You’ll never regret saving and investing for the future, but you should always be doing so strategically. There are cases where maxing out your RRSP can actually be the wrong choice!
RRSP stands for Registered Retirement Savings Plan. It is the self-directed retirement savings plan in Canada, and one of the best places to tax-shelter investments. All citizens can contribute up to 18% of their gross earned income to their RRSP each year.
The income that you contribute to your RRSP is not taxed. Instead, it will be taxed when you withdraw from the account in your retirement. For this reason, the RRSP tends to disproportionately benefit higher-income earners who are in a higher tax bracket.
The higher your personal income taxes, the more you stand to benefit from RRSP contributions to reduce your income tax burden. But getting a tax refund this year isn’t the only thing to consider when maxing out your RRSP!
Here’s when maxing out your RRSP is the wrong choice
It might be hard to believe there are times when you shouldn’t be socking away cash in a retirement account, but here are a few of the situations that suggest your money should go elsewhere.
Your income is below $50,000 per year
The number is different for everyone, but as a general rule of thumb you don’t have a lot to gain by contributing to an RRSP if your income is below $50,000 per year.
If you’re young and will likely earn more in the future, tax deductions will benefit you considerably more at that time than they will in your early 20’s.
If make less than $50K but you’re concerned about missing out on the “magic of compounding” (I hate that phrase), then you really should be investing for retirement in your TFSA.
You haven’t maxed out your TFSA
The Tax-Free Savings Account (TFSA) is actually a superior tax-shelter than the RRSP when it comes to saving for retirement. Why? Because tax-free always beats tax-deferred!
In an ideal world, you would have both a maxed out TFSA and a maxed out RRSP, but if you have to pick one ver the other, the TFSA is probably the better choice.
If your income is below $50,000 per year but you’ve already maxed out your TFSA with ease, you can put the spare change into your RRSP. You can then decide if you want to claim the deductions for a small tax break now or carry them forward to future years when your income may be higher.
You’re going to earn more money in the future
You have to record all your RRSP contributions for the year when you file your taxes, but you don’t have to claim them. You can actually carry them forward indefinitely, and use them in the future to give you a break on a bigger tax bill when you’re earning more.
You don’t have an Emergency Fund
One of the good and bad things about the RRSP is it’s meant for retirement… so it’s hard to get money out early without any consequences.
Once you put your money in your RRSP, it’s supposed to stay there. If you make an early withdrawal, you can be subject to some pretty hefty tax penalties. While there are ways to withdraw from your RRSP without paying tax, it’s much better to just not have to deal with the headache in the first place!
If you don’t have an Emergency Fund, save that first before you start setting money aside in an RRSP. You need to have a cash cushion you can access easily in crisis without it causing a tax crisis!!
You’re over-saving for retirement
Another reason maxing out your RRSP might be the wrong choice is you straight up don’t need it.
It is possible to save too much in an RRSP, with some retirees ending up with a higher income in retirement than they had in their working lifetime. As a result, they have a higher income tax burden in retirement than their working years – exactly what RRSP contributions were supposed to prevent!
It’s important to remember the goal of your retirement accounts is not to die with the highest balance remaining, it’s to fund the life you want.
If you’re young and your Registered Retirement Savings Plan has grown to a mammoth size that will make you a decamillionaire in your 80’s, maybe considering cooling it on your contributions and spending money instead. After all, you can’t take it with you!