Your RRSP – Yet Another Reason to Plan

February 17, 2017

The RRSP contribution deadline is less than two weeks away and many Canadians will again leave things to the last minute and perhaps miss the deadline altogether either because of poor planning or simply due to the fact that there aren’t adequate savings to allocate to their RRSPs. Some will decide not to contribute out of concern over the state of financial markets, while some will listen to advice that RRSPs just don’t make sense.

Over the past several years I have dealt with all of these issues, but it is worthwhile reviewing them again today, especially as the outlook is probably more uncertain now than in the past. Let’s deal with the easy ones first.

Every year after tax time, when Canadians receive their tax assessment, the RRSP contribution limits for the current year are known with complete certainty. If there is enough surplus savings the best strategy is to make the maximum contribution. The reason is that investments made inside the RRSP will generate income where tax is deferred, compared to the income that is taxed ongoing in either bank accounts or non-registered investment accounts. For those where there is not enough excess or available funds from other non-registered investments, the best strategy is to take that maximum contribution and divide it by the number of months until the contribution deadline for that tax year. This will require careful planning and budgeting, but it will prevent a mad dash at the deadline.

This applies to individuals that may not need an RRSP contribution to bring their effective personal income tax to zero (such as young Canadians working part-time while in school). The reason being that the deduction room created by the cumulative contributions can be carried forward to years where incomes and taxes are higher.

 

 

The market explanation for why some are reluctant to contribute to one’s RRSP depends on the state of the market around the contribution deadline. In times when equity markets are tumbling, investors will shy away out of fear that any new money put into an RRSP will simply vanish with the market. Still, others will look at a market that appears to be overbought (like today) as a bad time to invest new money out of concern the market will drop soon after the contribution. These concerns are irrational given that new money placed in an RRSP does not necessarily have to go into stocks. It should be invested such that the individual’s asset allocation strategy is not violated. More to the point, any contribution can just be parked in cash or lower risk securities, such as bonds. In other words, the condition of the equity market should not be used as a reason not to contribute to the RRSP.

 

 

One of the other reasons cited for not adding to the RRSP is that there will be adverse tax consequences down the road. Here is where proper planning is crucial.  While some Canadians may find themselves in an adverse tax situation  in later years from the RRSPs they have built up through life, this will be a minority of the cases for Canadians. Why? Basically because the majority of Canadians do not max out their RRSPs to begin with and therefore will likely be in a lower tax bracket by the time they reach 71. For those who might face a situation where taxes are higher, then planning well before the time their RRSPs are slated to convert to RRIFs will help determine the optimal contributions in their remaining earning years.

All of this, however, depends on what the tax environment in the future looks like. Are marginal tax rates going to be higher or lower when one turns 71? What if income splitting allows a couple to keep a lid on overall taxation at that age, but then one spouse passes away and income splitting is lost? Then there is the decision on whether to re-allocate non-registered investments into RRSPs. If we are talking about stocks with large capital gains, some will resist liquidating or even transferring in-kind as this will trigger a gain. Keep in mind that capital gains taxation is still the cheapest form of investment income tax going. That may very well change in future years, so triggering gains now for the sake of making an RRSP contribution might make sense.

 

Main Events Next Week

Canada:  Family Day holiday, wholesale trade, retail sales, CPI

US:  Presidents’ Day holiday, existing home sales, FOMC minutes, new home sales, Univ of Michigan sentiment

 

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