Daren Givoque, CDFA & Partner, O’Farrell Financial Services
Over the past few years there has been a rise in people feeling like RRSPs aren’t the great retirement savings tool they claim to be. Registered retirement savings plans (RRSPs) are a tool that many people use in Canada to finance their retirement. Contributions that you make throughout your working career are income deductions on your taxes, which leads to a lower tax bill and may mean you receive a tax refund cheque after you file your taxes. 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 a giant 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 the RRIF in minimum withdrawals, mandated by the government. Unfortunately, some people are reporting that they are being taxed at roughly 50 per cent on the dollar 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 actually 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, 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. This means that there are only tax savings if you will have a higher tax rate in retirement than you did in your working years. TFSAs are ideal retirement savings tools for low income Canadians as they won’t trigger a clawback of the Guaranteed Income Supplement. For others though, TFSA contributions may not be enough to build significant retirement savings as the limit you can contribute per year is $5500.
The percentage of tax filers who make contributions to RRSPs has been on the decline for the past 15 years; partially because of the economy but also because people are believing in the unfounded belief that they are a tax trap. Don’t believe the rumours. For most people, RRSPs are a great savings tool and making consistent contributions will help ensure your financial stability in retirement.