Making The Right RRSP Choice

decision_making

The RRSP deadline for Canadians that want to make a contribution is on March 1, 2018. That leaves just under 2 weeks away if you want to make a contribution this year. As RRSP goes, Canadians are making less and less contributions towards their retirement. In fact, as reported by the CBC, Canadians have been raiding their RRSP accounts over the past few years to pay for their everyday expenditures.

Now the numbers by the CBC are probably not as dire as reported because more and more Canadians are reaching their retirement age, but there are some concerning numbers regarding withdrawals.

  • 27% withdraw to buy homes
  • 20% need to pay off debt using their RRSP.

Can’t Become Financially Independent With A House

In my opinion buying a home using your RRSP is a bad idea. Most think dipping into the RRSP to buy a home is a great way to increase the down payment on a home you could otherwise not afford, but that in itself should already raise warnings. If the house is already on the borderline of affordability, then it should be an alert that you can’t afford the home to begin with.

A second statistic that shows that many people who use the Home Buyer’s Plan don’t pay back the amount that is withdrawn. A report in 2013 showed that almost 50% don’t pay back the amount that is withdrawn from their RRSP. This is one of the main reasons why I wrote using your RRSP for a home purchase is a bad idea.

Lastly, raiding a retirement fund to buy a home is not a means to become financially independent. Many feel that buying a home is the best investment one can make, but once all the costs and expenses are factored in, the only thing a house does is drain monthly cash flow. When retirement comes and the cupboard is bare, there is nothing left but to sell the home for funds to retire on. Just imagine what happens when 90% of the population is thinking the same thing as you when it comes time to retire. Will your house be worth as much as you think?

Use To Defer Taxes

The proper way to use the RRSP is to use it to defer taxes. This means that there are only a few instances where contributing to an RRSP is a must:

  • You are in the highest tax bracket
  • You plan to make less income in the future than you are right now
  • You plan to take an extended unpaid absence from working
  • You are income splitting using a spousal RRSP

There are some instances where contributing to RRSP is bad:

  • You will have a defined pension that pays a large sum back to you when you retire
  • You need the money in the short term
  • You are expecting a big raise in the short term that puts you into a higher tax bracket

If there is anything to remember about the RRSP, it’s that it’s best used as a tax deferral tool. It’s main use is not necessarily to retire on since there are many other options to saving for retirement.

Don’t Borrow From Future Self

I’ve written about it before, but one of the most important aspects about contributing to the RRSP is to not spend the refund. That’s because the refund is needed in the future to pay for the taxes when money is removed from the RRSP. Too many people make the mistake of spending the refund and thus are basically taking a loan from their future self. Don’t do it!

The difference between the TFSA and the RRSP is that withdrawals in the future are taxed when taken from the RRSP. The refund represents taxes saved at the current time, but since taxes must be paid in the future, spending it now will result in less money in the future.

If there is a short term use for the money that is going into an RRSP, consider putting that into your TFSA instead. Not only will gains be taxed free, but withdrawals can be made without taxes as well. One other bonus for the TFSA is that the contribution room comes back at the beginning of the next calendar year if money is withdrawn. The same can’t be said for RRSPs. Once the money is withdrawn, the contribution room in the RRSP is lost forever.

Mark Your Calendars

If you are still thinking of making a contribution to your RRSP, then better mark your calendar to get it done before the deadline passes. Once March 1, 2018 passes then RRSP contributions will no longer apply to income made in 2017.

There are a few easy ways to make your contribution depending on the financial institution you work with:

  • Make an online transfer to your RRSP account.
  • Book an appointment with a personal finance representative at the bank.

If you’ve already made your contributions for the year, then sit back and relax. There is nothing more you need to do.

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