G&M: RRSPs are getting a bum rap as a tax trap

[waterfall123]

@christian_bibin Now all I need is a link explaining what a "dick bicycle" is and I will be an educated man.

 

[angeline789]

@waterfall123

 

[asmodea]

@mtainmn43 It is likely that most of the people complaining to the author about the tax they are paying on their RRIF withdrawals are people who didn't have the TFSA option for most of their accumulation period. (Assuming that they RRIFed in 2016 at age 71 then they would have been 64 when TFSA were introduced.) For them it would be more important to demonstrate that even if they are paying high tax now they are probably better off because of all of the years that their retirement savings got to compound without the drag of annual taxation. (Before the introduction of TFSA it was easy to find newspaper articles that demonstrated this.) Of course some of them might be paying less tax if they had sought advice on the when to start using CCP, OAS and the RRSP funds.

 

[resjudicata]

@asmodea Agree. And a lot of those people (from statistics) with large RRSP balances are covered by DB pensions. It is the DB pension income that kicks the personal RRSP draws into the higher tax brackets. And it was the high wages paid to people with DB that prompted them to make personal RRSP contributions as they were working.

Maybe you remember .... in my memory historically those with DB pensions did NOT have their personal RRSP contribution room reduced. It was only relatively recently that there was an offset. So people back then could really stash away a lot in their personal RRSP.

 

[asmodea]

@resjudicata I knew that our RRSP contributions had always been reduced by our pension contributions but we only started contributing to one in 1990. So I did some "binging".

According to page 9 of this StatsCan report from 1957 forward RRSP contribution limits have always been reduced by the employee's contribution to the RPP.

What I don't remember, and bing isn't helping, is what happened to people who contributed to but didn't use RHOSP. Specifically, were they allowed to roll it into an RRSP and if so did they need to have unused RRSP contribution room?

 

[resjudicata]

@asmodea So my memory was wonky on that. Pretty sure I rolled my RHOSP into an RRSP but my memory could be wonky on that too.

 

[trail45]

@resjudicata Personal experience:

I just retired after working for the same company for 37 years - I started in 1979.

I had a DB pension plan and maxed
out my RRSP contributions every year.

My 2017 RRSP allowable contribution was $3495. Every year I could only contribute ... somewhere in the 2K to 3K range.

My RRSP balance is less than $200,000 (always invested conservatively, never lost, but never made huge gains)

 

[resjudicata]

@asmodea You had a year in which to withdraw all of the funds and pay no tax. No extra RRSP room generated as a result of an (unused) RHOSP contribution, which have always and only been tied to earned income.

 

[asmodea]

@resjudicata Thanks for the information. I remember that my brother didn't want to close his account so I thought he might know. He didn't but he found a reference that had the same information.

 

[okeoma]

@mtainmn43 The RRSP seems much better for early retirement than for retirement at 65. If you are planning on working until you’re eligible to receive CPP, my guess would be you are likely either a)a middle- or lower-income earner who will work until that age in part because the CPP leg will be a significant part of your retirement stool; or b) someone who loves working and whose career is a big part of his or her personal identity.

In both cases, your tax rate in retirement will not be appreciably lower because, in the case of a), your tax rate was never that high to begin with and b)I am assuming you are a higher-income earner who is likely to have at least some other sources of income in retirement (a private pension, maybe, or a non-registered account or other investments). In the case of b), OAS clawbacks could definitely make your marginal effective tax rate higher than your rate when employed.

The RRSP, I think, is a good tool for people who want to retire early, who can collapse it between their retirement age and the age of taking CPP (or at least before they have to convert it to a RRIF), when they will then rely on a combination of CPP, private pensions (if applicable), and more tax-efficient income from non-registered accounts. For people with children nowadays, there’s a bonus to the RRSP as it can reduce net income when their children are young and eligible for the Child Benefit, the clawback rates on which can be very large for some families at some income levels.

I know that the article is about existing retirees who didn’t have access to the TFSA, and that’s why I didn’t mention the TFSA above. I think it’s a (very big) bonus. Those retirees the author is quoting probably would have been better off using non-registered accounts with more efficient taxation. That’s especially true if they had an employer pension plan, which was more common in the past.

Summary: the RRSP is for income smoothing, not retirement. Collapse it before taking CPP and receiving other pensions, if applicable. Don't let yourself be forced to convert it to as RRIF.

