Spoiler alert: you probably do.
Most Canadians aren’t big savers to begin with, so when you start throwing financial acronyms at them like RRSP, TFSA, ETF, HESG (that last one is made up), it’s no wonder they get confused. Even those with good intentions might partake of the investment vehicles these acronyms represent but lack an understanding of their potential leads to them being underutilized.
The RRSP might be one of the least understood and most underutilized of all. Because contribution room is different for everyone, taxes matter, and it has more flexibility than most people think, it’s easy to get confused about how to make the most of it.
What is the RRSP?
RRSP stands for Registered Retirement Savings Plan and refers to a tax-advantaged account for Canadians to save for three big things:
- Retirement (obvs!)
- A down-payment on their first home (yay!)
- Post-secondary education (surprise!)
Your individual contribution room is proportional to your taxable income and works out to be approximately 18% of your gross income earned.
Unlike the Tax-Free Savings Account (TFSA), money in your RRSP is simply tax-deferred, not tax-free. This means you won’t pay taxes on it the years you make your contributions, but your withdrawals from you RRSP in retirement will be subject to income tax then. Because the majority of people will have a lower income in retirement than in their working years, you can save a whack of income taxes by contributing to you RRSP now and make the withdrawals in the future when you stop earning an income.
The biggest lie about the RRSP ever
The RRSP is poorly named because the S stands for “Savings” and misleads many people into believing the money you put in your RRSP must be in a savings account. This is AWFUL. Mainly because current savings account interest rates are less than 1%, so that money won’t even keep pace with inflation.
The truth is you can and should invest in your RRSP instead of save.
Instead of keeping your RRSP money in cash savings, you should buy mutual funds, ETFs, stocks, and bonds. These higher-return investments will help your money grow, which means you’ll have more of it when you need it.
When should you start saving in an RRSP?
The easiest rule of thumb is as follows:
You should probably be using the RRSP if your income is greater than $50,000 per year.
If your income is greater than $70,000 per year, you absolutely need to have an RRSP.
Why $50,000? Because after that income, your taxes really start to make a dent in your take-home pay, and you can use the RRSP to ease the burden. When you claim your RRSP contributions when you file your taxes, you’ll receive an income tax refund.
For incomes less than $50,000, you instead want to focus your efforts on saving in your Tax-Free Savings Account (TFSA). If you manage to max it out, then you can start putting leftover savings into your RRSP. Otherwise, you’re better off focusing your efforts entirely on the TFSA until your income increases past the $50,000 threshold.
When you file your taxes, most online programs will let play around with how your RRSP contributions will influence your income tax refund, so you can determine before your file how much of your contributions you want to claim.
Sometimes it makes sense to make RRSP contributions, but not to claim them until later years. You’re allowed to carry forward unclaimed RRSP contributions, so you can get a larger tax break in higher earning years. For example, if you’re currently making $52,000 but your income is going to jump to $67,000 in 3 years, you might choose to put off claiming your RRSP contributions right now, and use them when you’re being taxed more at a higher income. The higher your income taxes, the more beneficial it is to have an RRSP.
How to make the most out of the RRSP
Your RRSP can only serve you if it exists, so the first thing to do is open an account and put some money in it. Have you heard of the 80/20 Rule? This is literally the 20% that leads to 80% of the results. Opening an RRSP mutual fund or brokerage account takes very little effort, but is the only way you’re going to enjoy any of the benefits of this account.
The second thing to do is to start contributing to your RRSP regularly. You should be saving at least 10% of your net income for retirement, and dividing this amount between your TFSA and your RRSP based on your income and contribution room in each account. If you cannot save 10%, then save 5%. If you’re currently saving 0%, begin with 1% and double it every 3 months until you get to 10%.
The easiest way to get in the habit of saving is to set up an automatic transfer from your chequing account to your savings account on payday or the day after. This will let you save on autopilot while ensuring there’s always money available to be saved.
When you claim your RRSP contributions on your income tax return and get a refund, use it to further propel you towards your financial goals. If you receive a refund, put it in your TFSA, use it to further top-up your RRSP, or put it towards any high-interest debt. All three of these options let you amplify the positive net worth impact of saving for retirement, by increasing your net worth even further.
Finally, decide how you want to use your RRSP. Remember, this account can be used for more than retirement: you can borrow from it under the Lifelong Learning Plan to go back to school or to buy a home under the First-Time Homebuyer’s Plan.
Stop worrying about your income in retirement
When it comes to making use of the RRSP, many people (especially financial advisors) agonize over what your income will be in retirement. This is because contributing to an RRSP only makes sense if you expect your income to be lower in retirement than it is in your working years.
If you’re in your 20’s or 30’s, STOP WORRYING about your income in retirement.
Why? Because when you get to your 40’s or 50’s, you’ll have a much better idea of what your income will be when you leave the workforce, and you can adjust your RRSP contributions then. Many people get stuck in the muck of performing elaborate calculations of how much they need to save and where and why, trying to piece together a perfect financial plan that they can follow every week from now until age 67. This is a colossal waste of time and effort. You have no idea what fortunes and misfortunes will befall you in 2 years or 5 years or 15, and trying to plan for it all is an exercise in futility.
Save as much money as you can, when you can. Worry about how you will spend it later.
You’re going to have much bigger problems in your life than potentially putting too much money in your RRSP. If you are one of the lucky few that accidentally banked hundreds of thousands more than they needed, pivot your financial plan in your 50’s, not right now.
My fat RRSP is more than a retirement fund. It’s a financial asset that helped bolster my net worth to secure business credit when I left my full-time job to work for myself. It’s an instantly available $25,000 if I need to put a down-payment on a home. It’s a sum growing rapidly all on its own thanks to capital gains, interest, and dividends. Your RRSP might be meant as a retirement savings account, but it will start serving you long before you’re old and grey.
So who needs an RRSP? You do.