Choose the right savings vehicle for your dreams.
While few Canadians may feel they don’t have enough tax-friendly savings vehicles, most ordinary working Canadians are well pressed even to maximize the contribution room they already have for their registered retirement savings plans.
Unfortunately, personal contributions in RRSPs have declined for more than a decade and will continue to do so as Baby Boomers start retiring over the next 10 years.
It seems that RRSP participation peaked in 1996-1997, when 36.2% of those who were eligible contributed to their RRSP, then fell to 28.9% in 2008. In 2008 there was $79.3-billion worth of new RRSP contribution room, but total contributions were just $33.3-billion. These came from just over six million people. The average contribution amount was $5,392.
But clearly, the vast majority contributed very little or nothing at all. This decline in contributions raises public policymaker concerns that Canadians are not saving adequately for their retirement and this may negatively affect the economy.
Experts proposed solutions like: raising contribution limits, but that seems pointless for me, when these limits are not being maximized now. Other alternatives could include the age extension when RRSPs must be cashed out or raising the contribution limit of the new tax-free savings accounts.
The truth is that Canada’s lowest earners don’t need to save in RRSPs at all, because they can replace 100% of their pre-retirement earnings with the Canada Pension Plan, Old Age Security and, for those with no other income sources, the Guaranteed Income Supplement.
The great majority earners, those earning $25,000 to $125,000, may have more RRSP room than they need and some intentionally don’t use it.
The truth is many middle-income Canadians need to replace only 50% of their working incomes. Because the other half of their pre-retirement income goes to taxes, savings, children and mortgages, and once they retire they will not have these expenses anymore. The Canadian system is build to suppress the standard of living of young Canadians during their working lives so they are not disappointed with low incomes when they retire
Yet a number of people retire voluntarily in their early sixties and keep saving in retirement.
Statistics shows that, those under age 35 are least likely to contribute. For them, the priority might be paying off debt, especially if they’re not in the top tax bracket, where RRSPs provide a relatively large tax deduction. In younger age paying off debt make sense too, as people often pay higher interest on their debts, then they would earn on their savings.
As people get older and closer to retirement, are more likely to maximize the contribution room they do have.
It was a lot easier to maximize out RRSPs back in 1989, when the most you could contribute was only $7,500. If you earned $122,200 or more in 2009 and have no employer pension, the maximum you can put in is $22,000.
Besides RRSP there are also a few more saving vehicles to choose from, such as the registered education savings plan (RESP), the registered disability savings plan (RDSP) and last year’s introduced TFSA.
The RESP helps parents accumulate savings tax-free to send their children to post-secondary education. Up to $50,000 per child can be sheltered in RESPs.
Instead of providing an upfront tax deduction like RRSPs, RESPs attract a 20% grant for the first annual $2,500 in contributions, which is $500, to a lifetime limit per child of $7,200. There are strings attached to withdrawing the money, so once you’ve maxed out the Canada Education Savings Grant, families may be better off using the TFSA for extra savings. Find out more how TSFA can pick up where RESP leaves off.
If for whatever reason, the children don’t go on to post-secondary education, they could use the money in the TFSAs for other things, such as starting a business or making a down payment on a home.
The other is the new registered disability savings plan, or RDSP. For families in which one member is eligible for the Disability Tax Credit, up to $200,000 can be sheltered in RDSPs. They resemble RESPs in that earnings and growth accrue tax-deferred but contributions are not tax deductible.
With all these tax-efficient saving vehicles, the last priority should be non-registered investment accounts.
TFSA room is not tied to the prior year’s earnings, nor is it reduced by participation in employer-provided registered pension plans. To open an account you just have to be 18, an age when it makes more sense to use TFSAs than RRSPs.
Young employees in lower tax brackets may want to wait until future years when their wages rise before worrying about RRSPs. TFSA should be the priority over an RRSP if you earn under $40,000 a year. This group will only be giving up a tax refund of 24% or less, while the money in a TFSA will never be taxed when it’s eventually withdrawn. With an RRSP, the tax rate on withdrawal will likely be much higher than 24%.
Personally, I think middle-income investors who want to save as much as possible would benefit to start to invest as early as possible because over the years even a little can go far ahead. Consistency can go far when it comes to invest into your dreams.
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