Personal Finance

Should we max on RRSP limit

  • Last Updated:
  • Dec 10th, 2012 9:40 am
Tags:
None
Member
Aug 10, 2008
404 posts
16 upvotes
Markham

Should we max on RRSP limit

I've been told that if we expect to make more annual income in the future, then we should not max on RRSP and save up the contribution room to lower tax brackets in the future.

However, I'm not sure if that statement is true.

If people have money lying around not being invested, why not max your RRSP room every year? When your income is high, then you can claim your RRSP that year to lower your tax bracket. The benefit of maxing out RRSP every year, is so that you can invest your money earlier and have it grow.

What are your thoughts, is that what people should be doing, or is there more to this logic than I thought?
17 replies
Member
Feb 7, 2012
331 posts
43 upvotes
Toronto
sctfung wrote: I've been told that if we expect to make more annual income in the future, then we should not max on RRSP and save up the contribution room to lower tax brackets in the future.

However, I'm not sure if that statement is true.

If people have money lying around not being invested, why not max your RRSP room every year? When your income is high, then you can claim your RRSP that year to lower your tax bracket. The benefit of maxing out RRSP every year, is so that you can invest your money earlier and have it grow.

What are your thoughts, is that what people should be doing, or is there more to this logic than I thought?
You can invest your money in a non-registered account, you're just going to be taxed on the income return. For Canadian equities, this turns out to be not so bad. For any given year, you need to compare the overall return if you were to use the contribution room immediately or later, making certain assumptions about your income in the future. For example, I am bumping up against a tax bracket right now. After my contract renewal in January, I fully expect to be up in the next tier, so I am saving this year's contribution room for next year, but I am still going to invest my savings, it will just be in a taxable account.
Newbie
Dec 20, 2007
20 posts
2 upvotes
Very true, you should defer the deduction.

However you may want to check on the CRA website, but I am fairly certain that you can contribute into the RRSP (and get your investment building) but defer the deduction for a later year.
Still fill in the details on your tax return (and retain the slip) but just don't claim the deduction this year.

Same thing for contributions made in the first 60 days of the year - most tax programs will allocate them to the prior year (to get the deduction faster) but you can defer them to the next year.
Deal Expert
User avatar
Nov 2, 2003
17117 posts
3872 upvotes
GTA
i don't buy this definition
you have NO IDEA what's going to happen next year / in the future
take the deduction now
Member
Sep 27, 2009
400 posts
65 upvotes
Redflag Uno wrote:
However you may want to check on the CRA website, but I am fairly certain that you can contribute into the RRSP (and get your investment building) but defer the deduction for a later year.
This is true. You can park the money into a TFSA as well. It really depends on your goals and income level ultimately. Do you have any other tax deductions, such as non-working spouse and children?
Sr. Member
Sep 24, 2010
917 posts
65 upvotes
Toronto
I agree that if you have extra money just sitting in an account, then it is a good idea to put into a TFSA and put it in some mutual fund (to get better return than savings but a little less volatile than the investing directly in stocks).

If you think that your tax bracket will not change in the next year then, you should just put it in RRSP this year (or first two months of next year) and get the tax refund.
Deal Addict
Jun 19, 2007
1618 posts
2254 upvotes
Halifax
actng wrote: i don't buy this definition
you have NO IDEA what's going to happen next year / in the future
take the deduction now
It is for this reason exactly that I would highly recommend against putting money in the RRSP if you're not doing it with a conscious plan and goal.

Gov'ts everywhere are stretched thin, the very nature of gov't spending means it goes up (they're spending money which isn't theirs that they didn't have to work for, and the more they spend, the more people will vote for them). Because of this I honestly feel we can expect tax rates to go up between now and 20-50 years from now when you retire. The huge population growth (7 baby families) that fueled economic growth in the past is dwindling, and people hate immigrants, so I honestly feel you're looking at fairly meager population/economic growth in the future. How many jurisdictions do you know of where administrators actively tried to lessen their budgets, expenses, powers, number of people working under them? While you don't know what will happen, what do you think is more likely in terms of taxes? They decide to take more or to take less?

