Happy Valentine's Day, also known as the unofficial beginning of "Panic to get your RRSP contribution in before the deadline season". Whether you're single or spoken for, chances are you're fairly comfortable with your routine each year, your yearly love affair.... with RRSPs.
Well, STOP! Think it oh-oh-ver.... Are you and your "savings plan" compatible? Did you know there are other fish in the sea possibly bigger if not better than RRSPs? Just because your parents liked them doesn't mean the RRSPs are always the right choice.
Depending on your financial situation, your savings contributions could be directed into better savings solutions, such as your TFSA. Here's a run-down of some scenarios where contributing to RRSPs are possibly NOT the best solution:
1) If you are currently in a lower tax bracket: Since you're already at a low tax rate, chances are, your taxable income will be higher in the future when you withdraw your RRSPs. This may actually cause you to pay more taxes which defeats the purpose of deferring them. Consider using the TFSA instead if:
- You're early in your career
- You were on parental leave, worked part-time or for only part the year.
- You are a business owner and not drawing a sizeable salary (or paying yourself in dividends, etc).
As a general rule of thumb, if your taxable income is under $45,000 then you most definitely do not want to contribute to your RRSP and instead, invest in your TFSA. If your taxable income is between $45,000 to $90,000 per year, then it is a grey area on whether the TFSA or RRSP is better for you and you will want to talk to a Financial Planner to decide what makes the most sense based on your current and future situation.
2) If you anticipate you will be in a higher tax bracket later: The withdrawal of RRSPs are taxed as income. This means, if sizeable enough, they could lead to OAS claw-backs or claw-backs of other income-tested government benefits. Contribute to your TFSAs first if:
- You will be earning sizeable income in retirement
- You currently or expect to have a large RRSP portfolio
- You have a pension
3) If you have high interest debts: Deferring your taxes isn't going to earn more than you are losing through high interest rates.
4) If you have short- or medium-term needs for money: If you withdraw your RRSPs early, not only do you pay the income tax at that time (potentially boosting your tax bracket), but you also lose the contribution space - forever.
5) If your spouse is in a low tax bracket: This isn't really against contributing to RRSPs, but generally a reminder that you can contribute to a Spousal RRSP instead to split future income.
6) If you will be moving away from Canada: Unlike your Valentine, the RRSP cannot travel with you to other countries. If you have an RRSP, you must either leave it in Canada or withdraw the balance and pay a large one-time tax bill.
When you're making choices regarding your registered investments like RRSPs vs TFSAs, be sure that they make dough for you, like you want them to. When you understand how these investment tools are designed, there's no need for a blind date. You can make better more informed choices when tax season arrives. I believe in investing in the long term in a low-cost, diversified, passive portfolio of index funds / ETFs. Then, just like Richard Marx, your retirement nest egg will be right there waiting for you.