Today, there are a variety of ways to save money and several schools of thought to what is most effective. There are even some industry pundits who would weigh in and say that a TFSA, “tax-free savings account” has more value than an RRSP, “registered retirement savings plan”.
For sure, there are always situations that favour one scenario over another. In general, however, for the majority of the working population, an RRSP still holds the most value. The simple caveat to this is that the one glaring exception is the self-employed business owner that pays themselves a very low taxable income and is in one of the lowest marginal tax brackets. In that situation since there aren’t significant tax savings, a TFSA might make some sense. That said, in my experience if the self-employed individual has such a low income they are unlikely able to contribute to any investments anyway.
How an RRSP works is clean and understandable for all. Whatever you contribute is essentially deducted off the high point of your taxable income, and you pay income tax on that lower number. So, if your marginal tax, the tax rate your next dollar of income is at, is for example 40% then a $ 10,000 RRSP deposit should reduce your taxes by $4,000, 40% of the $10,000. Now, that $10,000 goes into the basket of your RRSP and any growth that basket obtains is tax-free. Later, when you withdraw you will pay tax at your current marginal rate when you take the money back out, usually a lower tax rate than when you were actively working.
A TFSA works differently, you pay tax on all your income so if no RRSP deposit, you would pay $4,000 more income tax then you put that after-tax money into your TFSA where it grows tax-free. When you withdraw from your TFSA there is no tax on the withdrawal since it was funded with after-tax money.
The reality is most advice against using your RRSP falls towards either the low reported earning self-employed or the folks in the highest marginal tax bracket after they’ve accumulated more than $1,000,000 into their RRSP with five-to-ten years or more left of contributing time. Once an RRSP basket of investments will generate the highest marginal tax rate when you withdraw from it there is no more value in the tax sheltering and it has mandatory RRIF requirements once you hit age 71 so you lose some flexibility.
The majority of the population wishes they were in this situation but the reality is most Gen X’ers haven’t saved enough to be on track for this kind of situation. Does that mean they should panic, no absolutely not? The situation was somewhat similar for boomers. How and why did boomers get into a more positive position, timing? Until most people are roughly 50 they are dealing with their highest years for expenses, housing, children, post-secondary education for their children and so on, a normal phase of life. Once they hit 50 they are better positioned to save, they have more cash flow and are usually at their peak incomes just as they have fewer expenses. This allows them to over contribute the last 10-to-20 years they work, playing catch-up to fill their retirement nest egg.
Today we read about fewer contributions going in. Some of this is from the growing craze about fees and use of online investing. Statistically, people using a financial advisor generally have a higher net worth and are better positioned to retire. Is this because they earn more? No, it’s because using a planner they are better able to see what their goals are and get instructions on how to get there. Advisors can help them plan tax efficiently, let them know how much they need to save and review their goals annually to make sure they stay on track. We’re all human and the fact is many of us wouldn’t have the discipline to save so effectively without the help of a planner. They hold your hand when the market fluctuates, prevent you from buying high and selling low and while they don’t have a Chrystal Ball guaranteeing returns (run if the say they do) they can help you make less emotional and more structured decisions to reach your goals.
Is there a cost, absolutely, they must run offices, manage compliance and have the staff to manage running financial plans and to monitor your investments. All things you want them to be doing. They can, however, give you the diversification and discipline you need to get to your goal. Using an RRSP is just one of the methods they can use to help you obtain your goals and maintain your targeted lifestyle. It also happens to be the most efficient way for most of the population in Canada to save.