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Money When an RRSP isn’t worth it

07:06  23 may  2018
07:06  23 may  2018 Source:   moneysense.ca

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It ’s the time of year when Canadians are bombarded with ads about filling up their Registered Retirement Savings Plans , or RRSPs . But whether you should put your hard-earned savings into an RRSP isn ’ t always obvious.

Maxing out your RRSP is a smart move, but for most people an RRSP loan isn ’ t the way to do it . Lenders don’t calculate your refund on your declining marginal tax rate when doing a refund projection.

Q: I’m a teacher of 11 years, and I’m wondering about where to invest money after my TFSA is topped up. What I love about the TFSA is that I can have a high performing portfolio and, years down the road, I can cash in without worrying about being taxed or having to temper the amount I would like to withdraw. (This is also why I’m hesitant to take on RRSPs given the healthy pension upon retirement).

What is your recommendation for next steps? Should I invest in a non-registered account? Or give in to the RRSP option? My goal is to harness the magic of compounding, so I can be successful in later years.

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Is it worth me investing in an RRSP , when chances are I will be back in my home country in say 10 years? A: People who are living temporarily in Canada or Canadians who are planning to retire abroad often wonder if they should contribute to an Registered Retirement Savings Plan ( RRSP ).

On the other hand, the worst situation is to put money into an RRSP when you are in a low marginal tax rate (23%) and take it out when you are in a high As a result of being a saver, she has accumulated 0,000 in RRSPs , 0,000 in investments and her business is worth at least ,000,000.

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When I first read your question, Davina, my first thought was that there really isn ’ t a difference. You don’t want to over contribute to a TFSA or an RRSP . Is an RRSP worth it if you’re retiring abroad?

After 10 years of reinvested tax refunds and 5% annual growth, your RRSP would be worth almost ,000. Contributing a lump sum to your RRSP when markets are down is also a lot more emotionally difficult than it sounds.

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—Julia

A: There seems to be a lot of anti-RRSP rhetoric going around these days. Ever since Tax-Free Savings Account (TFSAs) came along, some people are skeptical about paying tax when they take money out of their Registered Retirement Savings Plans in the future.

So, to avoid paying tax in the future, those people instead pay tax today.

Given your TFSA is maxed out and it sounds like you expect to max it out every year, Julia, you can either contribute to your RRSP or you can open a non-registered investment account. The RRSP gives you tax deductions, tax-deferred growth and better compounding than the non-registered option. Non-registered investing gives you no tax deduction, taxable growth on interest, dividends and realized capital gains, and eventual capital gains tax payable on deferred capital gains.

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Both of these things make the RRSP a valuable tool when it comes to preparing for retirement . This ,310 tax savings would be more than enough to pay back the ,000 loan on the spot plus 5.17 in interest. Are RRSPs worth it in the long run?

The truth is that RRSPs are beneficial, not only for people whose tax rates are the same or lower in retirement , but even for some (but not all) people who find themselves in a higher tax bracket when they make withdrawals. They think that ,000 inside an RRSP is worth the same as ,000 outside.

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Capital gains may only be 50% taxable, compared to 100% taxable RRSP withdrawals, but how important is that tax deduction up-front?

When I run the numbers, Julia, if someone expects to be in a similar or lower tax bracket in retirement, it is generally advantageous to contribute to an RRSP over a non-registered account. Most people are in higher tax brackets during their working years and a lower tax bracket during their retirement years, but it depends on your situation.

RELATED: Are RRSPs ever a waste of time?

With a defined benefit (DB) pension, say you work 30 years and have a 2% pension formula, replacing 60% of your final average earnings. Canada Pension Plan (CPP) will generally replace less than 25% of your income unless you have a low income or work until 65. Old Age Security (OAS) won’t likely get you up to 100% income replacement between the three pensions. And unless your spouse also has a generous pension, you may ultimately split part of your retirement income with your spouse, all but ensuring you a lower income in retirement than during your working years.

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RRSPs do not have an inherent interest rate. It ’s difficult to predict how someone’s RRSP affects their net worth or future income since the investments are taxable when withdrawn. Money you put in an RRSP is money you haven’ t yet paid tax on.

5. It 's best not to withdraw from your RRSP 
 This might seem obvious, but it ’s worth reminding newbie RRSP investors that once money goes in it doesn’ t come out. In theory you can pull the money out, but you’ll have to pay tax on it at your income tax rate. The whole idea is to contribute when

The point is that not a lot of people have higher incomes in retirement, Julia. Someone working part-time or at a low income may be in a higher tax bracket in retirement. And these may be the people who should consider avoiding RRSP contributions because the tax savings today may not be worth the higher tax rate in retirement. TFSAs are likely better savings vehicles for them than RRSPs, and non-registered investing may also beat out RRSP investing as well.

Low income seniors may also be entitled to government benefits like Guaranteed Income Supplement (GIS). RRSP contributions for a worker with low projected retirement income may limit entitlement to such benefits.

TFSAs and non-registered investing therefore play important roles for savers who have a choice. But for someone with a high income during their working years, a retirement income likely to be lower, and TFSAs that are maxed out, what little RRSP room you have available should probably be utilized. And if you can’t max out your RRSP and your TFSA, your RRSP may be a better option.

MORE: Should I raid my RRSP to pay off my line of credit?

You haven’t mentioned debt, Julia, but debt repayment might be the only thing that causes me to reconsider whether RRSP contributions are worth considering for you. I’ve worked with clients over the years who are projected to have generous retirement incomes, but cash flow during their working years is tight and they can’t pay off their mortgage by retirement. There’s no point in being pay cheque to pay cheque during your working years just to be flush with cash flow and saving money each month in retirement.

So, if that’s the case, foregoing RRSP or TFSA contributions may not be a terrible idea. Saving too much money at the expense of living a bit today is better than not saving enough for retirement, but both scenarios have their drawbacks.

In summary, Julia, I think RRSP contributions could be beneficial for you. There are plenty of other factors to consider, but based on what you’ve told me, I think I’d opt for RRSP contributions over building a non-registered portfolio. You’ll pay less tax today and you’ll likely pay less tax over the balance of your life, which is the most important consideration.

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Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.

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