Not everyone needs an RRSP. Yes, you heard that right. I'm not sure when it happened, but sometime over the past 20 years there has been the evolution of a widespread notion among Canadians that everyone should have an RRSP. This simply isn't true.
On countless occasions upon financial review we have made the recommendation to a client to stop contributing to their RRSP. This suggestion is greeted with confusion. "What? A financial planner telling me NOT to put money into an RRSP?' The assumption is that we always recommend an increase in RRSP of course. A foregone conclusion. Because isn't that what financial planners do? Don't they tell everyone; you'll never retire at the rate you're going, so you better save more in an RRSP, right? A broad misconception.
Now let me explain myself. No, I am not a financial planner boycotting RRSP's. Not at all. My comment is based on my belief and experience that the general public has become somehow misinformed that RRSP's are ALWAYS a good idea. I'm not sure how this happened. The term RRSP seems to have taken on a life of its own, synonymous with saving money 101. In reality, the basic building block is saving money. Period. The next step is deciding where to put that money and an RRSP is only one option.
To use an analogy, it's like assuming that running 5 miles every day is something everyone should do. Yes, running can be good for your health but is it good for everyone? No. Running is not the building block. Getting physical fitness is. From there you can decide how you want to spend your physical fitness time. Running is an option but there are other options too. For example, if you have knee problems or arthritis then walking or yoga are better choices. For some people, running could do them more damage than good. Running is a good physical fitness option in general but it's not for everyone. RRSP's are a good savings option in general but they are not everyone.
So how do you know if an RRSP is right for you or not? Well it's mathematical. In order for an RRSP to work the way it is designed you need to put money IN when you are in a HIGHER tax bracket, and take it OUT when you are in a LOWER tax bracket. If you put money IN when your tax bracket is too low it can work against you.
For simple ‘Coles Notes’ example let’s reference the element of tax savings on deposit and withdrawal rather than tax deferral.
RRSP that works well:
Put $5,000 IN at 46% tax bracket (get $2,300 tax savings) and pull $5,000 OUT at 30% tax bracket (pay $ 1,500in tax) = tax savings of $800.
RRSP that doesn't work well:
Put $5,000 IN at 30% tax bracket (get $1,500 tax savings) and pull $5,000 OUT at 46% tax bracket (pay $2,300 in tax) = paying $800 more tax that you needed to
So, if you are in a low tax bracket currently; a student with little income, first job with starting pay, earning part time income only, on maternity leave, a business owner who write off income to lowest tax bracket, or business owner who earns dividends from a corporation via T5 vs. T4 earned income then and RRSP contribution this year is most likely not for you. Make another choice. A TFSA is a good option if you have room.
However, if you are in a high tax bracket currently; a nurse, teacher, manufacturing or specialized worker at the high end of your pay scale, a business manager, supervisor or executive who is not self employed but rather earning a high T4 income, and you are looking for the immediate tax write off and you have a strategy in place to be in a lower tax bracket in retirement when the money will be withdrawn, then an RRSP is probably a great choice. You are most likely the text book case for using an RRSP effectively.
Look at your personal situation and your tax bracket. Make the best choice for your savings that you can. It might be an RRSP or it might not be. Do your math. Get advice.
Stephanie Farrow, B.A., CFP., Stephanie has over 20 years experience in the financial services industry, a diploma in Financial Planning from the Canadian Institute of Financial Planning, and Certified Financial Planner designation. Stephanie has been writing a financial planning column for the local business magazine Elgin This Month since 2010. Stephanie and her husband Ken Farrow own Farrow Financial Services Inc. Our Farrow Financial Services Team.