Personal Finance

The lower your tax rate, the less beneficial an RRSP contribution.
By Pira Kumarasamy | 16/02/18

If the December holiday season is the most wonderful time of year for you, consider that early in the new year is an even better time to save for retirement. You can put money into long-term savings and receive a 2017 tax refund by contributing to your registered retirement savings plan (RRSP) by the March 1 deadline. Or you can shelter investment income for as long as you want by contributing to a tax-free savings account (TFSA), with new contribution room every Jan. 1.

About the Author
Pira Kumarasamy is a financial writer who writes for Morningstar on personal-finance topics, with an emphasis on issues affecting the millennial generation. She holds a bachelor of arts, economics and accounting from Wilfrid Laurier University.

As with saving for a child's education, saving for retirement can be a challenging concept to wrap your head around as a millennial. At this stage of life, retirement is decades away. It's very likely that you have near-term obligations that are currently a higher priority. In fact, a TD-sponsored survey, conducted by Environics Research Group and released in December, found that 42% of Canadian millennials (aged 18-34) believe they are too young to think about saving for retirement.

It's understandable that the idea of retirement can feel daunting, but if you wait too long to start saving, you'll need to save more on a regular basis to earn what you would have earned had you started saving now. In other words, $100 per month now is not the equivalent of $100 per month a decade from now.

Should you invest in an RRSP?

Canadians have a number of alternatives available when it comes to saving for retirement. One of the most popular ways to save is the RRSP. It might seem like the obvious choice for most people, but the reality is that the decision is not clear-cut.

"I believe it comes down to the individual and their current situation and what their goals are," says Jennifer Diplock, associate vice-president, personal savings and investing at TD Canada Trust. "Having a registered retirement savings plan does help reduce taxable income while ensuring that you have income when you're in retirement to help you live the lifestyle you want."

When choosing where to park your retirement savings, tax rates are an important consideration. Investing in an RRSP enables you to reduce your taxable income. Investors should keep in mind, however, that it's a tax deferral, not a permanent tax reduction. This distinction is important, because it means you'll need to pay taxes in retirement, when you're presumably in a lower income-tax bracket.

If you're early in your career and already in the lowest bracket, however, the savings you receive now will be taxed at your highest marginal tax rate when you eventually withdraw the money. Under this scenario, there would be no advantage to you in terms of tax rates. This doesn't mean you shouldn't consider an RRSP, since you'll still have the advantages of tax deferral. But it does mean that RRSP contributions aren't as beneficial as they would be if you were in a higher income-tax bracket at the time you make your contributions.

What alternatives are available?

The RRSP might be the most obvious way to save for retirement, but it's not the only way. If you're in the early stages of your career and suspect that you might not receive the full benefit of contributing to the RRSP, consider your alternatives. Among them:

  • A TFSA enables you to earn tax-free income and capital gains. The maximum contribution for this calendar year is $5,500. If you have the money, you can also take advantage of unused contribution room from past years, subject to the age requirement of being at least 18 years old in the contribution year. You won't get a tax deduction for your TFSA contribution, but you won't be taxed on any withdrawals. You also won't lose contribution room if you need to make withdrawals, as you would if you took money out of your RRSP.

  • A non-registered account doesn't have the tax advantages of a TFSA or RRSP. But if you need more contribution room than a TFSA provides, and you think you might need to pull out money before retirement, this alternative could play a role in your savings.

  • Life insurance is something that can work in conjunction with retirement savings to protect your loved ones. Certain plans include a cash component that accumulates and can be pulled out near the point of retirement to enhance your savings.

It's important to keep in mind that different types of savings and investment plans can work together to create a sound financial strategy. In deciding on the right mix for you, time horizon is an important consideration.

"A younger person might have goals on their short-term horizon such as investing in a business or buying a house, which has to be factored into the long term," says Chris McIntyre, a financial advisor with Edward Jones. "Breaking out short- and long-term goals helps younger generations understand that the retirement savings plan is just one component of what they're saving and what they're making."

Do your research

At the end of the day, it's important to set out goals for yourself and do your research. One of the common complaints, for instance, is not fully understanding the tax consequences of taking money out of an RRSP, says McIntyre.

When it comes to registered accounts in particular, it's a good idea to check out the government's online resources to determine eligibility and the implications of contributions and withdrawals from a tax perspective. If you have a financial advisor, now is the time to visit him or her for added clarification.

Retirement might seem like a distant goal at this point in your life, but taking the time to plan and incorporate it into your overall financial strategy will allow you to maximize your savings and live the life you want in retirement without sacrificing your current goals.

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