Are RRSPs da Bomb?

Yes, I know it looks like hip cool slang, but it's actually a valid question.

There are 2 perspectives to your RRSPs - one that they will be a useful pot of money when you're ready to retire, and the other is that they will be a tax bomb ready to explode when the last of you and your spouse pass away.

RRSPs work by giving you a dollar for dollar deduction on your tax return for every dollar you invest in your RRSP.  If Cindy earns $100,000 per year and puts $10,000 away into an RRSP, then her taxable income will be $90,000.  Cindy will have saved approximately $3,250 in tax which will directly factor into her refund for the year.  Now let's look at James.  If James earns $45,000 per year and puts $10,000 into his RRSP (assuming he has enough room), his taxable income will be $35,000.  He will have saved $2,100 in tax on his RRSP contribution which will also factor into his refund.  

Now let's fast forward 20 years and both are ready to retire.  Assuming that tax rates stay the same as now, and both James and Cindy retire on only their pensions (CPP and OAS) and whatever is in their RRSPs, both decide to take out their (now) $40,000 in RRSPs.  Both end up with approximately $60,000 in taxable income during the year because every dollar of RRSP withdrawal is taxed.  James will end up paying the same low rate of 22.70% on his first $25,000 of withdrawals, and a 28.7% tax rate on the remaining $10,000 - an effective tax rate of almost 22% - higher than his original benefit when he put the money in.  Cindy will end up paying the same tax rate on her withdrawal - approximately 22%, but because she received a 32% benefit on her deposit, she will see a clear tax benefit of approximately 10% on her RRSP contributions.

In this case, James would be better off to put the money into his Tax Free Savings Account and invest the money exactly the same way he would have done in his RRSP.  Cindy is better off saving her money in an RRSP in most cases because she will see an actual tax reduction over her lifetime.

There is one situation where RRSPs are never a good idea - What happens if James and Cindy contribute to their RRSPs every year and amass half a million dollars each?  If they can live long enough to withdraw all of the money from their RRSPs, then no problems.  If they happen to both pass away with substantial amounts of RRSP or RRIF remaining, then this is where a windfall for the government happens.  Let's say they both pass in the same year before they start withdrawing from their RRSPs.  All of a sudden, a million dollars will hit one of their tax returns, and despite diligently saving all their lives, the estate will end up paying a little over $505,000 in tax, just on the RRSPs, an average rate of 50.5% or 28% higher tax rate than when they put the money into their RRSPs.  In short... Boom.

These illustrations are just that - illustrations based on specific facts.  We can discuss your situation and what tools to use to achieve your retirement goals.  Just give us a call in North Battleford or Meadow Lake and we can help you optimize your plan.