RRSP continued… Approach with Caution

As promised, I’m here with a few important factors that you should be sure to consider when thinking of investing in a RRSP.

As I discussed in my last post, money invested in an RRSP grows on a tax sheltered basis. It’s important to differentiate between tax sheltered and tax free (like in a Tax Free Savings Account). Tax free means that any growth in your investment is received completely tax free, it doesn’t matter if you withdraw or keep it in the account. Tax sheltered or deferred means that it’s not taxed immediately, but it is taxed at a certain point. When it comes to an RRSP, when you withdraw from it, the whole withdrawal amount is taxable at your marginal tax rate in that year.

You are able to withdraw from your RRSP before you retire, but keep in mind that your financial institution will deduct a withholding tax before you receive your funds. The amount of the withholding tax will range between 10% and 30% depending on how much you withdraw. In the year you withdraw funds from your RRSP, you’ll declare the whole amount as taxable income. In which case, you may have also to pay additional tax (on top of the withholding tax) depending on your income of that year.

When the RRSPs were introduced, the idea behind the plans were that you would get a tax deduction in the years that you were working and when your income was high. Once you retired and were no longer earning any income, you would withdraw from the RRSP and the taxes paid on the withdrawals wouldn’t be very high since you didn’t have any other income. Unfortunately, things have changed since then, and we see that people are working for longer and still earning income in their retirement years. This means that people’s RRSP withdrawals are being taxed at a relatively high rate. Another issue is, when you contribute into your RRSP you know exactly what your tax savings are today, but the rates you get taxed at when you withdraw in the future, may change down the road.

Like I said in my previous post, after the end of the year that you turn 71 you have to start withdrawing from your RRSP, either from a RRIF or an annuity. This rule may change, as it has done so in the past. Before 2007, the age to start withdrawing from your RRSP was set at 69 years old.

So, I think that RRSPs are a very useful savings tool, but just like everything else, it’s important to review and understand all of the different uses and features they have. Time’s have changed and RRSPs haven’t, so make sure you talk with your advisor to ensure that it’s the right thing for you, as well as the right time.