After the Christmas season, apart from credit card statements, our financial thoughts turn to RRSPs. There’s a lot of advertising for them in the New Year. Why is that, what is an RRSP and is it the right investment choice for me?
Registered Retirement Savings Plans, or RRSPs, were introduced by the Canadian government in 1957 as a way for Canadians to save for retirement. They have proven to be exceedingly popular, and with good reason. The amount you contribute is tax deductible, which means this contribution is taken right off your income. If you have an income of $50,000 and contribute $5,000 to an RRSP, then for all intent you now have an income of $45,000 and would pay income tax on that. You could save about $1,620 in taxes. Everyone loves getting those tax refunds in the spring! The money you contribute grows on a tax deferred basis, meaning you pay no tax on anything you earn on your RRSP. Deferred is the key word. Unlike a Tax Free Savings Account, you pay tax on your RRSP later on, when you withdraw the money, which you must do whether you need to or not. Here’s some basic information about RRSPs
- You can contribute up to 18% of your earned income with a maximum contribution of $26,230 in 2018.
- If you have not maximized your contributions, the unused room accumulates for future use. You can find your total contribution room on Line A of the notice of assessment you receive from the Canada Revenue Agency.
- Contributions in the first 60 days of the year (sometimes longer if the 60th day occurs on a weekend) can be used against your income of the previous year. Hence, the reason for the promotion of RRSPs in January and February.
- Your RRSP can be invested in a wide variety of investments including Guaranteed Investment Certificates, stocks, bonds, mutual funds and exchange traded funds.
Unlike an RRSP, money in a Tax Free Savings Account, or TFSA, can be withdrawn with no tax charged. However, you do not get a tax deduction like you do with an RRSP.
So, what is better for you, an RRSP or TFSA? I can do all sorts of calculations and prepare charts and graphs. The thinking often goes that if you are in a lower tax bracket now, a TFSA is better. However, here’s the thing which has nothing to do with numbers. Psychologically, people look upon their RRSP as their retirement savings, which it is. Their intent may be to save in a TFSA for retirement, but human nature being what it is, if the basement leaks or the car’s transmission goes, or February is so unbearable I need to get away for a week, then the TFSA becomes the emergency fund. Yes, you can dip into your RRSP if you need to (tax is paid on any withdrawals), but with an RRSP you would only do that in a desperate situation. This is why I prefer, especially for younger people, that they save in an RRSP. Many people working today have no workplace pension and little in the way of other assets. An RRSP will help them secure a better future.
Start saving what you can. Once you are in the habit of saving you can increase your contribution. It may not seem like much, but if you invested $100 a month and earned a rate of return of 6%, do you know how much you would have in 30 years? Send me a message and I’ll let you know! Feel free to connect for a complimentary financial fitness call. I’d love to get you started on a savings plan!