When not to use a RRSP
This is a timely conversation. After a recent discussion with several young clients in the past couple of weeks, the topic of when not to use a Registered Retirement Savings Plan (RRSP) has been re-occurring.
At one recent example – a good client of ours brought her daughter in to sit with us, and produced a list of items she wished for us to talk about with her college aged daughter. One of the items she wanted discussed was “investing in an RRSP”. You can only imagine the surprised look on my client’s face when we reviewed that investing in an RRSP may not be the best idea at this time.
“You don’t want my daughter to save in an RRSP?” my client offered to me, “I always thought the best advice would be to start the RRSP right away?” she said.
This is such a very common conversation, and I can see why. The belief that the RRSP is the best and only way to save is so ingrained in our belief structure, it almost feels wrong not to listen to it.
There are some times and situations when we should be looking at other alternatives to the RRSP. This doesn’t mean that we shouldn’t be saving, it just means there may be a better place to save (often a Tax Free Savings Account (TFSA)) depending on the person’s situation in life.
Here are some situations that we should potentially not save in an RRSP:
- Low salary, and / or beginning a career: One of the easiest conditions to catch, is the person with a low salary, and / or beginning a career. If they are currently being paid a below average salary and in one of the lowest tax brackets, it may not be the best choice for them to be placing deposits into their RRSP. Often the immediate disadvantage here will be the loss of the potential tax credit for that year (if depositing elsewhere). The best move may be a deposit to a TFSA in that year, and then ultimately a transfer of the TFSA to an RRSP at a later time (and presumably in a year that they are earning more). A transfer of the TFSA to an RRSP at age 30 (at an average salary) instead of age 20 (at a below average salary), may result in thousands of dollars more in the hands of the saver. The RRSP works the best when the money is deposited at a higher income tax bracket, and removed in a lower income tax bracket. If this isn’t going to be the case – you may wish to consider your strategy.
- Above average pension, and RRSP already starting to grow sizably: Again with the perception that the RRSP is the only way to save we often come across many people who in addition to their above average sized pension, continue to contribute to RRSPs with as much zeal as possible. RRSP savings may work well for these clients in earlier years – when they are just growing their accounts, but as the account sizes begin to take on six figures – they should start doing some planning on how and when they will get that registered money out. The RRSP income will come out taxable, and care should be taken on how this will look in addition to their pension amounts.
- Next year you will be paid significantly more. If this is the case – then you may wish delaying your RRSP deposit until next year. By doing so, you will be entitled to a much larger tax break.
- You are a brand new business owner. New business owners may often experience some early successes, and start bringing in some sizeable savings deposits wanting to invest it in their RRSP. Some issues that they may not be predicting on their short to mid-term time horizon may be; the purchase of new equipment, hiring of new staff, low earning business years, and the need for immediate liquidity. As RRSP income is taxable, it can be a discouraging experience to deposit $20,000 one year, to only receive $12,000 of it back in your hands when you need it the most. It may be best for the budding owner to defer their RRSP deposit, and deposit their savings in a TFSA. TFSA income would be non-taxable.
- You are carrying high interest debt. In the event that one is carrying high interest debt on credit cards, or other high interest debt – they may wish to consider paying down these debts before investing. Often someone is particularly eager to save any new money in an RRSP when they opportunity presents itself, but the reality may be that the money may be best spent paying down the debt they hold. If you are paying 18% high interest debt rates – it makes more sense to pay that back, than earn 6% in the RRSP.
These are all common situations, and I find that simply talking about these with clients, often helps unravel some of the questions that we have when utilizing RRSPs. Through good discussion comes clarity. RRSP investing is a terrific solution for many people. The design, features and implementing of an RRSP is usually an attractive solution which allows many to receive a timely cheque in the mail in the spring. Not understanding when you shouldn’t be investing in an RRSP sometimes isn’t as clear, and really needs to be discussed more often.