It is easy to not trust Canada Revenue Agency (CRA). We know their job is to tax our income and tax incentives such as those available with the RRSP sometimes seem too good to be true!
Here are the top objections I hear regarding RRSPs, along with my honest opinions:
Why invest in an RRSP when you must eventually pay back all the money you save?
Although you will pay income tax on your RRSP withdrawal in retirement, remember that you did not pay income tax on that part of your income that you set aside for retirement! You also experience the magic of tax-free compounding on your investment as it grows. In most cases, the income you take in retirement will be taxed at a lower rate than when you took the tax deduction.
I’m better off investing my money in a TFSA.
More and more Canadians are discovering the benefits of the TFSA, while unnecessarily throwing the RRSP under the bus. There is a place for both.
We forget that TFSA contributions are made with after-tax dollars while RRSP contributions are made with pre-tax dollars. For example, someone in a 40-per-cent marginal tax rate must earn $10,000 to contribute $6,000 into a TFSA after taxes. On the other hand, the person who contributes $6,000 into the RRSP deducts that amount from income and thus must only earn $6,000 to make that contribution.
If your income tax rate in retirement will be lower than during your working years (most people), your RRSP should take priority.
It’s better to pay down my debts.
Paying off expensive consumer and credit card debt is a no-brainer. However, your mortgage interest rate is probably a lot lower and rates of return on equity portfolios have been a lot higher. Focusing too much on paying down a low interest rate mortgage may be preventing you from investing in a higher return investment portfolio. The net result could be a sacrifice in your retirement lifestyle.
Putting too much into an RRSP will result in Old Age Security (OAS) clawbacks in my retirement.
Some fear the Old Age Security (OAS) Clawback tax without realizing how much income you need in order to be affected. If you qualify for full OAS payments and make more than $79,845 net world income in 2021, you will pay 15 per cent on the excess of that amount until your income reaches $129,075. At that point, 100 per cent of your OAS payments will have been clawed back. If you are a married couple and use pension income splitting effectively, you could earn as much as $159,690 between the two of you and not be affected by the clawback. Clearly, the OAS clawback affects only a small percentage of taxpayers. However, it is a potential problem and there are ways to plan for it.
There are so many variables and exception beyond the scope of this article. We have a useful set of financial calculators that you are welcome to use to evaluate different scenarios. Beyond that, consult with your professional financial advisor.
Richard Vetter is a Certified Financial Planner and owner of WealthSmart Inc.
