If the RRSP were named the Tax-Deferred Savings Plan, it would clarify to folks how it all works. Most folks think of it as a Tax Avoidance program, but there is no hiding from taxes like death.

The government rarely wants you to get something Tax Free (except for the Tax Free Savings Account (TFSA) and a few other programs). When you get a refund for your RRSP deposit, all you do is defer paying tax on your deposit. When you withdraw, you will pay tax on the money in your RRSP. This is why I am calling it the Tax Deferral Savings Plan. Remember that tax-deferred advantages are possible, but you must realize that is what the RRSP does.

Some of the underlying assumptions for your RRSP are simple. When you withdraw money from your RRSP, you will:

• Be in the same or lower tax bracket. Thus your tax deferral is a net positive (if you have kept your refund from depositing into your RRSP).
• You have money saved to pay the taxes on the withdrawal.

This is where folks tend to get tripped up. They look at their RRSP balance and see the entire value ($X) when the actual value is  ($X – Income Tax). How much income tax? It depends on when you take the money out and how much you withdraw. Take it all out at once, and you pay the most tax on that withdrawal.

Retirement Withdrawal

Assuming you make less when you are retired, you are withdrawing at a lower tax rate (hopefully). If you have a higher tax rate when you are retired, you will pay more tax than you got as a refund. This is why most “Influencers” are down on the RRSP. They do seem to forget that a Spousal RRSP is an option.

Emergency Withdrawal

The idea is to use your RRSP as an emergency fund. While it might work if you are unemployed (and have no income), using it to pay for a large purchase might give you a much bigger tax bill. If you are working with a Spousal RRSP this may work out better. This assumes your spouse is in a lower tax bracket.

What to do with the Refund?

If you put money into your RRSP (or tax-deferred savings plan) and receive a refund, what should you do with it?

• If you spend the refund, you need a plan to recover it in some fashion. You must be able to pay the taxes on your deposit.
• Keep in mind the actual value of your RRSP deposit
  • $X deposit gives $N refund, thus you will need approximately $N in tax payment money to withdraw all of $X again.
• Put the refund into the RRSP, problem solved, and you get another refund next year (repeat).
• Refund into TFSA, let it grow there, thus you have the Tax Money. An added bonus is you are using it to grow you nest egg (tax free).
• Hope your RRSP investments grow enough to cover $N worth of taxes due on the initial deposit.

Your RRSP Balance is Before Tax Money

Remember this. You must pay tax on your RRSP withdrawal (with a few exceptions). Plan accordingly!