Despite my best efforts to plan ahead, everything is kind of happening all at once these days. It’s still pleasant as most of it is positive. The irony is that I will probably have too much time to spare on my leave of absence that kicks off just in a few months. I still wanted to take a moment today to talk to you about RRSPs.
As by all the publicity that we get from financial institutions, it seems like RRSP season is already upon us.
I feel kind of sad when I see a lot of folks rushing to the bank for their last-minute annual RRSP contribution. From my standpoint, here’s the typical scenario. Incited by financial salespeople (I must admit I have a hard time calling them advisors), most people blindly fill up papers to contribute to their RRSP (press hard there’s three copies) because they are told it will be awesome for their finances. A lot of months later (because they take too much time to pay their accountant to file their taxes), they get a RRSP-related tax refund and immediately spend it all away! Ouch!
I think you should at least ask yourself these questions before contributing to your RRSP this year.
Is this a good year to contribute to my RRSP?
Is a TFSA a better option for me this year?
How much tax can I expect to pay when I intend to withdraw these funds from my RRSP?
Some basic rules of thumb are easy to apply.
RPSP contributions are great in high-income years. Go for it if you have made more money this year. Probabilities are in your favor to relatively pay less tax in retirement or at withdrawal.
Avoid RRSP contributions in low-income years. Young people at the start of their career should consider TFSA contributions instead. Older folks should also privilege the TFSA route after a slow year (we even consider RRSP withdrawals).
Try to keep your taxable income just over the lower tax level. That way, your RRSP contributions will have the greatest impact and you will get refunded the optimal marginal tax rate. Contributing more is not worth it. It won’t make you save enough on taxes. Keep that money for next year or even better, put it in your TFSA.
This can be a little more complicated, but you should also try to consider all long-term tax implications. Anticipating how much tax will you owe when you withdraw is the key. Most people only consider how much tax they will get refunded this year. Comparing that refund to your probable future tax bill is a more financial and tax efficient strategy. Also consider how much money you will need in the future, not only how much can you save now.
If you don’t have the money to contribute, only consider short-term RRSP loans. For your sake, if you ever consider a RRSP loan, make sure to pay it back quickly within a few months. Maybe your tax refund can be used to pay your loan back (instead of buying a third large screen TV with it). Also consider regular pre-authorised payments for next year’s contribution. It’s easy to set it up right now.
People often talk about maxing out their RRSP. We think maxing out relative tax advantages is much better. In that sense, combining TFSA with RRSP contributions can often result in the most effective fiscal strategy.
Similarly, people insist in living in the moment. But only thinking about today may be a mistake as far as RRSPs go if you don’t rudimentarily consider future tax repercussions. We believe in a balance approach where you live well today while still planning for a better tomorrow as opposed to a bitter one.