RRSP Pitfalls that CRA does not tell you
About the Author: Wilson Wong PC, are Chartered Accountants in Calgary providing tax and accounting services to small and medium sized businesses and high networth individuals.
If you are like most Canadians then you are banking a portion of your retirement plan with your Registered Retirement Savings Plan (RRSP). Before I get into the details of this article, I want to first qualify that I think everyone should have some RRSP regardless of what I have to say about them herein. We all will retire one day and the RRSP should be factored into all our equations.
The features of the RRSP is that when you are young(er) you will make a deposit to your RRSP and in turn you get to deduct that amount off the top of your net income that is used for calculating your taxes. When you are old(er) you will start to draw on that RRSP and it becomes part of your income to you in that future. When you turn 71 you have no choice but to start taking a minimum of 7% of the balance in your RRSP each year into your taxable income. With the above features the idea is you don't pay tax today but you pay at a later day and the growth you get within your RRSP is also tax free.
The RRSP is designed by some really intelligent people as on the surface it looks like its a great tool to defer your taxes but if you consider statistics and forecasting into the equation then you realize that the RRSP actually isn't in your favour in the long run.
When you are in your early working years you will earn a lower income and that's just the way it is, as you obtain promotions and salary increases you will gain more income in later years than you did in your early years of working. As a result you will save income taxes in your early years at lower tax brackets. If you are retiring with a company pension or you have calculated that in your retirement years you don't expect to be making a whole lot less income than you did in your working years then the RRSP becomes a negative tax benefit. You are making a lot more income in your retirement years than you did in your younger working years and that means when you draw on your RRSP you are being taxed at a higher tax bracket than when you saved money in the lower tax bracket. Even if say you're not going to get a promotion or a company pension, by virtue of inflation you will be making more in the future than you are in the early years. Almost always true then is that you will pay more taxes in the future than the savings you gained in the early years from your RRSP.
Another item of interest about the RRSP relates to the Old Age Security pension in Canada (OAS). As of writing this article the OAS is a pension available to individuals who have been residents of Canada and are aged 65 and over. Individuals who make more than $67,668 of total income will start to see their OAS being "clawedback" to be repaid as an additional tax in their personal taxes. If you have a company pension or some other source of significant retirement income other than your RRSP, receiving CPP benefits, and receiving the OAS then your RRSP at age 71 will become a problem. Consider that age 71 you must withdraw 7% at minimum of your RRSP. Also consider that in the long run, your RRSP is going to appreciate in value. I know most of us have seen our portfolios taking a big hit over the last few years but in the long run the S&P500 index performs at 11% a year over the last hundred years and if the world isn't ending tomorrow then that statistic is probably going to hold true for the general population who has a bundle of investments. What you may find then is that you may suffer from the clawback of your OAS at age 71 because that 7% minimum withdrawal may just trigger your income to be over the $67,668 threshold and is likely something you did not plan for or could plan for. After all you can't plan for what 7% is going to look like because you don't know how big that portfolio may grow to become in that future year. The RRSP here will effectively disqualify you for the OAS without you knowing about it.
This is some scary stuff I'm talking about in regards to the RRSP. Please do not misunderstand me and stop contributing to your RRSP. What I tend to think is that retirement is a very fragile planning process between yourself and your accountant. All of us must contribute to our RRSP in some way or form if you are to have a reliable retirement plan. My recommendation is that you plan for your retirement early in age, even if you are taking small steps. I also recommend that you review that plan with your accountant and financial planner once every few years, and practically every year in those final years leading to retirement.
-Wilson Wong, Chartered Accountant