Managing Your Money

RRSPs, also known as Registered Retirement Savings Plans, are the Canadian government’s way of encouraging us to create our own pension plans. They can be controversial for those who worry about the tax implications of withdrawal, but with government and many companies slowly getting out of retirement savings, they are still a good bet.

Because the government legislates RRSPs, there are many rules that go along with them, and some people miss out on opportunities to benefit more from them than they actually.  There’s not usually a “one-size-fits-all” answer when it comes to RRSPs because considerations have to be made regarding tax bracket, age, amounts, etc.  But here are some things to consider that often get overlooked.

Contribute but don’t deduct!

Most people want as big of a deduction as possible from their RRSP.  So why would you contribute to your RRSP but not deduct it?  Isn’t that the whole point? If you know that you’ll be in a higher tax bracket next year, then consider holding off on deducting all, or part of, your RRSP contribution. My client Jordy began working as a consultant in late 2017 after leaving a full-time, high paying position in aviation. In 2018 he earned just over $30,000 from his part-time consulting work. He had $16,000 of RRSP contribution room in 2018, so we contributed the whole $16,000. Knowing that 2019 and onwards would be higher income years, we opted to deduct only $3,000 of the $16,000, leaving $13,000 contributed, but not yet deducted from his income. In fact, he did earn a strong six-figure income in 2019 and will benefit far more from the RRSP than he would have in 2018. Had he deducted the additional $13,000 in 2018 the benefit would have been a tax savings of approximately $3,600, whereas in 2019 it will be closer to $6,500, for the same amount of contribution!

Contribute into your Golden Years

Not everyone aspires to retire at 65. I have worked with many people who continue earning income into their late seventies and even eighties. Once you reach the age of 71, you must convert your RRSP into a RRIF (Registered Retirement Income Fund).  Once you have converted to a RRIF, you can no longer make RRSP contributions to your plan. BUT, if you have a younger spouse, you can continue making RRSP contributions to your spouse’s Spousal RRSP until your spouse reaches 71. This created a great tax saving opportunity for my client Charlie, who continued to work into his late 70’s, as a consultant to an American engineering firm, putting him in a very high tax bracket. His wife was 8 years younger than him, which allowed him to continue contributions to her plan, while he received the tax deduction. This strategy doesn’t always make sense. Other factors such as pension income and RRIF amount need to be considered to ensure that another tax problem isn’t being created.

Penalty Tax Contribution

If you don’t have a younger spouse, and are still working at 71, you can make a last RRSP contribution to your RRSP for the following year if you can estimate what you’ll earn. Rachel turned 71 last year, in 2019. She is still working and plans to work through 2020. She has an annual RRSP contribution room of approximately $20,000.  Last year, we had to convert her RRSP to a RRIF because she turned 71, but before we did, we made a $20,000 contribution to her RRSP in December, for 2020. Because she over-contributed in December of 2019, she will pay a penalty to the government of $180 ($20,000 RSP contribution room, less $2,000 allowable over contribution, multiplied by 1% per month of over contribution). However, as of January 2020, she got new contribution room based on her 2019 income and therefore will deduct the $20,000 against and receive $9,142 in tax savings. Generally, you would never pay a penalty, but in this case its worth it to pay $180 penalty for a $9,100 tax savings!

Depending on your situation and your needs,

don’t miss out on opportunities that may be available to you”

 Withdrawing from RRSPs

RRSPs are intended to be your personal pension plan. While you have the right to withdraw anytime from them (unless they’re locked-in), it’s not advisable except under specific circumstances.  Emily, who is 58 and retired is living on savings with almost zero taxable income.  Because of the personal tax exemption, it made sense for her to pull out $13,000 from her RRSP, pay no tax, and move the money to her TFSA. This strategy can work in various situations and can reduce future tax liability. Under normal circumstances, the cost of withdrawing from your RRSPs can be huge – not only tax wise, but the loss of future compounding. I’ll never forget the 38-year-old client I had years ago who pulled out $60,000 (almost all) of his RRSP to buy a red, two-door, Mercedes sports car. Mid-life crisis, you think?  I still shake my head when I think of it. This table will give you an idea of how much future value you stand to lose by pulling out a lump sum early. It doesn’t factor in the tax hit you take at withdrawal depending on your tax rate.

LUMP SUM RRSP WITHDRAWAL LOST RRSP VALUE AFTER 20 YEARS
$10,000 $25,500
$25,000 $63,000
$50,000 $126,500
$100,000 $253,000

Assumes the amount withdrawn from the RRSP would have grown at a 4.75% compounded rate over 20 years. Amounts are rounded to the nearest five hundred.

Maximize Contributions

When it comes to how much you’re able to contribute, maximizing your contributions today can make a huge difference down the road when you retire. But maybe current cash flow is tight, and you can’t make the contribution you would like. Consider this example. Let’s say you have $20,000 of contribution room but no free cash flow to make that contribution. Take a look elsewhere. Maybe you have $10,000 in your TFSA, that you could use then replace later in the year. Leaving $10,000 for which you could take an RRSP loan.  Provided you are in a high tax bracket, a $20,000 contribution would give you almost a $10,000 tax reduction/refund, which you could then use to pay off the RRSP loan only a few months later.

RRSP ACCUMULATED AT RETIREMENT PROVIDES A TAXABLE ANNUAL INCOME OF:
$200,000 $11,000
$400,000 $22,000
$600,000 $33,000
$800,000 $44,000

Assumes an annual growth rate of 4.75% over 25 years of retirement with annual income indexed at 2% for inflation. Amounts are rounded to the nearest five hundred.

Other strategies like Individual Pension Plans (IPP) can make sense to provide higher contribution room than regular RRSPs, enhanced retirement benefits and important tax advantages. They are more complex and generally only ideal for self-employed business owners, key employees or professionals earning over $100,000 per year. As with most things, RRSPs can be purchased with little thought online, or with various levels of professional guidance. Depending on your situation and your needs, don’t miss out on opportunities that may be available to you!

Lynn MacNeil, F.PL. Vice President, Investment Advisor, is a Financial Planner with Richardson GMP Limited in Montreal, with over 24 years of experience working with retirees and pre-retirees. For a second opinion, private financial consultation, or more information on this topic or on any other investment or financial matter, please contact Lynn MacNeil at 514.981.5795 or Lynn.MacNeil@RichardsonGMP.com. Or visit our website at www.EphtimiosMacNeil.com.

The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Limited or its affiliates. Assumptions, opinions and estimates constitute the author’s judgment as of the date of this material and are subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results.

Richardson GMP Limited, Member Canadian Investor Protection Fund. Richardson and GMP are registered trademarks of their respective owners used under license by Richardson GMP Limited.