The only use of an RRSP in my opinion isn't necessarily for retirement. Rather it's an income tax averaging tool. If you have a highly variable salary, and are prone to taking say the odd year off it makes sense. If you make 150k this year, and 0 next year, then this allows you to essentially "move" 30k or however much to next year.

You just need to be sure that the tax rate on the income when you cash it out, will be less than you would pay in tax now. RRSP isn't a tax avoidance tool, it is merely tax deference. The two things questions you need to ask are "what will my income be when I cash this out?" and "what will the tax rate be?". Do you want the same income in retirement as you have now? OK. Then where do you think tax rates will be then? Higher or lower?

I did this as a student. I made more than the tax free bracket for a couples years, knew I would make 0 the next, so one year I would lessen my taxable income by putting money in RRSPs, the next year I pay no tax (pulled out the tax free limit from RRSP) and got whatever was in my RRSP tax free.

Like I said it needs to be done consciously with a plan. If you just want to blindly stick it in there "for retirement" 30 years down the road so that you can get a tax refund today, there is a decent chance it may cost you money in the long run. (for instance if tax rates go up and you choose to keep the same standard of living in retirement as you live now, both of which I would say are likely for a lot of people)
Jr. Member
Mar 10, 2007
124 posts
107 upvotes
Toronto
seadog83 wrote: It is for this reason exactly that I would highly recommend against putting money in the RRSP if you're not doing it with a conscious plan and goal.

Gov'ts everywhere are stretched thin, the very nature of gov't spending means it goes up (they're spending money which isn't theirs that they didn't have to work for, and the more they spend, the more people will vote for them). Because of this I honestly feel we can expect tax rates to go up between now and 20-50 years from now when you retire. The huge population growth (7 baby families) that fueled economic growth in the past is dwindling, and people hate immigrants, so I honestly feel you're looking at fairly meager population/economic growth in the future. How many jurisdictions do you know of where administrators actively tried to lessen their budgets, expenses, powers, number of people working under them? While you don't know what will happen, what do you think is more likely in terms of taxes? They decide to take more or to take less?

The only use of an RRSP in my opinion isn't necessarily for retirement. Rather it's an income tax averaging tool. If you have a highly variable salary, and are prone to taking say the odd year off it makes sense. If you make 150k this year, and 0 next year, then this allows you to essentially "move" 30k or however much to next year.

You just need to be sure that the tax rate on the income when you cash it out, will be less than you would pay in tax now. RRSP isn't a tax avoidance tool, it is merely tax deference. The two things questions you need to ask are "what will my income be when I cash this out?" and "what will the tax rate be?". Do you want the same income in retirement as you have now? OK. Then where do you think tax rates will be then? Higher or lower?

I did this as a student. I made more than the tax free bracket for a couples years, knew I would make 0 the next, so one year I would lessen my taxable income by putting money in RRSPs, the next year I pay no tax (pulled out the tax free limit from RRSP) and got whatever was in my RRSP tax free.

Like I said it needs to be done consciously with a plan. If you just want to blindly stick it in there "for retirement" 30 years down the road so that you can get a tax refund today, there is a decent chance it may cost you money in the long run. (for instance if tax rates go up and you choose to keep the same standard of living in retirement as you live now, both of which I would say are likely for a lot of people)
You're failing to mention that the contribution room isn't returned when you withdraw.

You also ignored the compounding interest on the investment income tax the government charges outside of an RRSP. You would have to assume that income tax rates raise far beyond current levels to outweigh this advantage.

For a person trying to maximize the amount of income that they can allow to accumulate tax free in an investment vehicle, contributing and withdrawing is a terrible idea. You could end up with no contribution room left in your 40s or 50s and no RRSP savings for retirement.
Deal Addict
Aug 30, 2011
3537 posts
1279 upvotes
Ottawa
depending on your situation, this...

[QUOTE]I've been told that if we expect to make more annual income in the future, then we should not max on RRSP and save up the contribution room to lower tax brackets in the future.[/QUOTE]

Unless you're in a high tax bracket and you plan to either cash the RRSPs in during a low-income year (before or after retirement), I would use TFSAs instead. In RRSP, you're taxed on the interest, whereas in TFSAs you're not.
Member
Oct 25, 2010
499 posts
61 upvotes
seadog83 wrote: The only use of an RRSP in my opinion isn't necessarily for retirement. Rather it's an income tax averaging tool. If you have a highly variable salary, and are prone to taking say the odd year off it makes sense. If you make 150k this year, and 0 next year, then this allows you to essentially "move" 30k or however much to next year.

