Common Sense

When NOT To Contribute To An RRSP

Daniel Duval, CFP - December 1, 2001

If we were to listen to all the advice out there, we would all be contributing the maximum to our RRSP's and we would each be able to enjoy early retirement as multi-millionaires. However, even if you’re able to contribute the maximum every year, is it always wise to do so? For most of us, it still makes sense to put away as much as possible inside an RRSP, but there are generally 2 times when a person should reconsider: 1) When you currently have low income and/or pay very little income taxes; or 2) If you've already accumulated a fairly large sum inside your RRSP. The reason behind both of these has to do with taxes, but that’s where the similarity ends.

Before we can appreciate why we sometimes shouldn't contribute, it's important to understand the benefits of RRSP’s and why most of us should take maximum advantage of this tax-saving vehicle. There are 2 main reasons for contributing to an RRSP: 1) The immediate tax savings, and 2) Tax-free compounding of your investments within the plan.

If your income is low and/or you're paying little or no income taxes, are you going to get any substantial tax back from contributing to an RRSP? The answer is no. You can't get a tax refund if you don't pay taxes. Not only that, but the government will then tax you later on when you take the funds out. In this case, a person would be better off investing outside of an RRSP, and then moving the funds to an RRSP if and when they begin earning a higher income and the tax benefits make it worthwhile.

At the other end of the scale, is there such a thing as having too much money in your RRSP? The short answer is yes. Like most things that are good for you, over-indulging can be harmful to your (financial) health. The reason is that as your RRSP nest egg builds, you're also building up a larger and larger tax liability.

This liability can hurt your pocketbook in two ways: First, once you turn 69, you're forced to begin withdrawing a certain percentage of your retirement savings every year. If you have too much in your RRSP, those large withdrawals will push you into a high tax bracket, which means losing a large part of your income to taxes. Secondly, those large withdrawals may cost you part or all of your Old Age Security (OAS) pension. The OAS is an income-tested benefit, which means that if a person collecting OAS earned over $55,309 in other income in 2001, the government began reducing their OAS payments. And the more you make, the more they take away. We've all paid our share of taxes, and should not put ourselves in a position to have to repay any OAS benefits just because we've done a good job saving for retirement.

For most of us, having too much money will not be a problem, however a little planning can go a long way in avoiding potential pitfalls of this kind during your retirement years. There are many options available as investment vehicles to supplement RRSP's that can provide the diversification and flexibility needed to minimize income taxes both before and during retirement. A competent financial advisor will be able to determine how much you will need to save to provide the desired retirement income, and can also help in determining the best investment vehicles to get you where you want to go.

We pay enough taxes already, there's no point in willingly setting ourselves up to pay a whole lot more in the future.

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