Trick…or Treat?

October 10, 2019

Investment trends can be so fickle sometimes, it scares me.

In the early 1990’s, RRSPs (and more specifically, RRSP Loans) were all the rage. Every bank was pushing them and every tax payer wanted to get in on the action. It was so easy to get caught up in the hype that few of us stopped to consider if an RRSP was the most suitable means for us to save and what the long term implications would be. Many of us failed to see beyond the immediate tax savings (or refund) that our contribution created.

Then we got older.

More and more of us started hitting retirement age and wanted to access our RRSP assets. Some of us got sick and needed to withdraw large, lump sums to help cover our rising living expenses. Only problem was that we forgot the tax man was still owed his pound of flesh. What do you mean “withholding tax?” What do you mean “no Guaranteed Income Supplement?” What do you mean “OAS clawback?”

Then we got mad.

Many of us stopped saving at all for a few years. Instead, spending became all the rage. With interest rates at an all-time low, the banks now focused on our unrealized “richness” and encouraged us to borrow, borrow, borrow. But not for retirement this time. For the things we deserved. Renovations. Trips. New shoes.

Then we got in over our heads.

Debt became all the rage. Money coaches and reality TV shows flourished, as banks now focused on helping us budget and save for the things that really “mattered.” Tax Free Savings Accounts promised easy access to our money (and any growth earned) with no strings attached. RRSP or TFSA? So many letters, so little disposable income.

Then we lost confidence.

In the markets. In our job security. In the advice we’d been given. In 2011, only 24% of us contributed to an RRSP and only 1 in 3 to a TFSA. That same year, the ratio of credit market household debt to disposable income exceeded 160 percent. 1

So where do we go from here?

When someone asks me a question about how much and through which means they should invest, my answer is always the same; “It depends.” It depends on their unique set of circumstances and the options available in the marketplace at the time. It never depends on the flavour of the month or the latest trend being mass marketed.

I was reminded of this again recently as I sat down with a couple to help them hash out their retirement planning strategies. Their question was simple. Should we be saving in an RRSP?

Meet Mr.

In his early 40s and a skilled tradesperson, he has spent most of his career moving from one project and employer to another. He has more than $100,000 in unused RRSP room and no defined pension plan. However, his current employer is contributing to an individual RRSP for him that has grown to approximately $4000 in the past year. With an annual earned income of $115,000, he is in approximately a 30% average tax bracket. He has never contributed to a Tax Free Savings Account (TFSA) and, as such, has $63,500 of unused contribution room available there, as well. Due to a recent issue with his health, he has been declined for life insurance.

Meet Mrs.

As a University-educated “30-something,” she has been working in her chosen career for more than a dozen years. She loves her work and plans to continue working for her government employer until retirement. She contributes to the public sector’s defined benefit pension plan and, therefore, has a formula that allows her to determine – with relative certainty – her income when she retires. She contributes a small amount each pay period to an individual RRSP plan and has accumulated almost $15,000 in the account since she began working. She still has approximately $25,000 in unused RRSP room. With an annual earned income of $70,000, she also has never contributed to a TFSA. She is in above average health and has sufficient life insurance in place.

The couple has two young children.

The Advice

In this scenario, the RRSP makes absolute sense for Mr. With no real employer pension plan and being in a high income bracket, he would benefit most from both the savings in the future and the tax break right now. Also, with no life insurance in place, his spouse could benefit from the tax free rollover of his RRSP assets in the event of his death. Taking advantage of the tax deferred growth, his priority should be to use all his RRSP contribution room as quickly as possible and forgo a TFSA contribution at this time.

Alternatively, Mrs. should stop her bi-weekly RRSP contributions and redirect that savings to a TFSA. Her pension plan, CPP and OAS will already put her in a high tax bracket in retirement. Income withdrawn from an RRSP is taxed as all other earned income and will only end up costing her more taxes in the future. Finally, as a parent to a young child and spouse to an uninsured partner, she may likely need access to tax free money in the future. Therefore, the TFSA gives her both the flexibility and peace of mind she needs.

When people have the opportunity to share their stories, their goals and their data, the investment planning process can be less scary for all involved. When you can understand the “why” the “how” doesn’t seem so frightening after all.

When it comes to any type of investing, the real trick is to be guided by the facts and not manipulated by the marketing.

1 – Source Government of Canada website