Is it over – the affair Canadians have had with RRSPs? Is that scrumptious, good-looking new TFSA just plain irresistible? Not so fast! It’s true that the
ardor for Registered Retirement Savings Plans (RRSPs) has cooled somewhat in recent
years with the advent of the Tax-Free Savings Account (TFSA). Still, there’s a big
marketing push every year around this time to open up and contribute to an RRSP. And there’s a good reason for it.
The fact is, RRSPs still offer the best retirement saving and tax-deferral opportunities available for Canadians, even though a majority of us do not use
them to their full advantage. According to the Bank of Montreal’s third annual study of RRSPs, unused RRSP contribution room is expected to climb to $1,000 billion (that’s a trillion dollars) by 2018.
Yes, you can retire with a million Basically, an RRSP lets you contribute 18% of “earned income” every year to a pre-set maximum. For 2012, the maximum contribution limit was set at $22,970.
And the last day to make a contribution for the 2012 tax year is March 1, 2013. In addition, you can carry forward any unused contributions from 1991 on
and use them as well. You also get a tax deduction on your contribution for a given year. (Tip: If your tax deduction results in a tax
refund, reinvest the refund in your RRSP right away to keep that compound growth working for you. If you begin at age 40, and contribute, say, $20,000 per
year for 25 years, at an 8% return, you’ll retire with $1.7 million.)
And don’t forget, your investments grow tax-free inside an RRSP. You don’t pay tax until you withdraw funds from your RRSP at retirement, and then you pay
at your full marginal rate, which is typically lower than it is during your peak earning years.
Don’t break open the piggybank In general, it’s not a good idea to break into the RRSP piggybank before you’re ready to retire. Not only will you lose the effect of compound tax-free
growth on the funds you remove, but you’ll pay tax on your withdrawals at your top marginal rate. If you’re in your peak earning years, that could be a
significant tax hit.
Some individuals still in their prime earning years wonder whether they should use RRSP withdrawals to recontribute to a TFSA. The answer to that one is
easy: No! If you do, you’re essentially taking that tax hit needlessly. You’ll simply be contributing to a TFSA with highly-taxed dollars, and because
there’s no deduction or credit for TFSA contributions, you’ll never see that tax money again.
Generally, you should not withdraw funds from your RRSP until you’re ready retire, at which time you can collapse your plan or roll it over into a RRIF or
annuity (collapsing an RRSP is mandatory in the year in which you turn 71).
Take advantage of both In the meantime, try to contribute as much as you can to both your TFSA and your RRSP. Both have immense tax benefits, but the rules can get a little complicated. To cite just one example, you lose the tax advantages of both the dividend tax credit and the capital gains exemption (as well as the ability to offset capital losses against gains) on investments in both RRSPs and TFSAs. If this is a key consideration for you, it might be prudent to discuss your needs with a qualified financial advisor.