Why you shouldn't be monogamous......with your RRSP

Hello friends.  How are you?  Fully recovered from your holiday hangover?  I know that if you read my blog about budgeting for the holidays your finances definitely aren’t hungover.  If you didn’t...well re-read my blog about paying down debt because this one isn’t about that.  

It is about the third most magical time of the year, the first being my Birthday (June 22 in case you wish to buy me something), the second being Christmas and third…..RRSP Season.

That’s right ladies and gentlemen, the time of year when everyone tries to throw any and all excess cash into an RRSP (Registered Retirement Savings Plan) in hopes of the most magical gift of all….the elusive tax refund.  Oh and to save for retirement...because that is important as well.  

For years the RRSP has been the apple of our eye, the one who swore to provide us with a wonderful retirement, full of cheap trips to Mexico, Netflix and wine.  Leading up to retirement it gave us the thrill of a tax deduction for saving money, contribute enough and that deduction leads to a refund.  Let’s admit it….tax refunds are sexy...in a baggy sweat pants, no makeup, day three of dry shampoo kind of way.

We have this incredible attachment to our tax refunds.  Don’t deny it, our favorite thing to do is to brag about our refunds.

Guy 1 “Guess what, just finished doing my taxes….yep...getting $3000 back from the Government”

Guy 2 “that’s awesome….I did mine last week and we are getting $4000 back…..”

Photo by  Clark Young  on  Unsplash

Photo by Clark Young on Unsplash

*Author's note: I am going to need you to picture the two old guys snapping their suspenders as they talk...*

But here is the thing….tax refunds aren’t that great.  Calm down and let me explain.  A tax refund is money you OVERPAID to the government that they gave you back.  Without paying you interest might I add….and you know if you owe them money they charge interest.  In the words of Stephanie Tanner “How Rude!”

*Author’s note: I am specifically speaking about refunds due to RRSP contributions, not tax credits/deductions due to raising really expensive children, medical expenses...etc...those have time limits to claim them so always claim them*

I know what you are thinking...but Caval if I don’t contribute to my RRSP all that I can financially I won’t retire.  That may have been true until 2009, when a new exciting (dare I say sexier…..I know I am weird) savings plan walked into our lives...the Tax Free Savings Plan (TFSA).  

It came out as an additional way to save for retirement and it got everyone riled up...in more ways than one.  People couldn’t wrap their heads around a savings plan where you never have to pay tax on the growth.  People couldn’t comprehend leaving the RRSP behind for the TFSA.  

Photo by  Clem Onojeghuo  on  Unsplash

“What about our tax refunds?  Think of the RRSP and all it has done for us!” the people of Canada cried!!!

Thus the title of my blog….you don't need to decide...you can have both!  They go together like cake and ice cream..... 

*Author’s note: this is the only time I am saying monogamy isn’t cool*

Let me break it down for you:

RRSP

You contribute money now, get a tax deduction - then in retirement you take the money out, pay tax on the amount withdrawn (including the growth)

TFSA

You contribute money now, no tax deduction - then in retirement you take the money out, pay no taxes on the amount withdrawn (including the growth)

 

So how do you know which plan to contribute to?  Which one will make the most sense and why would you use both at the same time?  I could throw a bunch of numbers at you with marginal tax rates, impress you with my calculator skills but I hear a glass of wine calling me soon so here are my fast tips on RRSP vs TFSA vs Both.

First you need to know which marginal tax rate you are in now and will be in retirement.  Quick hint - Most (not all) will be in the mid tax bracket in retirement.

*Author’s note: This is a EXTREMELY simplistic estimate for illustration purposes only...thus I recommend you seek out a Certified Financial Planner *cough cough* to determine your actual retirement projections...I can recommend someone if you want…*cough*..damn cold season, excuse me*

 

Photo by  Matthew Brodeur  on  Unsplash

Moving on...

Are you in a higher marginal tax rate now than you will be in retirement?  RRSP and TFSA

Are you in a lower marginal tax rate now than you will be in retirement?  TFSA  

Are you it the same marginal tax rate that you will be in retirement?  RRSP and TFSA

If you are in the same or higher marginal tax bracket you should be utilizing both an RRSP and a TFSA.  So how do you use both?  Glad you asked.  

Contribute to the RRSP only as much as is needed to get any tax owing to zero or to lower you into the next bracket or the one you will be in when you retire.  The rest should go in a TFSA.

Don’t know what those amounts are….a Certified Financial Planner can help you.  Already maxed out your TFSA….I am not sure why you are reading this article then.

Again these are some simple rules to help you but they can only help you if you also get rid of your emotional attachment to RRSPs and the refunds they provide.  I am not lying when I say that financial monogamy is dead and you can live a poly-amorous financial life with your RRSP and TFSA.

*Author’s note: This article is not a permission slip to cheat on your significant other*

Do you use both an RRSP and TFSA?  Are you attached to your refund?  Share your story in the comments!

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