Almost time to have your RRSP story closed off (although, you should be doing this all year around). You know my love for top 10 lists, (and evidently the correct cardinality of a financial list is 7) but, here are 5 things to remember about RRSPs.
Things to Remember about RRSPs
Your RRSP balance is not how much money you have to withdraw. The RRSP program is a tax deferral savings system, you will have to pay taxes on your balance.
If you take it all out at once, you will end up paying the highest tax rate on the withdrawal.
Are you sure your tax rate when you withdraw the money is going to be lower than your current rate? You may not withdraw at retirement, what if you get laid-off? If you are not sure about the tax rate, is the RRSP is the right place to put your money?
When you take money out of your RRSP, that RRSP “room” is lost (except for a few specific programs (e.g. 1st home purchases). Every year you are allocated RRSP room, but if you cash out before retirement, that room is lost.
The Spousal RRSP is one of the few ways to income share. I have written countless posts about this, but if your spouse will have less retirement income, this is an important tax evasion tactic for Canadians.
Always name a beneficiary for your RRSP (or any registered savings plan), to ensure a smooth and easy transferral should you die before you can spend it.
There are really not only 5 things to remember for RRSPs, there are many more, but here are five to start with.
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.
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.
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).
RRSP banking web sites must be white hot with action today, as we all have an extra day to add more funds to our RRSP and then claim it on our previous year taxes. Leap Year adds one more day for the festive RRSP Rebalancing Season, and gives financial pundits another day to argue RRSP or TFSA ? The answer (of course) is it depends.
No doubt there will be countless articles today arguing that you should be trying to sneak a little more money into your RRSP, because you have an extra day to do it (and that is always the best reason).
You could also view this extra day, as a day to clean up a bunch of financial things you have been ignoring like:
Putting Money in your RRSP !!! OK, enough of that.
Make up a financial plan for the rest of the year (you have 10 months still to go, after all).
Check that all your insurance policies are up to date.
Make an extra payment on your debt, just because that would be cool!
I view a Leap Day with trepidation because I am not getting paid for this extra day, am I? I am working an extra day for free? Not really, as I get paid bi-weekly, but for those that are being paid bi-monthly, you are making a little less per day in February than you would normally.
Question of the day:
If you were given a free day to do whatever you want, what would you do? Today is that day.
If you were planning on rebalancing your RRSP or something similar you have until Monday (end of the day) to get this all done. There will be a plethora of exciting articles out there to read (including from me), but remember that the RRSP is really a Savings/Tax Deferral System, because you will have to pay your taxes on the money (hopefully not more than you saved by putting money in your RRSP in the first place). Is it worth madly panicking to try to make a last-minute RRSP deposit if you don’t have a specific need to do so? I don’t think so, you might do better putting the money in your TFSA (if you have room, for either, for that matter), or paying down debt?
The Ontario Government decided that they wanted to have the biggest sub-national jurisdiction Debt in the world ($308 billion), so they continue to run big deficit budgets with big promises. I will be reviewing the alleged extra funding for the Autism programs (with a lot of input from Mrs. C8j, hopefully), $333 million over five years. Why couldn’t they just give me a cut of that? Speaking of huge debts, evidently the World Debt is Rising (according to Bloomberg) but who are we borrowing from then? Mars? Venus? Maybe that is how Pluto ended up being demoted from planet (it owed too much money to the Intergalactic Banks).
Another very confusing week of weather here in Ottawa, but luckily my writings didn’t seem as confusing (I hope).
To absolutely no consumer’s surprise Stats Canada published last week the monthly inflation numbers and it showed that healthy food costs a lot more than it did a year ago, and even Gasoline is more expensive too? Given the new taxes the Ontario Government is going to put on booze and smokes, that won’t help these numbers either.
What is a Spousal RRSP? That is a question a few folks have asked me, and I keep thinking about how only 10 years ago it was really the only way to income split (in retirement), but now thanks to Pension Income splitting the Spousal RRSP seems to have disappeared off folks’ savings radar?
During this exciting RRSP season (where the main topic seems to be whether you can sex up the argument about TFSA or RRSP) there does not seem too much being mentioned about the Spousal RRSP and its uses in an Bimodal Savings system.
Is This For Me ?
Let me be clear if you fit into any of the following groups then this advice is not for you:
Not married, if you don’t have a spouse, you can’t have a spousal RRSP.
If you are married but your spouse makes as much as you do
You and your spouse have a good pension plan (which you are sure is going to exist when you retire)
RRSPs are viewed as the devil’s own way to screw you into paying more taxes later in life.
The spousal RRSP was first introduced as the original income sharing mechanism. It can also be used for income sharing even before you retire (if you are careful, and you don’t care about your retirement funds).
On the retirement side of things, a spousal RRSP is relatively straight forward. It allows your spouse and you to split your moneys for your retirement years.
The way it can be used for income splitting(this is really simplified, do not do this until you consult with a financial professional) is once you put money in a spousal RRSP your spouse can withdraw from it and it will be taxed in their hands after three years. The 3 year settling period (for lack of a better term) is the key to this, after 3 years the money is viewed to be in your spouse’s hands and thus will be taxed with their tax account. Something to think about, but not really a good use of the Spousal RRSP overall (you lose that RRSP room each time your spouse withdraws from the funds). As I said, do not attempt this before consulting with a Financial Professional.
So let us give a cheer for the forgotten Spousal RRSP. It still can be an important part of your retirement plan!