Well, it’s a good thing RESP season is over. Now we can head straight into RRSP season.
I’m sorry, what? You didn’t know RESP season was a thing? That’s okay, neither did I. Until December hit and all of a sudden it seemed everyone was looking to top up their RESPs to make sure they catch as much grant as they can for the year.
Given the recent emphasis on RESP contributions, I thought it would be fitting to morph this year’s RRSP season column from all the technical bla-bla-bla on what makes RRSP investing important, to a more mature column on why RRSPs may not be the right fit for you. Fun, right?
An RRSP may not be right for you if you have a solid employer pension plan. There aren’t many of these left (ones we tend to run into are RCMP Pension, LAPP, and Saskatchewan Teachers’ Superannuation), but the people who have them are often contributing a good portion of their wage to them. Many pension companies look nervously to the future, factoring in volatile market conditions, increasing life expectancy, and previous underfunding. They are doing what they can to make it work, but for many of them, changes are on the horizon.
When you contribute to a pension, something called a Pension Adjustment reduces your RRSP contribution room in an attempt to equalize tax deferral with non-pension members. This reduced RRSP contribution room is the issue. Since pensions are often invested much more conservatively than personal investments, the reason that RRSPs may not be suitable for people with pension plans is they may be give the false impression that their combined pension and RRSP contributions will be enough. It very well may not be.
I like this topic quite a bit because it’s so involved and so personalized. It’s not that I’m bored or anything, it’s just that I find complex financial planning more intellectually stimulating. Trying to figure out an appropriate way for entrepreneurs to save is currently one of my favorites (although I think decumulation planning still takes the cake).
Unlike T4 employed individuals, entrepreneurs have a choice. The can choose to take salary income, which produces RRSP contribution room, but then they’d have to pay into CPP, pay personal taxes (although the company can deduct this salary as a corporate expense) and then invest in an RRSP. Alternatively, the company could pay corporate taxes, and then the entrepreneur can dividend out just enough to cover their living expenses, invest any surplus income inside of their corporation. Investment structures such as corporate class mutual funds make this especially interesting.
For the entrepreneur, RRSPs may not be appropriate if taking salary and paying into CPP ends up being less efficient than investing inside of their own corporation.
Note however that this is an advanced tax strategy and comes with words of warning. RRSPs are creditor proof, whereas corporate investments are not. Income produced by the corporate investments could potentially jeopardize the small business tax rate. And if the intention for the corporation is eventually to sell it, investing what would otherwise be your personal life savings inside it is likely inappropriate. If this is a strategy you are considering, be sure to discuss it with a Financial Planner with knowledge on advanced tax strategies first.
Tax Free Savings accounts are great. They are possibly the coolest investment shelter currently available. Sure, there is no tax deduction going in like there is with an RRSP, but there’s no tax to pay going out either. And that can be substantial.
One reason is that many people would like to make lump-sum purchases with their savings once they’ve stopped working. Maybe for an RV to tour the country, maybe for a new car, or maybe to take a trip black water rafting in New Zealand. And unfortunately, these expenses are not worthy of a tax deduction in the eyes of the CRA. If an RRSP investor need to tap their registered investmetns in order to make any lump-sum purchases a reality, the amount of additional investments that will need to be pulled just to pay the taxes could choke future growth and make meeting future lifestyle income needs challenging.
Another reason is that the government provides income-tested benefits for seniors through the Old Age Security and Guaranteed Income Supplement programs. Once taxable income hits a certain amount (currently $70,954), OAS income is clawed back at $0.15 per dollar of income. RRSPs are turned into RRIFs at age 71, and RRIFs have minimum income requirements. If the minimum income from a RRIF is too high (along with other sources of taxable income), then these government benefits will be clawed back. TFSA withdrawals are not included as income, and therefore can potentially protect entitlement to income-tested government benefits.
RRSPs may not be appropriate for anyone who has accumulated enough RRSPs to produce sufficient taxable income for their lifestyle expenses. They may want to look towards other savings vehicles, such as a TFSA, instead.
If you’ve saved enough already
During our discovery process, I like to ask new clients what the worst investment they’ve ever made is, and what the best one is. The most common answer to the latter question is saving for their child’s, or their grandchild’s education. Regardless of any triumphs or mistakes in their own investing experience, creating a better life for the next generation is something that few people forget.
And so, RRSPs may not be appropriate for you if you’ve already reached financial independence but have decided to continue working. In this case, education savings or juvie whole life policies for your children, nieces & nephews, or grandchildren may add more value to your life than your own personal savings will.
RRSPs are a great planning tool, but they’re not a perfect solution for everyone. If you have questions on why there’s so much hype around RRSP season, or for more information on how financial planning can help you build a customized savings plan centred on your family’s needs, speak with a CERTIFIED FINANCIAL PLANNER® today.
Written by Meagan S. Balaneski, CFP, R.F.P CERTIFIED FINANCIAL PLANNER®
Advantage Insurance & Investment Advisors
Investment Funds Representative
Manulife Securities Investment Services Inc.
The opinions expressed are those of Meagan S. Balaneski and may not necessarily reflect the views of Manulife Securities Investment Services Inc.