Why late-career savers need to be careful with RRSPs

When should you keep contributing to your RRSP?

If you have a group RRSP with matching contributions from your employer, this provides a significant boost to your savings. Many group plans offer matching contributions of 25%, 50%, or even 100% on contributions up to a certain dollar amount or percentage of income. To get your hands on this free money, you have to keep contributing. Defined contribution (DC) pension plans fall into this same category, with employer contributions making maximum participation a compelling opportunity. 

If you do not have much retirement savings or pension income, RRSP contributions are also generally advantageous. The reason is that you are likely to be in a lower tax bracket in retirement. Paying a lower tax rate in the future than today makes RRSP contributions even more compelling. 

Anyone in a high tax bracket today—especially near or at the top tax bracket in their province—will probably benefit from making RRSP contributions. 

If someone plans to retire abroad in another country, late-career RRSP contributions are also typically advisable. The withholding tax rate on RRSP and registered retirement income fund (RRIF) withdrawals for non-residents generally ranges from 15% to 25%. Most countries have lower tax rates than Canada and will recognize tax withheld in Canada as a credit against foreign tax payable. Some countries do not tax foreign income at all, so the withholding tax on RRSP/RRIF withdrawals may be the only tax implications of withdrawals. 

When should you not contribute to your RRSP?

Although most people find themselves in lower tax brackets in retirement, some may pay more tax. One example may be someone who has a spouse with a large RRSP or pension whose income is fairly modest today. Pension income-splitting allows most pension income, including RRIF withdrawals after age 65, to be split up to 50% with a spouse. So, a high-income retiree can move income onto a low-income spouse’s tax return. A low-income taxpayer today may be in a much higher tax bracket in retirement in a case like this. It would make sense for them to redirect retirement savings to a tax-free savings account (TFSA) if you have the contribution room or simply save in a non-registered account.

Someone who is transitioning to retirement and working part-time may be another good example of someone whose tax rate may be higher in the future, and further RRSP contributions are not advisable. 

Someone whose retirement income is likely to be in the $100,000 to $150,000 range should also consider the impact of Old Age Security (OAS) pension recovery tax. OAS clawback acts like an effective 15% tax rate increase for RRSP/RRIF withdrawals for OAS recipients. 

Government support like the Guaranteed Income Supplement (GIS), a means-tested benefit that is payable to low-income OAS pensioners, could be affected by RRSP/RRIF withdrawals. So, if someone has a choice between RRSP and tax-free savings account (TFSA) contributions, and may have little to no income beyond CPP and OAS, a TFSA may be a better choice than an RRSP. 

If someone has debt with a high interest rate, especially credit card debt, this may be another reason to pause the RRSP contributions. 

Should most people contribute to RRSPs? 

Most working age Canadians can expect to be in a lower tax bracket in retirement than in their working years. As a result, most people should be contributing to their RRSPs and will be better off in the long run by growing their savings. If someone has maxed out their TFSA, and choosing between RRSP and non-registered savings, RRSP contributions may still be advantageous even if their tax rate is the same or slightly higher in retirement. 

There is a non-financial benefit to segmenting savings into less accessible accounts like an RRSP. A TFSA or savings account is more likely to be raided for a discretionary expense, so the psychology of RRSP contributions is a worthwhile consideration beyond the financial factors. 

If you have an employer match on your retirement account contributions, you should almost always be contributing regardless of your current or future tax rate. 

Professional financial planners can help you project your future income, taxes, and investments using financial planning software. This can help determine whether RRSP contributions will benefit your potential retirement spending or estate value in the future based on your actual numbers, rather than a rule of thumb.

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About Jason Heath, CFP

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