You just need to be sure that the tax rate on the income when you cash it out, will be less than you would pay in tax now. RRSP isn't a tax avoidance tool, it is merely tax deference. The two things questions you need to ask are "what will my income be when I cash this out?" and "what will the tax rate be?". Do you want the same income in retirement as you have now? OK. Then where do you think tax rates will be then? Higher or lower?

I did this as a student. I made more than the tax free bracket for a couples years, knew I would make 0 the next, so one year I would lessen my taxable income by putting money in RRSPs, the next year I pay no tax (pulled out the tax free limit from RRSP) and got whatever was in my RRSP tax free.

Like I said it needs to be done consciously with a plan. If you just want to blindly stick it in there "for retirement" 30 years down the road so that you can get a tax refund today, there is a decent chance it may cost you money in the long run. (for instance if tax rates go up and you choose to keep the same standard of living in retirement as you live now, both of which I would say are likely for a lot of people)
No offense, but I think this is terrible advice. While I'm sure there are situations where the above approach will work out, and seadog83 has probably done a great job of optimizing his own income stream, it's the sort of thing that causes the average person to fail miserably (if, for no other reason, because they put off making a decision due to all the perceived complexity).

In almost all situations you are exactly better off blindly sticking your money away for retirement in an RRSP, invested especially if you do not know what you're doing.
In almost all situations when you "choose to keep the same standard of living in retirement as you live now" as seadog83 says, the (adjusted for inflation) *cost* of maintaining that standard of living will decline: You are not supporting kids, paying a mortgage, traveling as much, entertaining as much, etc..., you've bought most of the stuff you want/like, etc...Hence the 50% rule on the income levels you will need. Some people even argue 50% is more than you need.

If you do maintain the same post-requirement *income* then:
  • RRSP vs TFSA is close to a wash, or TFSA may have the advantage especially if you think marginal tax rates are going up (I don't agree that they are but that's speculation)
  • RRSP vs. unregistered account then RRSP wins in a landslide unless you magically invest in the right thing the first time, and don't realize any capital gains until retirement. If you change your investment just once over that time horizon then the capital gains hit almost certainly destroys any advantage you may have had.
Member
Oct 25, 2010
499 posts
61 upvotes
sctfung wrote: I've been told that if we expect to make more annual income in the future, then we should not max on RRSP and save up the contribution room to lower tax brackets in the future.

However, I'm not sure if that statement is true.

If people have money lying around not being invested, why not max your RRSP room every year? When your income is high, then you can claim your RRSP that year to lower your tax bracket. The benefit of maxing out RRSP every year, is so that you can invest your money earlier and have it grow.

What are your thoughts, is that what people should be doing, or is there more to this logic than I thought?
The benefit of the RRSP is twofold:

1) You defer the tax, meaning you get money now that you can also invest, to a time where most people have a lower marginal tax rate (retirement)
2) Your investments are sheltered against capital gains and income tax while they are in the RRSP. This is HUGE. This is also why TFSAs are great.

...there's actually a 3rd benefit, to the gov't: It smooths your income stream out into retirement, so all the "retiring" people still appear to the gov't as earning an income, meaning they get to collect income taxes. It's a masterstroke of economic planning.

By adding/subtracting constantly as your income changes, you loose the second benefit - which is really the biggest benefit. That's might be ok, but it means you're not really saving for retirement - you're maximizing your current crash on hand. More money now might be great and all, but will you feel that way when you're 75? Also, as someone already pointed out once you remove the money from your RRSP you don't get to recontribute that amount. It's gone forever.

So, I'm sure you could find an income stream scenario where you should deposit into your RRSP, then withdraw and put that money into a TFSA - like if you only worked every other year or something. For most people, it just won't be worth doing this and likely results in you not saving for retirement.

