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By Jason Heath | Financial Post
A common concern is how much you should contribute to a Registered Retirement Savings Plan (RRSP). The answer can be different depending who is asking the question.
Tax Free Savings Account (TFSA) contributions should be considered instead of RRSP contributions for a young saver early in their career. It may seem like a 20-year-old has a long time to invest for retirement, but there can be costs like education, a car, a home down payment, a wedding, and children, to name a few, that need funding in your 20s and 30s. Contributing too much, too early to an RRSP account can lead to the risk of having to borrow at high interest rates (i.e. credit cards) or even taking subsequent RRSP withdrawals to fund these expenses (likely at higher tax rates than the initial tax savings).
RRSP withdrawals can be taken to fund some of these costs like education or a home down payment. The Lifelong Learning Plan permits withdrawals of up to $20,000 from an RRSP to fund eligible post-secondary education. Up to $35,000 of RRSP withdrawals can be used to buy a qualifying home under the Home Buyer’s Plan. This is not to say a young person should not save for retirement. It is just that a young person should save for the short term as well as the long term. Early career RRSP contributions may not be as lucrative as contributing later as income and tax payable increase as well. A TFSA withdrawal can be used to make a RRSP contribution as income rises and while balancing other planned early life expenses.
One of the biggest impediments to RRSP contributions in your 30s and 40s is the escalation of other expenses such as mortgage payments, maternity or paternity leaves, child-care costs, children’s activities and saving for a child’s post-secondary education. This reinforces the importance of proactively planning and budgeting, especially as it relates to a potential home purchase. Buying a home that is too expensive to allow for retirement saving, or just leave room for other necessary luxuries like a family vacation can be both a financial and a marital mistake.
Peak spending often occurs in a saver’s 40s, but it depends if you have kids and when you have them. How much someone should be saving at this point is largely driven by personal factors like their existing retirement savings, the size of their mortgage, their planned retirement date, whether they or their spouse have a pension, whether they plan to downsize their home, and whether they expect to receive an inheritance. Proactively planning retirement on your own or with a professional can help identify monthly savings targets. There is no rule of thumb.
Late-career income tends to be relatively high. RRSP contributions and the resulting tax reduction may be beneficial late in a saver’s career. The differential between tax savings on contributions and tax payable on withdrawals is one factor that can make RRSP contributions beneficial in the first place. Of course, contributing earlier in your career and the resulting compounding effect is also important. A saver who is planning to downsize their home in retirement could be that much more motivated to contribute to their RRSP, even if it means paying down their mortgage more slowly by increasing their amortization to be able to contribute more.
One of the biggest risks late in one’s career is a potential job loss, disability, or death preventing a retirement savings target from being achieved. This emphasizes the importance of not waiting too late into your 50s or 60s to bulk up your retirement savings. A corporate restructuring or a change in your industry could leave you struggling to earn the income you are hoping to earn for as long as you are hoping to earn it. Disability, critical illness, and life insurance should be secured early in one’s career and maintained until a saver and their dependents become financially independent. Late-career retirement planning is important to not only set appropriate expectations for retirement, but also to avoid the risk of saving too little and balance that with the risk of working too long.
Employees should aim to maximize group savings plans that include matching contributions. Employers often make contributions of 25 to 100 per cent of an employee’s contributions as an incentive to save. Group RRSP investment options are often good and fees are generally competitive compared to typical options available outside a group plan. The forced saving aspect of investing before your salary hits your bank account is beneficial. Payroll contributions also accelerate your tax refund. The reason is group RRSP contributions have no tax withheld. This compares to making a lump-sum contribution from your bank account with after-tax dollars and waiting until April to get a tax refund. Beware buying shares of your employer’s company in a group RRSP unless there is an incremental employer matching contribution relative to other investment selections. The reason is you can have too much exposure to your employer. If the company does not perform well, not only can your investment in your employer’s shares perform poorly, but your bonus or even your job could be at risk — all at the same time.
Incorporated business owners can save and invest within a corporation or take withdrawals to fund RRSP contributions. These withdrawals can take the form of salary or dividends. Salary creates RRSP room, but dividends do not. Business owners with corporations should be considering the benefit of salary versus dividends as part of their compensation strategy. Planning for incorporated business owners can be complex, but it often makes sense to take compensation as salary, and it usually makes sense to contribute to an RRSP instead of solely saving corporately. There can be exceptions. New Tax on Split Income (TOSI) rules came into effect in 2018 and can increase tax payable on business income if a corporation or affiliated corporation like a holding company has significant investment income. This further reinforces the potential benefit of salary and RRSP contributions to reduce corporate investment income and tax payable.
How much to save in an RRSP depends on a lot of personal factors. Financial advisors and the media may like to quote rules of thumb because they are easy to understand and give savers something to relate to their own experience. The fact of the matter is how much you need to save for retirement depends on a lot of personal factors.
By Jason Heath | Financial Post | Published Feb 25, 2020
NB: This article may have been edited and/or condensed. The information contained is as of date of publication and may be subject to change. These articles are intended as general information only.