RRSP Planning
Caveat
For this article, we are speaking about RRSPs specifically. However, if you qualify for the First Time Home Savings Account (FHSA), that should be your priority.
A Bit About the FHSA
An FHSA account has the best parts of an RRSP account and a TFSA account. You can contribute up to $8,000 per year for up to 5 years once you open your FHSA, and these contributions can come off of your taxable income like an RRSP.
The investment income in your FHSA is not taxed. When you withdraw the funds to buy your first home, the funds are not taxed. However, when you withdraw your RRSPs after you retire, that income IS taxed.
Currently, capital gains on your principal residence are not taxed. This means that if you use the FHSA funds to buy your home, and it is your principal residence for as long as you own it, you won’t pay tax on the money when you make the withdrawal or when you sell the home.
The FHSA lasts for 15 years, and once that time limit expires, you have to use the funds to buy your first home, withdraw them (at which point they’re taxed at whatever your tax rate is), or transfer them to your RRSP.
When you transfer them to your RRSP, it does not come off of your income again – that already happened when you made the FHSA contribution. However, when you withdraw those RRSPs, you will be taxed at your personal tax rate at that point.
The short message is, if you’ve never bought a home, consider using the FHSA before using RRSPs. We have another blog post about My Advice to a Young Canadian, and in it, we discuss how a savvy couple who are reasonable earners can end up with more than $200,000 as a down payment on their first home. Be sure to check it out if this applies to you.
RRSPs
How do RRSPs Work?
When you contribute to your RRSP (Registered Retirement Savings Plan), the contribution amount comes right off your income when you file your tax return. When you choose to, or in the year you turn 71, you need to convert your RRSP to an RRIF (Registered Retirement Income Fund) and start withdrawing from the account. While the funds are in your RRSP (or RRIF), the investment income is not taxed. However, when you withdraw the funds, those withdrawals will be taxed at your personal tax rate.
The Importance of Investing
Remember that no matter which program you’re using – FHSA, RRSP/RRIF, or TFSA – it’s important to put your contributions to work by investing the funds. Many financial institutions offer an interest rate on the cash balance of your contributions, but that interest rate is generally so low that you’ll lose buying power against inflation. Calling these programs “Savings” accounts might be part of the problem.
Remember to invest your money and keep an eye on it. It’s your money, it’s your right, and it’s your responsibility. If you don’t take care of your money, someone else will take it.
Short-term vs Long-term Thinking
When it comes to taxes, most individuals “want a bigger refund.” Keep in mind that income tax refunds are not guaranteed. Depending on your situation, you may end up having to pay taxes above what was taken off your paycheck by your employer.
Although it’s nice to have a tax refund, it might be better to pay more taxes now (or get a smaller refund) to save a lot more in taxes later. Everything depends on individual circumstances.
For instance, when a person retires, they can start collecting CPP (Canada Pension Plan), which they contributed to, and OAS (Old Age Security). However, OAS can be clawed back if your other sources of income are too high. Since you have to draw down your RRIF and you can’t necessarily control your other sources of income, you might end up losing OAS that you would otherwise have been eligible to receive.
In another example, when a person dies, if they have a lot of money in their RRSP/RRIF, all of that money comes into their income in one big chunk. This often drives them up to the highest tax bracket and can result in hundreds of thousands of dollars in taxes payable. This can be amplified if they own real estate beyond their principal residence.
Financial Planning Matters
The best way to navigate these waters is to use a financial planner or financial adviser (or advisor if you’re at the bank). Be sure to shop around and get some referrals. Many “Financial Planners” or “Financial Advisers” are really just salespeople. They don’t understand the nuances of financial planning and are there to make money off the products you buy.
“There’s a difference between a financial adviser and a financial advisor: “Advisers” are regulated and have a legal responsibility to act in your best interest. “Advisors” are … not the same.
So, be careful: Banks may call them “advisors” so a salesperson sounds impressive, but you could be stuck without protection.” – CBC Marketplace
If you can work with a Financial Adviser or a CFP (Certified Financial Planner), that would be better than working with a bank salesperson. There have been frequent cases of bank salespeople providing bad tax advice or recommending products that are better for the bank than for you. Financial Advisers and CFPs have access to a lot more products and aren’t beholden to their employers as bank staff are. They should act in your best interest.
So, What’s Right for Me?
It depends.
I know that’s not the answer you want to hear, but everyone and every situation is different. For some people, it’s better to invest in a TFSA rather than an RRSP – and for anyone who hasn’t bought a home before, the FHSA should be prioritized above both of those.
Get your financial information together. Get your goals set and get an understanding of what you need. Then, make an appointment with a good financial advisor to get the quality advice you need to make sure you’re making the right decisions.
As always, we’re here to help if you have any questions.