You have until March 2, 2020 to contribute to your Registered Retirement Savings Plans (RRSPs) for the previous calendar year. The question is should you?
Since the introduction of Tax-Free Savings Accounts (TFSAs) in 20091, RRSPs, which have been around in some form since 19572 have ceded their standing as the investment vehicle of choice for Canadians to the newcomer. Why? Penalty-free access. If you withdraw money from an RRSP before you retire, you will have to pay a withholding tax and you also have to report that money as taxable income to the Canada Revenue Agency. Taking money out of a TFSA does not trigger any tax.
Perhaps the biggest selling point for contributing to an RRSP is the tax deduction it will bring. Plus, you can hold a variety of investments in an RRSP, including cash, gold and silver bars, GICs, Savings bonds, Treasury bills, Bonds, mutual funds, ETFs, equities (both Canadian and foreign), Canadian mortgages, mortgage-backed securities and income trusts. However, when it comes time to retire and draw on those funds, you will have to pay income tax.
While contributions to a TFSA do not trigger a tax deduction, investments held in a TFSA do grow tax free and you can withdraw money at any time without penalty. If you do withdraw money, you have to wait until the following year to re-contribute, at which point you can also make the annual maximum contribution, which currently sits at $6,000. You can also hold a wide range of non-registered investments inside a TFSA. However, if you contribute too much to your TFSA, you’ll pay a penalty of 1% per month on the excess amount until you remove it.
Contribution limits for RRSPs increase each year. For 2019, you can contribute the lesser of $26,500 or 18% of your earned income for the previous year plus any carry-forward contribution room you may have.3 As of January 2020, a person that was over the age of 18 as of 2009, will be able to have as much as $69,500 in a TFSA.
Should you make a lump sum contribution or regular monthly contributions? If you are risk averse, then contributing to portfolios regularly over time makes more sense and is easier to do than having to find money at the end of the year to contribute. That said, it’s also perhaps more difficult to grow your portfolio when you contribute monthly rather than a lump sum. If you give me a lump sum of $12,000 on January 1, v $1,000 a month, then I have more money working for you longer. If it’s a good year, it will generate higher returns. In a down year, you would have worse returns than if you had contributed monthly. Dollar cost averaging protects while lump sum contributions may help your portfolio grow quicker. As with most things in life, it’s a trade-off.
A few final thoughts: Deciding between paying down debt versus saving for retirement in either an RRSP or TFSA, comes down to two factors: 1. The interest rate on your debt. Is it high or low? Can you get more by investing that money instead? 2. You’re own psyche. Does it bother you to have debt? If you are going to invest for the future, don’t need access to this money but do need a tax deduction, then contributing to an RRSP makes sense. If you don’t need the deduction, any excess money you have sitting outside a registered plan should be held in a TFSA, where it can grow tax-free.
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