As for deferring RRSP contributions until your income is higher - it of course depends. Right now the biggest marginal tax rate jump happens at $43k where the next tax bracket is 7% higher. If you assume a 7% rate of return then it takes about 3 years for your "lower-income" return to match the "extra" refund you got by waiting. For all other tax brackets its about 2 years. For this reason, I'd only suggest you bother deferring when you KNOW there is a big jump across that $43k mark coming. Like, for example, you're working as a TA right now and will have a high-paying-full time job next year.
Deal Addict
Jun 19, 2007
1618 posts
2254 upvotes
Halifax
Ash20 wrote: You're failing to mention that the contribution room isn't returned when you withdraw.
So what? You seem to be arguing it is better to have $1000 in an account that you'll have to pay $200 on when you take it out, vs $800 in another account that you have free and clear, or depending how you time it, $1000 free and clear.

You seem to ignore that if you don't claim the $9k/yr tax free allowance, THAT room is lost forever.
Ash20 wrote: You also ignored the compounding interest on the investment income tax the government charges outside of an RRSP. You would have to assume that income tax rates raise far beyond current levels to outweigh this advantage.
You ignore that you will pay higher tax on RRSP withdrawals (income) than you will on non-registered gains (dividend/cap gains). There is also no/very little advantage to "tax-free" compounding. $100 in RRSP compounded at 10% annually over 10 years = $259. You withdraw and pay 20% tax = $207. Or. You pay the tax up front. $80 at 10% for 10 years = $207. Again. The only advantage would be if that $100 came off your income at a higher tax bracket than when you took it out.
Ash20 wrote: For a person trying to maximize the amount of income that they can allow to accumulate tax free in an investment vehicle, contributing and withdrawing is a terrible idea. You could end up with no contribution room left in your 40s or 50s and no RRSP savings for retirement.
RRSP doesn't allow you to accumulate tax free. You simply pay the tax later, and in many cases the net amount of tax you pay will be more. If you contribute in the lowest tax bracket, and then later withdraw while in the lowest tax bracket, you have saved nothing. In fact your worse off because the gains are taxed as income, instead of at preferred rates.
Member
Feb 7, 2012
331 posts
43 upvotes
Toronto
seadog83 wrote: You seem to ignore that if you don't claim the $9k/yr tax free allowance, THAT room is lost forever.
No it's not, this carries forward indefinitely.
seadog83 wrote: You ignore that you will pay higher tax on RRSP withdrawals (income) than you will on non-registered gains (dividend/cap gains). There is also no/very little advantage to "tax-free" compounding. $100 in RRSP compounded at 10% annually over 10 years = $259. You withdraw and pay 20% tax = $207. Or. You pay the tax up front. $80 at 10% for 10 years = $207. Again. The only advantage would be if that $100 came off your income at a higher tax bracket than when you took it out.
In your second example, unless you invested that $80 in a TFSA (hint: this is still tax-free compounding), you would be taxed on the income each year; at a marginal tax rate of 30% (pseudo-arbitrary), that 10% looks more like 7%, or $157 after 10 years -- not so good now.
seadog83 wrote: RRSP doesn't allow you to accumulate tax free. You simply pay the tax later, and in many cases the net amount of tax you pay will be more. If you contribute in the lowest tax bracket, and then later withdraw while in the lowest tax bracket, you have saved nothing. In fact your worse off because the gains are taxed as income, instead of at preferred rates.
Yes, that's the whole point of placing your money within the tax shelter of an RRSP -- trade your current income tax bracket against your future tax bracket. If your future marginal tax rate is going to be higher than your current one (for whatever reason), then no, an RRSP doesn't make sense for you (this the case for people with very nice pensions, for example, or whose current income is non-taxable or at a very low marginal tax rate for some reason).
Deal Addict
Jun 19, 2007
1618 posts
2254 upvotes
Halifax
How can I claim the 9k/yr tax free allowance that was carried forward? So you're telling me that between ages 0-17 when I had no income, I can essentially move 17 years of 9k/yr forward and claim 17*9000 ($153k) tax free? First I've heard of this. I have not done this, so please advise.

If you are reinvesting dividends via DRIP you will not pay tax on it until you sell the investment. If you do this all investments will compound tax free (no tax on compounding) with TFSA you wont pay any tax when you sell the investment. Non registered investments you pay tax up front and the base compounds. Registered, the base compounds, but the tax liability also compounds at the same rate.