 

[mormarw]

@okeoma I agree, from examples I've seen, RRSP definitely has a clear advantage for those who plan to retire early with no form of pension during that time.

On the flip side TFSA has a clear advantage when the goal is to leave money for inheritance. Any money in an RRSP when you die, will be instantly cashed out, with all the tax coming out at once, often at one of the highest tax rates. But the TFSA will be available at market value.

 

[rainbowdreamer]

@mtainmn43 I haven't yet seen this "debate" address the scenario that taxation increases (regardless of your income level Increasing/decreasing). Then would rrsps not work? I would think tax rates should increase, not decrease, with time.

 

[davetownsend]

@rainbowdreamer If you look at the past 20 years of federal brackets, there hasn't been a huge amount of change. There has been some minor increases both up and down, but nothing that dramatic.

https://en.wikipedia.org/wiki/Income_taxes_in_Canada#Personal_federal_marginal_tax_rates

 

[mormarw]

@mtainmn43 While like others say, GIS & even OAS may at some point become means tested, but they aren't and until they are those clawbacks do factor into the equation.

However, lost in this TFSA vs. RRSP argument is the fact that the majority of people should probably be putting away more per year than the the TFSA can take. I'd hate to think that people who make around $100K/year are filling up their TFSA every year, and calling it a day, hoping that the 5.5% savings rate will be enough.

The reality is for most lower income Canadians TFSA is the right answer, but for the rest RRSP & TFSA in some mix is probably the right answer.

 

[kevinott777]

@mormarw Unless the lower income people have kids! That can change the RRSP equation quite a bit, as CCB goes up for every dollar you put into RRSPs. With three kids, you can get 20% extra, tax free. Plus the RRSP refund.

 

[resjudicata]

@mormarw

that the majority of people .....

It is important to remember that about 50% of workers are earning income in the bottom tax bracket. So by definition 50% of workers are better of in TFSAs. And the $5.500 TFSA funding limits will provide a complete replacement of their income in retirement.

 

[mormarw]

@resjudicata When I was 18, I was in the lowest tax bracket, now I'm not. That would be typical of many people. I'm guessing that the majority of people fit into similar circumstances. Also consider households with one person working full time and one person working part time.

The majority of families will need to put away more than $5500 per person/per year to maintain their lifestyle.

Also worth noting that these TFSA vs. RRSP arguments also only hold up for people who turned 18 at or after 2009. For those of us who turned 18 before TFSAs were even around, it's even more important that it isn't the only form of savings used.

 

[stackhouse1981]

@mtainmn43

You'll have $3,000 for the RRSP on an after-tax basis because of the tax deduction you get for making the contribution (this assumes your tax deduction goes into your RRSP and isn't spent elsewhere).

That right there is the key. How many people do you think take their tax refund from RRSP contributions and stuff it back in to their RRSP/TFSA? I bet it's nearly non-existent outside of the people on this sub.

edit: I suck at formatting

 

[resjudicata]

@stackhouse1981 I agree that just about the most important 'tip' or 'advice' for savers now is the fact that $1,000 into an RRSP does NOT equal $1,000 into a TFSA.

But I disagree that most everyone increases their consumption spending when using an RRSP. IMO any tax refund simply goes into the chequing account. Your lifestyle spending continues as always, and the larger bank account balance will trigger another contribution to either an RRSP or TFSA faster than otherwise. So the tax savings from the RRSP does get cycled back into savings - just not directly.

Same if you get no refund because you had other income from which there was no withholdings. In that case if you had saved in a TFSA you would have been stuck with a bill on filing. Payment of that bill would have reduced your chequing account and delayed the next point at which you moved $$ into savings.

 

[soikeobongda]

@resjudicata I need more than one hand to count the number of people I personally know who would unquestionably (and unquestioningly) increase their consumption with a bigger tax refund. In fact, one of them fairly consistently pre-spends his anticipated tax refund each year at The Brick with no-interest financing. And if he was the type who contributed to his RRSPs with post-tax dollars (it won't surprise you to learn he isn't), I've every confidence he would factor that anticipated increase to his refund into his new TV or living room furniture or whatever that year.

But that's just my anecdote, which doesn't count as data. I also feel like we could well be in a bit of a bubble here on PFC with respect to anticipating how most people make financial decisions. I wouldn't be so bold as to say "most everyone" would increase consumption but I think a very significant portion of the population would.

Happy to see data on this point of how refunds affect consumption. Would be really interesting actually.