While I believe very strongly that everyone who has the means to do so should be putting money away for the future, the RRSP might not be the best place to put your money.
For nearly sixty years, Canadians have been encouraged to save for retirement on their own using the RRSP so they could be less reliant on government sources for money in the golden years. To do this, the government entices us to save by providing a tax deduction, allowing us to get back a portion of what we contribute to the RRSP as a tax refund. The main theory behind the RRSP is that when we draw on the funds in our savings after we’ve stopped working, we’d be in a lower tax bracket than we had been during our working years, thus we’d pay less tax on the income we received from our Retirement Savings Plans.
I’m going to poke a hole in that theory for many Canadians: If, during your working life, you are already in the lowest tax bracket, which for 2014 is $43,953 or less, putting money away in the RRSP might not be worth it because you’ll pay the same amount of tax on the money in retirement as you’re paying right now. In fact, depending on how much time you have until retirement, tax rates could change and we might be paying more in future, which could make saving in the RRSP a losing proposition.
A Different Perspective
Instead of saving in your RRSP, you might want to put some money away for the future in a Tax Free Savings Account (TFSA) instead. There are two reasons this is often a better strategy, depending on your personal situation:
First , unlike the RRSP, which is a tax-deferral program, the TFSA is truly tax free. What do I mean by this? When you save money in an RRSP, it can grow inside of the plan tax free until you begin to withdraw the money, presumably at retirement. Then, when you’ve stopped working, or at age 71, whichever comes first, you must start withdrawing the money and it will be taxed as income at that time. With the TFSA, the money grows tax free inside the plan and is completely non-taxable when you withdraw it. There is one trade-off, money contributed to the RRSP gives you a tax deduction, putting money into the TFSA does not.
Second , if you typically don’t contribute much more than a couple of hundred dollars a month to an RRSP, that amount would fit very nicely into a TFSA. The contribution limit for the TFSA in 2014 is $5,500. If you haven’t opened a TFSA yet and you’ve been a Canadian resident, 18 or older since 2009, you have been accumulating contribution room for your TFSA, which as of this year would be up to $31,000.
When I have shared this idea with friends or other people I’ve met, the first comment I usually get in response is, “But I like the tax deduction.” To be honest, when I was younger, I did too. When I first started working I thought the whole idea of reporting income tax was to get money back. My parents always received a refund, so did most of my friends, and I wanted that refund cheque in my name too.
Then one day a good friend of mine who was a few years older and apparently much wiser than me, pointed out that getting a refund back meant the government had been holding onto some of my money without paying me any interest. That’s money I could have used throughout the year for other things, so it was a lose-lose situation for me: no interest and less money in my pocket. Don’t get me wrong, I’m also not a fan having to pay money owed at tax time, but rather than hoping for a big refund, I try to be as close to break-even as possible.
One thing I want to make clear before I move on: I am not a tax expert and what I’m suggesting here is of a general nature. Everyone’s tax situation is different so it is best to consult with a tax professional to determine the right strategy for you.
How Not To Miss The RRSP Deadline Next Year
While contributing for the 2013 tax year is no longer an option, if you still plan on making a contribution to your RRSP for 2014, there are a couple of things you can start doing now so you don’t miss the deadline next year.
1) Set Up A Monthly Contribution
Putting money into your RRSP every month means you won’t be scrambling to find the money next February and risk missing the cut off again. Monthly contributions are also much easier to manage for most people rather than one lump sum contribution at the end of the year.
2) Take Advantage of RRSP Matching Through Your Employer
Check with your employer. If the company you work for offers an RRSP matching plan, that is some extra money, some might even say ‘free money’, that you definitely want to tap into. Companies that offer matching programs often do so at fifty cents on the dollar. Some even match dollar for dollar what their employees contribute.
Ultimately, whether you use the RRSP, a TFSA or a non-registered account, saving for the future is a good idea for all of us. Government programs like CPP and OAS do not provide enough income for most people to live their desired lifestyle in retirement so we need to help out our future selves by saving now. Talk to a tax professional to review your situation and determine which saving method is right for you.