, I agree.

  4. Kevin on October 17, 2016 at 9:37 pm

    Using after tax dlrs to put into an investment that is taxed later doesn’t make a lot od sense especially for a retiree. In fact if I could get enough debt interest from borrowed money that is invested I would free up some of my RRSPs and offset the tax with using the debt interest as a deduction. Is this not a better way to defer tax if you are a retiree?

  5. Wes on October 18, 2016 at 7:41 am

    Kevin, in the case of GRSP, I contributed pretaxed dollars directly docked from my salary into the account. I got tax credits later come tax filing time to reduce personal income tax. The scam of the plan comes in later at withdrawal time when all withdrawals are considered as part of your total income. We pay income taxes to support our social programs, don’t we? Open investment accounts are also good vehicle for wealth accumulation. But you still pay tax on the income your investments earn. You can expect to pay from 50% to 100% of tax on the incomes depending on the investment types that generate the incomes. Leveraging or OPM ie using borrowed money to invest is also a good way to invest but there are Caveats that you have to be aware of when using this method. Our only salvation from the tax scam is using TFSA account where your investment incomes are not taxed when you withdraw them. The only thing to watch out is your contribution limit to TFSA account. You go over your limit, you pay penalty (tax grab?) on the excess amount.

  6. Stephen Weyman on October 18, 2016 at 9:40 am

    I think the TFSA has made the RRSP much MORE valuable. You can now easily fund your retirement by making withdrawals from both your TFSA and RRSP simultaneously.

    This reduces your REPORTED income to the government but allows you to have plenty of money to live on. That means you can easily qualify for OAS and keep your marginal tax rate down. By doing this you have a much higher chance of being in a lower tax bracket when you withdraw than when you contributed to your RRSP.

    As you said, the general rule of thumb is to deposit into TFSA in low income years and the RRSP in high income years. Then, in retirement withdraw from both in such a way as to minimize your taxes and maximize your government benefits.

    Another great trick is to withdraw from your RRSP in a low income year BEFORE retirment – say you go back to school or get laid off. Even if you don’t need the money to live, you can simply transfer it over to your TFSA if you have room there. That way you get to keep the refund you got earlier and pay little or no tax on the withdrawal. Yes, you will have to pay withholding tax upfront – but you’ll get most/all of that back when you file your taxes for the year.

  7. Wes Philips on October 18, 2016 at 10:12 am

    Thank you Stephen, I have always used this ‘Multi-level Thinking’ in my investment strategy just to decrease my marginal tax rate. I thank Brian Costello for instilling the idea from years ago. Anybody remembers this great ( to me ) Financial Guru?

  8. Cool Koshur on October 18, 2016 at 8:32 pm

    All good comments. I particularly like Stephen Weyman strategy. Everyone goess through a job loss. We can always withdraw this RRSP money with little to no tax in case of job loss. We dont always have take it out in retirement only.

    If an employer provides the matching contribution for an employee, this to me is free money which so many employees leave on table.

    One key advantage to RRSP is savings money at tax filing time. As we know we are taxed on net income. When you contribute to RRSP it reduces your net income to lower level where you pay significantly lower marginal tax rate (26% to 20.5) for net income up to $90,563.

    I keep all my emergency fund (6 months living expenses) in TFSA. It grows and I can always withdraw it. For emergency like job loss I would tap into RRSP. Otherwise TFSA

  9. Echo on October 18, 2016 at 8:50 pm

    Another interesting option for families today is with the Canada Child Benefit. It’s means-tested based on your net family income, so because RRSP contributions reduce your net income at tax time, the deduction will also help give you a higher benefit the following year.

    Here’s a good article about how the Canada Child Benefit works for different income groups – http://business.financialpost.com/personal-finance/complex-calculations-doing-the-canada-child-benefit-math-for-different-income-groups

    • Cool Koshur on October 18, 2016 at 8:52 pm

      @Echo

      That is a really good point. This further sweetens the RRSP deal. Canada Child Benefit is tax free money as well.

  10. Wes Philips on October 19, 2016 at 7:22 am

    The Canada Child Benefit is only beneficial to individuals supporting young children under 15??? When our children were receiving the benefit, we invested the money in their Education Trust Account which we set up ourselves so we could invest in stocks, mutual funds and limited amount of GIC. This was before we knew much about the RESP, even with the 20% grant ‘matching’ on the amount you contribute, I will not even consider of using it because of the intricate administrative nightmare one has to go through in order to get some funds out for the kids’ tuitions.

  11. Nicole on October 21, 2016 at 6:24 am

    Exactly right Wes. Administration on RESP is a nightmare. My mother developed dementia. And trying to move the accounts to Alberta (where I live) from BC (where she lives) and transfer them so I could manage the money for my children to go to school was an 18 month nightmare. Eventually we took a huge loss of money just so I could manage the withdrawals and she would not have to struggle with the confusion of numerous steps.
    I highly recommend that people look into these accounts if they have them set up for grandchildren and talk to someone about options for withdrawing – alternative investing options and possibly adding another signator on them.

  12. Big Cajun Man (Alan Whitton) on January 27, 2018 at 4:45 pm

    How is a tool to save for retirement and lower your taxable income a scam? I give up on some folk, they need to give their heads a shake.

    Pay Debt, Money into TFSA and RRSP savings for retirement, figure out how much in each and REPEAT…

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