In 1872, printing press workers in Toronto walked off the job to protest 12 hour workdays. It took decades before a 40-hour work week became the norm. In 1940, Canada became the last western country to introduce unemployment insurance. By the 1950s, many workers had pensions that promised permanent, lifelong income. Progress!
But one segment of society was conspicuously excluded from these gains: the self-employed. They got the luxury of unlimited working hours and taking all of the business risk, with no unemployment insurance and no pension.
An important group of self-employed people decided to do something about it. Medical doctors banded together and lobbied the federal government to create individual pension plans. In 1957, the Registered Retirement Savings Plan (RRSP) was born.
What’s so great about the RRSP?
Governments like the RRSP, because it encourages private saving and eases the burden on the social safety net. The financial industry like the RRSP, because it drives sales of mutual funds and other investments. Us citizens like the RRSP because it helps us get tax refunds and grow our investments tax-free until we retire, which can make a massive positive difference.
But despite all these strengths, an RRSP is not always the best financial move. If you’re seeing lots of advertising pushing you to make an RRSP contribution this year, stop and ask yourself these questions.
Is this the best year to contribute?
When you make an RRSP contribution, you get to deduct that amount from your taxable income. This can lead to a tax refund, which is a bit like a drug. We love to get those refund cheques. However, if you’re upwardly mobile, you might want to think about delaying that gratification a bit.
For example, if you made $80,000 and contributed $5,000 to an RRSP, you could save $1,483 based on the 2019 federal and provincial tax brackets in Ontario. But if you think you’ll make $100,000 in a year or two, you could wait to make that same contribution and save $1,858.
That’s an extra 25% in your pocket just for waiting. Think about parking your money in a TFSA and timing the RRSP contribution for when it will count the most.
“Think about parking your money in a TFSA and timing the RRSP contribution for when it will count the most.”
How much tax will I ultimately save?
An RRSP doesn’t let you totally avoid tax, just put it off until later. You’ll be handing back some of those refund cheques when you retire and starting withdrawing money. You want to make sure you won’t be handing it all back. Worst-case, you could end up paying more than you saved in the first place.
The key is to be in a lower tax bracket when you retire than when you initially contributed. If you have a financial plan and know how much retirement income you expect to earn, you can make an educated guess about whether an RRSP contribution is worth it or not.
If your income is relatively low today – perhaps you’re just starting out, experiencing some unemployment, taking maternity or paternity leave, or any other reason – you might want to think twice about contributing. A TFSA might be a safer choice without any unpleasant tax consequences down the road.
Do I have higher priorities?
Do you have an emergency fund set up? If not, I’d consider this a higher priority than making an RRSP contribution. If you ever get into a pinch, you want access to some cash without paying a bunch of fees or taxes. Three months’ worth of living expenses is a good starting point.
Do you owe money on a credit card? If so, you’re probably paying interest well into the double digits. Paying that off will probably yield a higher return than putting money into an RRSP. If you’re worried that you’ll simply run the card up again, destroy it or lock away somewhere.
Are you planning a major purchase? There’s a good chance you’ll be better off paying cash for it than putting your cash in an RRSP and financing the purchase. And you definitely don’t want to end up withdrawing money from your RRSP.
So there you have it. The RRSP is a great financial tool that makes sense in a lot of cases. But despite the common wisdom, it is not a no-brainer for everyone. Use your brain to make the best move, and if you’re not sure what to do, I recommend chatting with a professional financial planner about your options.