RRSPs turn 60: a birthday review

Happy birthday, RRSPs.

Introduced in 1957 (even before the Canada Pension Plan), registered retirement savings plans (RRSPs) were devised as and continue to be a way for Canadians who don’t have a defined-benefit pension plan to set aside money for retirement. In the beginning, taxpayers could contribute up to $2,500 or 10% of their annual income, whichever was less, into an RRSP.

Over the years, RRSPs have evolved. Now, you can contribute up to 18% of your previous year’s earned income to a maximum of $25,370 for the 2016 tax year and $26,010 for the 2017 tax year. (If you’re a member of a company pension plan, your RRSP contribution limit is reduced.)  Since 1991, you’ve been able to carry forward your unused contribution room to future tax years.

In 1968, the first year for which data on the number of contributors is available, only 172,000 individuals, or 1 out of every 50 tax filers, reported making contributions.

In 2014, the most recent year for which data is available, Statistics Canada says about 5.9 million Canadians, or 1 out of every 4 tax filers, contributed to their RRSPs.

As the name implies, saving for retirement is the biggest reason behind making annual contributions to an RRSP. There is also the immediate bonus of a tax deduction and potentially a tax refund for some Canadians. But in reality, the tax is simply deferred until the money is withdrawn. RRSPs were set up with the expectation that funds would be withdrawn in retirement when personal income tax rates were expected to be lower.

As with all savings plans, what you put into an RRSP should be tailored to your individual circumstances, with your strategy depending on whether your needs are personal, for family or for business, says Patrick Fitzgerald,¹ an Ottawa-based Sun Life advisor.

Alongside this saving strategy may be a host of other financial concerns you want addressed – issues such as reducing debt, managing cash flow and putting aside cash for emergency needs.

RRSPs are just part of the picture

“So there could be a lot of other moving pieces besides that one vehicle that you place priority on; when you’re making your financial plan, you want to make sure you are addressing all of these needs alongside your RRSP strategy,” says Fitzgerald.

For example, take a couple that both have defined-benefit pension plans.  Since they know how much income they will be receiving from their pensions when they retire, they would have to consider whether there is any benefit to having an RRSP as well. Or business owners with an operating or holding company might want to build wealth within their corporations rather than build up an RRSP, says Fitzgerald.

If you’re just starting off in your career and you hope to be in a management or executive role in the future, with an income 50%-100% higher than your current position, you might be tempted to  let your RRSP contribution room build up for a while. But that would mean missing out on years of tax-deferred investment growth. Instead, you can start contributing now, but carry the deduction forward to use it when your tax savings will be greater. You can use Schedule 7 to let Canada Revenue Agency (CRA) know that you have made the contribution but have decided not to deduct it that taxation year. This lets CRA properly track your remaining RRSP contribution room and carry forward the deduction amount.

“It’s important to work with an advisor to look at these calculations,” says Chris Poole,² an advisor with Sun Life in Toronto.

Quite often, people pair their RRSP savings with a tax-free savings account (TFSA), which can let them use after-tax dollars to build up wealth and not pay tax when they make withdrawals.

“It’s great to see RRSPs still here after 60 years,” says Poole. “That said, they are simply one piece of the puzzle that allows people to save over time towards the goals they’ve chosen. It’s always important to look at it on a case-by-case basis and speak to your advisor.”