It seems almost sacrosanct to question the benefits of making RRSP contributions these days – but is it always the right thing to do, even if you can?
It might appear to go without question that the benefits of making a yearly contribution to your retirement funding through an RRSP are great, but it is not so black and white.
We think that it would be important at this time to review the actual technical financial mechanism behind contributing to an RRSP.
Most individuals focus on two aspects of RRSP accounts.
The first thing people focus on is the tax savings in the year that the contributions are made. The second is the tax free compounding of those funds inside the RRSP over the years.
However, there should be another way of looking at RRSP contributions – and it may not be in such a positive light, not as tax avoidance, but as tax deferral.
In fact, if you begin early enough and the rates of return inside your plan are high enough, funds you contributed at relatively low tax rates might be withdrawn at the highest possible tax rates.
This idea of an RRSP as a tax avoidance method can sometimes be taken to extremes.
For instance, individuals in their 70th or 71st years of life may believe that avoiding taxes in their last year of RRSP eligibility is a good idea. However, they will then be mandated to withdraw those funds in the following year when they transfer to a RRIF and will be paying those taxes right back.
If it is tax free compounding you are after, an RRSP may not be the best route.
A Tax Free Savings Account (TFSA) is another option. A TFSA will allow you to make contributions without any tax deferral, but the compounding growth on funds within a TFSA is not taxed when you withdraw them.
When deciding whether to contribute to an RRSP it is important to consider both your present tax rate, as well as the tax rate you may be paying when you finally withdraw those funds.
Also consider the effect that withdrawing significant funds from your RRSP may have on other retirement funding sources – such as, if there may be a claw back of any Old Age Security (OAS) payments you may have been entitled to.
The best course of action when deciding to make RRSP contributions and whether it makes sense for you in any given situation is to speak to an investment professional at Campbell, Lee and Ross.