Why Most People Should Be Building a Registered Retirement Savings Plan (RRSP) Account
To be clear, my belief is firm that everyone should have at least some form of a financial plan. Too many clients we see have reached their 50’s and are playing catch-up to what savings they should have in place. Many simply don’t feel they need to do much and assume (or hope) they’ll have the same lifestyle when they retire as when they worked.
I don’t know how many people I’ve heard joke about the old “Freedom 55” slogan. Yet it is possible. There are so many variables that everyone’s situation is different. If you are nearing 50 and find your retirement plans are lacking, all is certainly not lost. For many people they have more disposable money post age 55 and can make up the difference. Others can downsize their principal home when they retire and use that to fund some of their retirement.
The only true way to know where you stand is to create a full financial plan, outline what your retirement goals are and most importantly what you need to save to meet them. Much of the value in having a Retired Registered Savings Plan (RRSP) account is in tax deferral and tax free compounding. It is critical to remember that when you do want to access your RRSP or convert it into a Registered Retirement Income Fund (RRIF) it becomes taxable income. By planning and knowing what other sources of income you’ll have when you retire, you can better determine how large you want (need?) your RRSP to grow.
When you do retire you will have government pensions, a work pension if you have one, TFSA’s and income from any rental properties or open investments you may have. The ultimate goal of a financial plan is to grow your wealth and to minimize your taxable consequences when you use your money.
One of the underused features of the RRSP rules are that you can carry forward your unused deposit room. If you know your income is increasing each year and the impact of a deposit in a given year is minimal, sometimes it is worth holding off. In other cases, far too often I see people who haven’t thought about the tax savings and the Canadian tax bracket system. As RRSP deposits in the qualifying period act as a reduction in taxable income you can often change your tax bracket. Some years taking an RRSP loan actually makes sense, particularly if you have room and had a higher tax year due to a bonus or unexpected taxable windfall.
What you and your financial planner should be doing is looking at the impact of the RRSP deposit based on your income. In Ontario, a deposit can save you as much as 49.4% in reduced taxes depending on your tax bracket. A great strategy is if you can reduce your income and get a return of 40% on your deposit: Then deposit the return, assuming you’ve paid up your taxes during the year, into yourTFSA. The funds can also be used to pay off the RRSP loan if that’s a concern.
Once money is in your RRSP, it is allowed to grow on a tax sheltered basis, allowing for compound accumulation. This is where the true strength of the product lies. If you invest when you’re young and do it regularly you really could achieve “Freedom 55” or early retirement. Having a financial plan in your 30’s has so much value over waiting until your 50’s to begin. It takes very little commitment to earn a million dollars in your RRSP if you start in your 20’s with compounding and tax sheltered growth.
Another point of consideration is the type of savings vehicle used for an RRSP. Often people do not realize that there is a wide array of investments allowed to be held in an RRSP. With everything we suggest, diversification and planning is the key. Some business owners for example may wish to use segregated funds due to the insured elements and added layer of creditor proofing. Other might use mutual funds, stocks, bonds or even GIC’s. Certainly finding an investment that matches your risk tolerance is never an issue.
Having a financial plan and planner allows you to determine what you invest in. Knowing your entire plan and creating goals allows your financial planner to drive more aggressively taxed investments into the registered shelter and more leniently taxed investments into your open accounts. Things like interest income for example is taxed at a higher rate than dividends or capital gains.
Taking advantage of the many features of having an RRSP makes sense to most people with a working taxable income over $35,000-$40,000. The higher the income the more it makes sense. Talk to your financial planner today to see if you are maximizing your tax advantages from your Registered Retirement Savings Plan account.
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