When maxing out your RRSP contributions is the wrong choice

18 Comments

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!

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18 Comments. Leave new

  • This was really interesting to learn. Since I am not a Canadian citizen I had/have no idea how your tax code works. I find it really interesting you can carry these credits to future years. Is there a time limit for you to carry forward these credits or can you pretty much do it indefinitely? Secondly are you just going to direct money that you would have saved towards a taxable investment account?

    Reply
    • There’s no time limit — as long as you continue to file an income tax return your unused RRSP contribution room will be carried forward. You can only contribute to an RRSP until you are 71 (I think) though.

      I max out my TFSA (Tax-free savings account) with money I don’t put into my RRSP, then whatever’s left I put into unregistered taxable accounts. This way if you’re in a fairly low tax bracket (ie. below $50K as experts suggest), you won’t be taxed on what you earn in these taxable accounts anyway.

      Reply
  • John S @ Frugal Rules
    September 27, 2012 9:46 am

    That was interesting to read as I really don’t know how the Canadian tax system works. That’s great you can take those credits into the future. Is there a certain time you have to use that up by, or is it forever?

    Reply
  • I love posts like these. Very helpful. Thanks!

    Reply
  • Thank you for writing this! I will clear 50K this year… but it still doesn’t make sense for me to contribute to an RRSP yet! Given the tax implications, etc, as a young person, I am much better off to direct my dollar to other forms of savings, such as paying off my mortgage and car and filling up my TFSA. I contribute to my RRSPs to the extent necessary to maximize my employer’s contribution.

    Reply
    • Agreed! I’m finally over the $50K mark too but because of my other tax credits for school etc. it doesn’t make sense for me to make my own RRSP contributions yet.

      Reply
  • Interesting point. My company matches my RRSP contributions up to $50 a month, so when my raise kicks in I’ll start contributing the maximum I can get matched. Other than that, I’ll try not to save too much into my RRSP until some other goals of mine are taken care of.

    Reply
  • Totally Agree. Across Canada it can vary slightly based on how the provincial income tax laws are set up, but overall $50K is a good ball park. I think a big part of the decision just comes down what your future tax bracket will look like compared to now, which admittedly isn’t always clear for some people. I also like your idea of contributing to an RRSP now and claiming the deduction in future years for when you’re at the 36% tax bracket or higher. We’re still racing to see who gets to $100K first right 😛

    Reply
    • haha we are so still racing to see who gets to $100K first 😉

      I feel like my future tax bracket will eventually be the highest… I hope. It’s my goal, anyway. Assuming I continue to work full-time and don’t do a major career overhaul 15 or 20 years in, there’s no reason why it shouldn’t be attainable — though the thought of paying 36% income tax is super depressing.

      Reply
  • You’re from Canada too??? Seems like 90% of personal finance bloggers live there 😉

    Reply
  • Good post. I always max out my TFSA before RRSP.

    http://www.myownadvisor.ca/2011/05/ill-maximize-my-tfsa-first-thanks/

    Reply
  • Great post. Quick question though, where is the $100,000 limit coming from? I thought the 2012 maximum contribution was $22,970. Does the $100,000 pose a limit on catching up on unused contribution room?

    Reply
  • forfundssake
    May 1, 2014 7:14 am

    Great post on this Bridget. It’s similar to what I tell my friends when they’re confused about TFSA vs. RRSP. One factor I point out though is to check with the hr where they work and see if they match rrsp contributions. I’ve found majority of them don’t even know what the company they work for offers. If they’ll match your contributions, take advantage of it 100%. When your rewarded with money for contributing money, that’s a good deal!

    Reply

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