Like the above example. You earn $1000. You can pay $200 up front and invest $800. Or, you can keep the whole $1000 and invest it registered. Divide that $1000 into $800 and $200 sections. The $800 represents "your" money. The $200 is "gov't" money. Both will compound at 10% per year or whatever. So while both compound and the total sum increases and is higher, once you pay the gov't their due (the entire contents of the second part of the money) You're in the exact same spot. That is unless your tax rate is lower.

People generally don't know much about finances and this thread is a perfect example of that. The bottom line is, the only long term benefit, is the contribution times the difference between tax rates going in vs coming out.

If the average tax rate is higher then compared to now, it will cost you money. Or if you die than your whole RRSP account is liquidated, then you will likely pay the top tax rate on a big portion of your money.
Member
Feb 7, 2012
331 posts
43 upvotes
Toronto
seadog83 wrote: How can I claim the 9k/yr tax free allowance that was carried forward? So you're telling me that between ages 0-17 when I had no income, I can essentially move 17 years of 9k/yr forward and claim 17*9000 ($153k) tax free? First I've heard of this. I have not done this, so please advise.
Your RRSP deduction limit is computed based on your income; it is not a 9k/yr fixed rate. No income means no deduction allowance for that year. Contribution room can be carried forward indefinitely; however once you have contributed it, it would seem you have 20 years to claim it against your income tax.
seadog83 wrote: If you are reinvesting dividends via DRIP you will not pay tax on it until you sell the investment. If you do this all investments will compound tax free (no tax on compounding) with TFSA you wont pay any tax when you sell the investment. Non registered investments you pay tax up front and the base compounds. Registered, the base compounds, but the tax liability also compounds at the same rate.
You are correct about capital gains not being taxed until they are realized; however DRIPs are not capital gains -- they are (by definition) dividends, which are indeed taxable (see page 10 of this). For Canadian dividends, these are taxed at less than your full personal income marginal tax rate, but still not insignificant (e.g. ~18% if you make > $80k) rate if held in a taxable account.
Deal Addict
Jun 19, 2007
1618 posts
2254 upvotes
Halifax
I'm referring to the 9k tax free personal deduction. That if you pay tax this year, you are far better to move 9k into RRSP and not pay tax on it, then take it out next year when your income is 0. It goes from being 9k with a tax liability, to 9k after tax.
Member
Oct 25, 2010
499 posts
61 upvotes
seadog83 wrote: I'm referring to the 9k tax free personal deduction. That if you pay tax this year, you are far better to move 9k into RRSP and not pay tax on it, then take it out next year when your income is 0. It goes from being 9k with a tax liability, to 9k after tax.
Surely you have to agree that this is not always true (which also means it is not always false) and that it depends on what you do with that $9k.
Member
Feb 7, 2012
331 posts
43 upvotes
Toronto
seadog83 wrote: I'm referring to the 9k tax free personal deduction. That if you pay tax this year, you are far better to move 9k into RRSP and not pay tax on it, then take it out next year when your income is 0. It goes from being 9k with a tax liability, to 9k after tax.
Ah OK, I didn't realize you were talking about your "basic personal amount". No, this does not carry forward =P

On the face of it you are right, you are putting into your RRSP at a higher marginal tax rate than when you take it out. Some quick calculations on a $9k marginal income in year one, assuming you earn $0 in year two, you get 10% return on all investments, and that your marginal tax rate is 30% in all other years (for simplification):

Year 10: $11,907 from staying purely taxable, $14,855 from staying in RRSP the whole time, $17,010 using RRSP for one year then withdrawing
Year 15: $16,700 taxable, $23,924 RRSP, $23,858 hybrid (this is the break-even point between the latter two)
Year 20: $23,423 taxable, $38,530 RRSP, $33,461 hybrid

In the purely RRSP scenario, I am including the 30% withdrawal tax, so this would be your take-home funds when all is said and done (in this extremely simplified scenario). So you're right about getting some short-term gain from using your RRSP as a buffer, but in the long run, you're still better off leaving it in the RRSP than a taxable account. Of course this assumes that you don't actually need to withdraw that money to survive, but that's an entirely different matter.

Top

Thread Information

There is currently 1 user viewing this thread. (0 members and 1 guest)