RRSP’s, the Good, Bad and Ugly…
An RRSP or a Registered Retirement Savings Program, is one of the leading programs Canadians use to prepare for their retirement income, but outside of all the hype that usually ensues on the Airwaves, in Print and TV commercials lies a few truths that are rarely brought to your attention. Lets look at some of the finer points about this Savings Vehicle…
RRSP, the Good:
RRSP’s have been helping Canadians save and grow their retirement nest egg for years, and without this valuable investing strategy, many Canadians would not save at all for their future.
So the good part of an RRSP allows a person to contribute into a savings vehicle which recognizes their full contribution, in a very tax friendly way today. This is achieved by returning the taxable portion of a person contributions back to them in April when all your taxes have been completed. This in theory is a great way to make sure every dollar you contribute today, is actually being put away for your future with no tax owing on the contributions.
This is the good part of the RRSP program, as it allows your full dollar to be invested today, without being eroded by after taxes. But, this is assuming you put your tax refund back into your RRSP, as it was intended, and this is usually the challenge.
Another good part of an RRSP is your investment flexibility, there are literally thousands of ways you can chose to invest your RRSP account, from GIC’s to Segregated Funds to Mutual Funds, and even self-directed mortgages if you chose to do so. A well designed plan will take into account your age, and your ability to contribute on a monthly basis. Once this is determined, we can get a fairly accurate picture of how your financial future will look like
RRSP’s, the Bad:
The bad part of an RRSP lies within the inflexibility of withdrawals. When you contribute your money into an RRSP, its intent is to hold it for years until your retirement, and at that point to slowly pay back the taxes that have been deferred inside of the RRSP program.
If you want to dip into your RRSP account throughout your life, you will find that there will be withholding taxes on any money you plan on taking out of your account. If you plan on making small withdrawals of $5000 or less, there will be a withholding tax of 10%, and if you withdraw more, then the withholding tax will increase to a maximum of 30% if you chose to withdraw upwards of $15,000.
So for this reason, an RRSP account becomes less and less attractive to make withdrawals out of when you need money the most. In most parts as well, even if you make a few withdrawals of $5000, the institution who controls your RRSP will have to take that into account, and your first withdrawal will trigger a 10% tax, but on your third withdrawal of $5000 you will be hit with a 30% withholding tax. And any additional tax owing will be assessed when you do your taxes in the following year.
This is why it is not wise to put all your investing eggs in your RRSP basket, because the money you believe is there for you will be eroded first by taxes, and the balance will be passed back to you. It is wise to use an RRSP in combination with a TFSA to give you the maximum flexibility.
RRSP, the Ugly:
The ugly part has to certainly be the deferred taxes that reside inside of an RRSP account. When you are young and contribute into your RRSP you are simply deferring taxes into the future, so you may have more spendable income in your pockets today. But as your RRSP account grows, so does your tax liability within the program.
As an example if you contribute $1000 into your RRSP today and you are in a 32% tax bracket, then you will generally receive a refund of $320 when you file your taxes for the year. Sounds great, but will you put that $320 back into your RRSP, or will it simply be absorbed in your family income?
Here comes the real problem. If you are like most people who invest their RRSP in the hopes of getting a great return over time, as your principle grows, so does your tax obligation. So when the $1000 grows into $2000 with time and good investment returns, your tax obligation also grows from $320 to $640 in the same timeframe. So not only growth for you, but also for the Government!
And with a near $1 Trillion dollars of Canadians money invested in RRSP savings vehicles, you can see that the government has also a very well-funded future, hiding inside our RRSP accounts. If you pass away without a spouse, assume the government will have deemed your entire RRSP account to be cashed in the day before your death, and the entire balance will be added to your final year of income and taxed accordingly. Any RRSP balances above $135,000 will attract the highest rate of combined tax both federally and provincially (Ontario) at a rate of 46.4% on every one of those dollars that you never used.
Can you imagine your kids getting a tax bill for nearly 50% of your RRSP account balance upon your passing? That is the ugly, which is not usually advertised…
What you need to Remember about RRSP’s
RRSP’s defer Tax until you Withdraw them
RRSP’s should be Actively Invested with Advice
RRSP’s start creating Income at age 72
Set up a Monthly withdrawal to Pay Yourself First
RRSP’s cannot be used as collateral for a loan
You may withdraw up to $20,000 for a New Home Buyer free from Tax
Use an RRSP and a TFSA to compliment ALL of your Savings Goals