A Registered Retirement Savings Plan has traditionally been a great way for young couples to get a head start on retirement. But the RRSP seems to be taking a back seat these days.
Young couples may have placed greater attention on accumulating funds for a down payment for a home. It isn’t just housing costs, improvements to accounts such as the Registered Education Savings Plans (RESP) help direct excess savings to grant eligible accounts. We anticipate that the introduction of the Tax Free Savings Account (TFSA) will reduce the amount of RRSP contributions even further.
RRSP accounts are still an effective savings strategy for some individuals all of the time. Here are a few examples of events and situations where an RRSP contribution makes sense.
Top Marginal Tax Bracket – Individuals who are in the top marginal tax bracket (43.7 per cent) should contribute to an RRSP. The main reason for this is that if you cannot avoid tax, the next best option is to defer it. The main risk of contributing to an RRSP when a person is in the top tax bracket is that personal tax rates may change in the future. We feel this is minimal and that the deferral advantage outweighs this risk.
Spike In Income – RRSP contribution room can be a tax saver if you find you have a sharp increase in income one year. Possibly you have held onto some investments for years and then suddenly one of them is taken over involuntarily and creates a deemed taxable disposition. What if you sell some real estate not considered your personal residence for a large taxable gain. Maybe one year you receive a large bonus at work. RRSP contributions during high income years can bring your income tax liability down considerably. RRSP are great if you can get a deduction when you are in a high income tax bracket and withdraw the amount when you are in a low income tax bracket.
Couples – One of the downsides to RRSPs is the income inclusion of the entire account upon death. Couples have the ability to defer tax on the first passing. Single people generally have no ability to avoid a large tax bill upon premature death. With the ability to share RRIF income for couples, there is certainly more flexibility for couples to have at least one RRSP account.
Fixed Income – RRSPs are more suitable for investors who do not require immediate income and prefer fixed income investments such as federal bonds, provincial bonds, corporate bonds, GICs, term deposits, debentures, etc. All of these types of investments create interest income, which is taxed annually if held in a non-registered account. By putting these types of investments in an RRSP, you may defer this taxable income.
Equities – One of the best features of Canadian taxation of equity investments is that they are not taxed until the investment is sold. Many investors choose not to take advantage of this feature and frequently buy and sell securities. Every time an investment is sold in a non-registered account, there is a tax consequence (capital gain or capital loss). If the equity investment is held within an RRSP then there is no tax consequence. Note that this is a negative if the investment is sold at a loss.
Minimum Amount – At age 65 investors who do not have pension (or a spouse with a pension) should have a minimum of $30,000 in their RRSP. Investors should have enough in their RRSP to convert to a RRIF and pay an annuity for life of $2,000 per year. This portion will be offset by the pension income amount and will essentially be tax-free. This is, of course, if the rules do not change. The last time the rules changed the pension income amount was increased from $1,000 to $2,000.
TFSA Maximized – The new Tax Free Savings Account (TFSA) should be maximized each year if cash flow permits. For some investors, their savings should be directed to a TFSA first. If this account is maximized then looking at RRSP options certainly boils down to the above points. We would see few cases for recommending an RRSP and avoiding a TFSA. In most cases the TFSA and RRSP should be complimentary to each other. It is possible that the TFSA could be eliminated one day. If this is the case, then some investors may feel they missed out on their RRSP deduction opportunities. There is always the risk that the government will change the rules. Better to cover all your “savings” bases.