Cole Seabrook, Financial Advisor
O’Farrell Wealth & Estate Planning | Assante Capital Management Ltd.
Over the past few years there has been mixed feelings regarding RRSPs with some individuals believing RRSPs are not the great retirement savings tool they claim to be.
Registered retirement savings plans (RRSPs) are vehicles that many people in Canada use to finance their retirement. Contributions that you make throughout your working career are income deductions on your taxes. Have you ever heard people around you saying, “it’s RRSP Season” or “it’s time to contribute to my RRSP”? Many people do not know that you can contribute to your plan until March 1st in the current year to reduce taxes owing for the previous year. This leads to a lower tax bill for the investor. Any investments or transactions made inside your RRSP are not subject to tax, however when you take money out of your account it is taxed as income. In simple terms, you can look at RRSPs as an excellent tax deferral tool.
At the age of 71 you must convert your RRSP into a registered retirement income fund (RRIF). It is at this point that people must start taking money out of their RRIF in minimum withdrawals, mandated by the government. Unfortunately, some people are reporting that they are being taxed at roughly 50 per cent when they withdraw their money, causing them to feel like the RRSP they had been paying into their entire career is a tax trap, rather than a valuable tool to support retirement.
While this situation is unfortunate, it is the exception not the rule. Recent studies have shown that RRSPs are no worse than any other savings options if your tax rate in retirement is the same as it was when you were paying into the RRSP. For most people, their tax rate decreases in retirement, so they end up paying less tax on their RRIF withdrawals than they would if they had used a different tool to save, which wouldn’t have had the same tax deferral benefit as an RRSP.
Regret over using an RRSP normally comes when they see a portion of their savings going to taxes when withdrawn, however, it is important to remember the tax breaks you received when you were paying into your RRSP. Many people are choosing to use tax free savings accounts (TFSAs) as they see it as a better way to save for retirement. While withdrawals from a TFSA are not taxed as income, contributions are not tax deductible. Furthermore, TFSA contributions may not be enough to build retirement savings as the limit you can contribute per year is $6,000. TFSAs can, however, supplement retirement income without any tax implications upon withdrawal.
Although every individual has a unique financial situation, with the proper planning, RRSPs are a great savings tool that can reduce current taxes owing and add financial stability to long-term financial plans.