See the Journal’s special RRSP report, starting on
Only 26% contributed to a registered plan in 2010 despite tax advantages
Still using stock-market volatility as an excuse to avoid putting money into an RRSP or even to avoid savings of any sort? Really now.
If a recent flurry of polls from financial institutions are at all accurate, Canadians will be topping up their RRSPS at least as much as in prior years, but that’s not saying much.
According to Statistics Canada data released in December, 5.96 million Canadians contributed to RRSPS in 2010, down 0.2 per cent from 2009.
The median contribution was $2,790 and total contributions rose 2.6 per cent to $33.9 billion. But that represented a meagre 5.1 per cent of total available contribution room. Almost 93 per cent of people filing taxes were eligible to contribute in 2010 but only 26 per cent made contributions of any amount, similar to 2009. The vast majority still have no RRSP.
Why such meagre contribution rates when seemingly everyone frets about retirement and more than half have no company pension plan to fall back on?
Excessive stock-market volatility is the pet excuse but this is the fourth RRSP season since the 2008 stock-market crash, so that excuse is becoming a bit threadworn. Even so, attitudes haven’t changed much from a year ago. An Investors Group poll released in December found 10 per cent still opting not to contribute to RRSPS this year because of the seemingly shaky stock market, similar to the nine per cent that used this excuse a year earlier.
Ironically, many bond investors are almost as gun-shy about bonds or bond funds as stock investors are about the risks of stocks — because of the widespread perception that interest rates are so low they “must” start rising soon, at which point investors in long-term bonds or bond funds might suffer capital losses.
Such protracted fence-sitting means a significant opportunity loss. There’s no law against making an RRSP contribution by the Feb. 29 deadline and leaving it in cash. That will still help defer taxes for calendar 2011 and a decision to reinvest it into riskier vehicles can be deferred. Meanwhile, you’ll at least be collecting some minuscule interest income that’s tax-free.
Confronted with this possibility, many RRSP-SHY investors toss out the other popular excuse — “exposed” early in January by BMO Financial Group — that households “just don’t have the money” to contribute.
Now it’s true that in the best case, $22,450 is a big chunk of change to come up with at a single shot (for the 2011 tax year, assuming a topbracket earner without an employer pension). But neither of the favourite stated reasons is valid if you go the route of regular investment programs: using a pre-authorized chequing arrangement to make monthly payments straight out of your bank account (for the above example, that would be $1,874 a month, but even $500 a month would be a meaningful amount for the average person).
This has two benefits. It allows you to take advantage of stock market volatility: Dollar cost averaging typically forces you to buy more shares or fund units cheaply when markets are temporarily down. And it’s a lot easier to come up with $1,000 or $2,000 a month than to make a single giant lump-sum payment at what may turn out to be a seasonal market high.
Monthly payments will cut into cash flow, but here too, planning can sweeten the pill. Because RRSPS create a tax deduction when it comes time to file your annual taxes, you can use your pre-authorized deduction as evidence to let your employer deduct less tax at source, in effect getting your tax refund every few weeks as your regular paycheque comes into your account, then putting it back to work in your RRSP before you’re tempted to spend it.
Despite this lower-risk, steady approach to building RRSPS, most Canadians still don’t contribute to them each year, and even the minority that do contribute tend not to maximize their contributions.
The RRSP, the vehicle most likely to make retirement possible as early as 55, is itself 55 years old this year: The RRSP was first introduced by John Diefenbaker’s Conservative government in 1957.
While “market volatility” and “I don’t have the money” are the two flimsiest excuses for not contributing, there are better reasons for not contributing — but only if you belong to certain segments of the population. It’s well documented that low-income older workers who expect to collect the Guaranteed Income Supplement to Old Age Security at age 65 should not save in RRSPS.
For them, tax-free savings accounts (TFSAS) make more sense and with a $5,000 annual contribution amount, low-income savers may be hardpressed to come up with more than that to add to an RRSP.
Similarly, younger people in low tax brackets just starting in the workforce may be better off putting money in TFSAS, or if they do contribute to an RRSP, electing to claim the deduction in later years when they’re in a higher bracket.
Another group that may not view RRSPS as optimal are high-income professionals who prefer to invest inside their own corporations.
Tim Paziuk, president of fee-only advisers Victoria-based TPC Financial, uses neither RRSPS nor TFSAS, since he prefers to invest inside his professional corporation and doesn’t want the constraints government places on contributing to and withdrawing from registered vehicles.
Beyond these singular exceptions, the vast majority of middle-income, middle-aged members of the workforce are well advised to maximize both RRSPS and TFSAS each and every year.
They certainly make sense for salaried employees whose incomes are steady or gradually rising over the years. They also make sense for part-time or seasonal workers whose incomes fluctuate year by year.
In this case, RRSPS can serve as an income-averaging and tax-smoothing mechanism: In high-income years when you’re in a high tax bracket, you maximize your RRSP contribution; in low-income years when you’re in a low bracket, you don’t contribute but instead withdraw RRSP funds to live on (paying 10 per cent tax if you do it in $5,000 chunks).
Similarly, those wishing to return to institutions of higher learning later in life may be able to use the Lifetime Learning Plan, pulling out up to $20,000 from their RRSPS.
True, this does to some extent defeat the purpose of building a large retirement nest egg, as does the other practice of withdrawing funds to raise a down payment for a first home.
Now that couples have built up a combined $40,000 in contribution room for TFSAS, I’d view the TFSA as a superior way to build a down payment, because withdrawals from TFSAS are tax free and there’s more flexibility in recontributing.
If you still don’t think you can “afford” to make a contribution by the Feb. 29 deadline, consider asking your friendly local financial institution for an RRSP top-up or catch-up loan.
This is when ultralow interest rates can be a benefit.