It’s getting close to the RRSP deadline and the pressure is on. Many financial services companies have been advertising the fact that you’re running out of time to make a contribution. They’re hoping that you’ll invest in your future with them, but did you know that it’s not always a good idea to contribute to your RRSP?
Despite what we’ve been taught to think, RRSPs aren’t for everyone. A tax refund is tempting but we all have different priorities. In the following situations, it’s best to not make a contribution at all.
1. You’re in debt – Debt can be crippling, so if you’re carrying a balance on your credit card, unsecured loan, or have an excessive car loan, it makes more sense to pay them off first. Reducing debt and adjusting your spending habits will be much more effective than any RRSP contribution.
“There simply is no excuse for having lingering consumer debt,” says Markus Muhs, an investment advisor with Canaccord Genuity Wealth Management in Edmonton. “If you have any, your number one concern should be paying them off.”
2. You lack an emergency fund – Talk to any personal finance expert and they’ll tell you that having an emergency fund in place that will cover at least three months of expenses is a must. You want to plan for the future, but being financially secure in the present needs to be addressed first.
Some would argue that you can simply use a line of credit in case of a financial emergency, but why would you want to borrow money to get out of a financial crisis? The last thing you want to do is make an RRSP contribution and then later realize you need to withdraw it due to an emergency. Not only will you pay withholding taxes and fees, you’ll lose that contribution room permanently.
3. You’re in the lowest tax bracket – Assuming you’re currently in the lowest tax bracket (25% marginal rate), you would get 25 cents back for every dollar you contribute to your RRSP. This sounds great, but don’t forget you have to pay this back when you eventually take the money out during retirement. It’s unlikely your marginal tax rate will be lower than 25% in the future so that means you would yield zero long-term tax savings. RRSP contributions benefit people in higher tax brackets the most so consider using your TFSA if you’re in a lower tax bracket.
4. You have a low income – If money is tight, you shouldn’t feel guilty if you’re not making RRSP contributions. After all, you still need to put a roof over your head and food on the table.
Those who expect to be a low-income retiree could also hurt themselves by contributing to their RRSP since the income from their eventual withdrawals may affect their ability to claim a Guaranteed Income Supplement or other senior benefits. In both situations using a TFSA might be better for short-term and long-term savings.
5. You have a defined benefit pension plan – If you have a defined benefit pension plan through your employer, there’s a good chance that you’ll already have a high taxable income in retirement. Combine that with the income that would come from your registered retirement income fund and you could see a clawback on your Old Age Security payments. This is really just an inconvenience, but it’s still a good enough reason to limit your RRSP contributions.
“People need to realize that the tax savings in contributing to an RRSP is not the short-term refund,” says Muhs. “The true tax savings is the tax rate differential between when you put the money into the RRSP and when you take it out, plus the tax-deferred growth.”
Flickr: KMR Photography