Are you trying to max out your Retirement Savings Plan (RRSP)?
It’s a common goal for many Canadians, but it’s not always desirable.
Once you have money in an RRSP, it’s generally locked away for a long time. You technically “can” withdraw the money early, but if you withdraw it while you’re still working, you’re likely to pay very high taxes on it.
One scenario where it may make sense to withdraw RRSP funds early is when you’re saving up to buy your first house. Under the “First-Time Home Buyer’s Plan,” you can withdraw up to $35,000 from your RRSP tax-free. Absent that one condition, you’re going to need to keep your money in your RRSP for a long time if you hope to realize the tax benefits the account promises.
In this article, I will explore one major downside of maxing out your RRSP and what you can do as an alternative.
Your RRSP becomes taxable when you retire
A major drawback of maxing out your RRSP is the fact that the money will become taxable when you withdraw it. If you withdraw the money early, you may end up paying up to a 50% tax on it! Now, the theory is that you’ll be paying lower taxes in retirement, because you’ll only be working part time, if at all. RRSP taxes go off your marginal tax rate, so once your tax rate goes down, so too should the tax rate on your RRSP. However, this ignores many practical realities.
A big one is the fact that your RRSP has to be converted to a Registered Retirement Income Fund, and the funds are withdrawn no matter what. This has to happen by age 72. If you’re still working at age 72, then you may have no choice but to start withdrawing money at a high tax rate. Should you be a very high earner at that point, you may be looking at 50% taxes on your RRSP funds!
Why you should consider a TFSA
If you’re concerned about getting taxed on your RRSP withdrawals, you may wish to consider investing in a Tax-Free Savings Account (TFSA). A TFSA lets you grow your investments tax-free, just like an RRSP does. However, with TFSAs, the money is tax-free on withdrawal, as well as when it’s in the account. If you were 18 or older in 2009 and haven’t opened a TFSA yet, you can deposit up to $88,000 into one of these very generous tax-sheltered accounts.
Some TFSA stocks to consider
If you’re thinking about opening a TFSA, there are many great stocks and funds you can consider holding in one.
First up, we have iShares S&P/TSX Capped Composite Index Fund (TSX:XIC). It’s an index fund built on the TSX composite index. The TSX Composite is an index of the 250 largest companies in Canada. XIC holds 240 of them, so it is very diversified. It has a 0.06% MER (i.e., management fee), which is among the lowest fees of all Canadian stock funds. Finally, it is managed by Blackrock, a reputable fund management company that you can count on to keep your assets safe. All in all, XIC is a worthy fund to consider owning.
Should you want to get your feet wet in individual stocks, you could consider a stock like Fortis (TSX:FTS). Fortis is one of Canada’s most reliable companies. It recently achieved 50 consecutive years of dividend increases, which made it a “Dividend King.” Fortis is one of the only such companies in Canada.
Why is Fortis so reliable? Part of it has to do with the industry it’s in: utilities, in general, have very stable revenue, because heat and light are essential services that people don’t want to cut out of their budgets. There’s more to the story than that, though. Fortis has outperformed the average Canadian utility over the last 10 years, because it has invested heavily in growth and expanded all over Canada, the U.S., and the Caribbean. On the whole, it’s a stock you can count on.
FAQs
A major drawback of maxing out your RRSP is the fact that the money will become taxable when you withdraw it. If you withdraw the money early, you may end up paying up to a 50% tax on it!
Is it worth maxing out your RRSP? ›
If you expect your income to grow into higher tax brackets as you progress in your career, Ms. Hasan says it could be worth saving your RRSP contribution room for future years, when larger contributions could save you further money by lowering your tax bracket. The same is true if you expect a windfall down the road.
Should I max out my RRSP in one year? ›
If you have a relatively high income, you may choose to deduct the whole amount in one year. But low-income contributors should beware contributing to their RRSP just to save tax. They may end up paying more tax on withdrawals than the tax they save on contributing.
