RRSP has fallen out of favor, but still plenty of reasons to contribute

Posted on by Duane Roberts

Retirement Personal Finance

Jason Heath: Savers who ignore the benefits of the RRSP could be making a costly mistake

Publication date:

February 22, 2022 • February 22, 2022 • Read 5 minutes • Join the conversation Some of the reasons why the RRSP has lost ground over the past generation are obvious. Some of the reasons why the RRSP has lost ground over the past generation are obvious. Photo by Chloe Cushman/National Post clip art files

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Historically, February was known as “RRSP season,” a time when banks promote RRSP loans and last-minute contributions that can be listed on your tax return in April. But in recent years, the allure of the RRSP seems to have faded, for banks and investors alike. Do savers make a mistake because of this?

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In 2000, 6.3 million Canadians contributed to an RRSP, and the median contribution was $2,700, according to Statistics Canada. In 2019, only 5.9 million people made RRSP contributions, with a median amount of $3,260. If RRSP contributions had simply kept pace with inflation, the median would have increased by more than 22 percent to $3,858.

The percentage of RRSP contributors between the ages of 35 and 44 fell from 30 percent in 2000 to 24 percent in 2019. Over the same period, the pension coverage rate — the proportion of all employees with a registered retirement plan — fell from 41 percent to 37 percent, by a disproportionate impact on younger workers. Traditional retirement savings is declining.

Some of the reasons why the RRSP has lost ground over the past generation are obvious. Canadian real estate prices have risen nearly eight percent year-on-year over the past 20 years, so more savings go to down payments and more cash flow is spent on housing costs. Rental real estate has also attracted more investment dollars. The TFSA came into existence in 2009 and has also competed for contributions at the expense of the RRSP ever since.

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In recent years, cryptocurrency and non-fungible tokens (NFTs) have also emerged as alternative investments, especially for younger people. An Ipsos survey last year estimated Canadian cryptocurrency ownership at 14 percent. Crypto and NFTs are not eligible for RRSP or TFSA. While foreign exchange is a qualifying investment for registered accounts, cryptocurrency does not qualify as it is not issued by a government.

“Rare coins and other forms of money held for collectible value are not a qualifying investment,” according to the rules of the Canada Revenue Agency. “Digital currencies, such as bitcoins, are not considered money issued by a country’s government and are not qualified investments.”

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There are a few Canadian cryptocurrency exchange traded funds (ETFs) from companies such as Purpose, Evolve, and CI Defiance Digital Revolution ETF, just launched the first NFT-focused ETF on the New York Stock Exchange in December, and it qualifies for RRSP or TFSA. While cryptocurrencies and NFTs packaged by an investment company go against the decentralization concept of the underlying investments, ETFs provide an investor with a way to leverage the tax benefits of their RRSP or TFSA.

Canadian cryptocurrency exchange traded funds offer investors a way to take advantage of the tax benefits of their RRSP or TFSA. Canadian cryptocurrency exchange traded funds offer investors a way to take advantage of the tax benefits of their RRSP or TFSA. Photo by Dado Ruvic/Reuters files

A dollar in RRSP contributions for someone with $75,000 in income saves between 28 and 38 cents in tax, depending on the county or territory of residence. At $150,000, the marginal tax savings rate rises to 35 to 47 percent. For a high-income earner with a long time horizon for their savings, especially if they are likely to withdraw their savings at a lower tax rate in the future, RRSP contributions remain a recommended strategy for tax and retirement planning.

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For lower-income savers whose income is less than $50,000 or who don’t have an employer agreement for their collective retirement contributions, TFSA contributions may be a better alternative to an RRSP. TFSA withdrawals can also be made in the future to make RRSP contributions as your income and tax rate increase. TFSAs are also more flexible for other short- and medium-term financial objectives.

Young savers can take advantage of RRSP programs such as the Home Buyer’s Plan (HBP). The HBP allows an RRSP withdrawal of up to $35,000 toward the purchase of a qualifying home from a starter. For a couple with a 30 percent marginal tax rate that can take up to $35,000 each, RRSP contributions can turn $70,000 in contributions into $91,000 in savings for their first home, factoring in the resulting tax refunds.

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If a 40-year-old makes a single $1,000 RRSP contribution growing at six percent per year in a low-cost stock portfolio, it would be worth about $4,300 by age 65. This could provide a retirement income of about $240 per year. year indexed to two percent inflation, about $145 a year in current dollars, albeit assuming relatively high investment returns.

At a more conservative four percent return, a $1,000 investment could grow to about $2,700 by age 65, and could return about $120 per year, or about $70 in today’s dollars.

Most employees will have a higher income and tax rate during their working years than when they retire, making RRSP contributions a tax-efficient way to save. Most retirees will also not be able to live on Canada Pension Plan (CPP) and Old Age Security (OAS) alone. The maximum CPP retirement pension in 2022 is $15,043 per year and the maximum annualized OAS pension for the first quarter of 2022 is $7,707. However, the maximum CPP may require maximum contributions between the ages of 18 and 65 to qualify for up to age 39. OAS is based on residency and generally requires 40 years of residency in Canada between the ages of 18 and 65 to receive the maximum pension.

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Investment portfolios grow tax-free as they are invested within the RRSP, and the rate-increasing effect becomes even greater over a longer time horizon.

Is it worth investing in an RRSP? Here’s the math

No matter how much you decide to contribute this RRSP season, it's important to stay within your contribution limit or pay a penalty tax of one percent per month for every dollar you contribute too much.

Tips so that you don’t go to court for contributing too much to your RRSP

How do you decide between money in a TFSA or an RRSP?

FP Answers: Should I invest in a TFSA or RRSP? And when does it make sense to do both?

Canada Pension Plan can start as early as age 60 or be deferred until age 70.

Four key things to consider if you’re planning to retire this year

Canada’s household savings rate was below five percent for most of the past 25 years until the start of the pandemic, when it peaked at more than 28 percent. It is now more than 10 percent for each of the past six quarters through the third quarter of 2021. This may be partly because of the uncertainty of the pandemic that Canadians have started hoarding money.

The fall of the RRSP has its reasons, but hopefully these higher savings rates will also translate into an increase in pension savings premiums. From a tax standpoint, there are compelling arguments for RRSP contributions for middle and high-income people. They can be a savings tool for young aspiring homeowners to collect a larger down payment. Extra savings are necessary for most retirees to supplement their government pension. There have also never been more RRSP-eligible investment options, including indirect ways to invest in alternative asset classes such as cryptocurrency and NFTs.

I never liked the idea of ​​an RRSP season in February. RRSP contributions are something to consider year-round and for employees at any age or stage of their retirement planning. I am hopeful that the RRSP may become attractive again for long-term savers in the coming years.

Jason Heath is a board-certified financial planner (CFP) who pays only a fee and provides advice only at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell financial products at all.

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This post RRSP has fallen out of favor, but still plenty of reasons to contribute

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