HOW MUCH SHOULD YOU CONTRIBUTE TO YOUR RRSP?
Jason Heath takes a look at factors you can consider at each stage of your career.
February is the month that retirement saving takes centre stage, though it should be a year-round affair. 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.
EARLY CAREER
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 an RRSP contribution as income rises and while balancing other planned early life expenses.
MIDDLE AGE
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
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.
HOW MUCH IS TOO MUCH?
How much is too much to have in a RRSP? At the expense of sharing a rule of thumb, a $1-million RRSP for a single retiree or $2-million combined RRSPS for a couple can potentially lead to higher tax payable in retirement than the tax savings on contribution. Minimum required withdrawals in your 70s coupled with Canada Pension Plan (CPP) and Old Age Security (OAS) pensions could result in taxable income of $75,000 or more. If a senior has a net income exceeding $79,054 on their 2020 tax return, it will increase their marginal tax rate by 15 per cent due to OAS pension recovery tax (clawback). A senior receiving OAS and earning $80,000 is in a marginal tax bracket of up to 53 per cent depending on their province or territory of residence. In fact, seniors subject to OAS clawback can have a marginal tax rate as high as 62 per cent in 2020. For some retirees with large RRSP accounts, tax on withdrawals could be higher than what they saved on their initial contributions.
All that said, there are lots of asterisks on any assessment of how much is too much to save in a RRSP, most retirees have nowhere close to $1 million in their RRSPS, and besides that, having too much money in your RRSP is a pretty good problem to have in the first place.