What happens if you withdraw $20000 from your RRSP? ›
You'll have to pay tax on your RRSP withdrawals
If you take money from your RRSP, the government will charge a RRSP withholding tax. The amount you pay depends on the amount you withdraw and where you live.
Is it better to max out RRSP or TFSA? ›
If you're earning between $50,000-$98,000: You may want to consider funding your RRSP and TFSA equally until you max out your TFSA. If you're earning more than $98,000: In this case, your tax rate approaches 40 percent. Investing in an RRSP will benefit you the most by reducing your taxable income.
How much RRSP should I have at 40? ›
At age 40, 2.1 times your annual income. At age 50, 4.6 times your annual income. At age 60, 8.5 times your annual income.
What is the disadvantage of a RRSP? ›
There is less freedom in how you can withdraw from an RRSP, compared to a TFSA. Withdrawals are classed as taxable income (unlike TFSA withdrawals). Low-income earners pay a low rate of income tax, so RRSPs don't make financial sense for this kind of investor (a TFSA would probably be a better option).
What age should you stop investing in RRSP? ›
You can contribute to your RRSP until the year you turn 71. However, it's essential to consider if contributing after retirement aligns with your financial goals and tax situation.
What happens if you overcontribute to your RRSP? ›
There is a 1% monthly penalty for overcontributions greater than $2,000, until the amount is withdrawn or your limit covers the excess contribution. For more information, consult our page on maximum RRSP contributions.
Should I move money from RRSP to TFSA? ›
Let's recap for a second: Basically, a TFSA makes more sense if you find yourself in a situation where your income is on the lower side, while an RRSP makes more sense if your income is on the higher side and you expect to be in a lower tax bracket during retirement.
Key Takeaways. The 4% rule says people should withdraw 4% of their retirement funds in the first year after retiring and take that dollar amount, adjusted for inflation, every year after. The rule seeks to establish a steady and safe income stream that will meet a retiree's current and future financial needs.
What happens to RRSP if you leave Canada? ›
Canadian citizens that have become non-residents can continue to hold RRSPs after leaving Canada.
How do I avoid withholding tax on my RRSP? ›
How to avoid withholding tax on an RRSP. The simplest way to make sure you don't pay RRSP withholding tax is to wait until you're ready to retire, then transfer the money in your RRSP to either a RRIF (registered retirement income fund) or an annuity.
What is a better investment than RRSP? ›
If you have already maximized your RRSP contributions, then a TFSA may be an option for you to save more money and get the benefits of tax-free growth and withdrawals.
Should I max out my RRSP each year? ›
As you approach retirement, max out your RRSP contributions each year. Continue to grow your money in a TFSA and pull funds when you're ready to retire. Starting retirement? Save money in your RRSP until age 71.
What are the benefits of maxing out RRSP? ›
It makes sense to maximize your RRSP contributions if you're expecting to have a lower tax rate in retirement than you do now. This is because an RRSP offers a tax deduction now, but when you make withdrawals (presumably in retirement), the full amount of the withdrawal is included in your taxable income.
What is a good amount to have in RRSP? ›
Generally speaking, you should aim to contribute at least 10% of your gross income each year to your retirement savings. Start contributing in your early 20s, and that 10% per year could add up to a sizeable savings and a comfortable retirement. Start later in life—say, your late 30s—and 10% a year may not cut it.
Is it worth over contributing to RRSP? ›
If you end up with an RRSP over-contribution in excess of the $2,000 buffer, you may owe taxes. The CRA will charge you a 1% penalty, assessed monthly, for each month you're over the limit.
At what point should I stop contributing to RRSP? ›
December 31 of the year you turn 71 years old is the last day that you can contribute to your RRSPs.
Should you take money out of your RRSP? ›
If your current income is higher than your retirement income, you'll pay more taxes now. You lose out on tax-deferred compounding: Because RRSP contributions can compound over time, even a small withdrawal made today can have a big impact on your savings later.
