You’re in a low tax bracket
Contributing to an RRSP benefits people with a higher income much more than those who earn less.
Canada uses a marginal tax system, where the amount you’re taxed is based on how much you make. So, as a general rule, you’ll pay a higher tax rate when you earn more money. That said, the higher tax rates only apply to the part of your income earned in the higher tax bracket.
Focusing on your RRSP when you’re not earning much isn’t ideal since the tax break is minimal. It’s possible that when you withdraw the funds in retirement, you’ll have a higher income than you do today. In that case, you’d actually be paying more taxes on that RRSP money than you would today.
That’s not to say you shouldn’t invest any of your savings. You’d just likely be better off using your Tax-Free Savings Account (TFSA) instead, since any capital gains or interest you earn are tax-free.
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You have a defined benefit pension
If you’re fortunate to have a defined benefit pension, perhaps provided by your employer, you may not need to contribute to your RRSP at all. With defined benefit pensions, you’re guaranteed an income when you retire. How much you’ll get depends on your pension plan. Generally speaking, the formula is usually the number of years served multiplied by a percentage of your income.
For example, your pension plan might state that you’ll get 2% of your best income year multiplied by years served. If you were to retire after 35 years, you’d get 70% of your income every year.
When you add the income from the benefits retirees get – the Canada Pension Plan and Old Age Security – to your employer pension, you could easily be in a high tax bracket. In this case, making RRSP contributions likely won’t be worth your while.
Your RRSP has performed well
Within your RRSP, you can invest in various products such as mutual funds, stocks, bonds, exchange traded funds and more. Any capital gains you make or interest earned is tax-free until you withdraw funds from your account.
Since you have so many options with your RRSP, there’s always a chance that one of your investments pays off big. For example, someone who invested early in Apple, Facebook, Tesla, or Amazon could have easily seen their account grow substantially. Having a seven-digit RRSP portfolio is amazing, but you do need to think about your endgame.
You’re required to convert your RRSP to a registered retirement income fund (RRIF) no later than Dec. 31 of the year you turn 71. Once converted, you must withdraw a minimum amount every year that’s determined by the CRA. The more money you have in your account, the more taxes you’ll have to pay.
If you’re fortunate enough to grow your RRSP to a significant amount, you may want to consider holding off on any additional contributions.
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You plan on leaving the country
If you think you’ll be leaving Canada shortly or when you retire, then investing in your RRSP may not be worth it. That said, it really depends on the country you’re moving to.
As you know by now, RRSP withdrawals are taxable. Let’s say you’re a non-resident when you start withdrawing from your RRSP. The Canadian government will automatically withhold 25% for taxes. By doing this, there’s no need for you to file a Canadian tax return if your only Canadian income is from your RRSP.
However, the country you reside in may have its own tax rules regarding income from other countries. That means you could potentially be taxed twice.
To get around this, many countries have a tax treaty with Canada. That means you would not be taxed in your country of residence on income that was already taxed in Canada.
Keep in mind that not every country recognizes the tax deferral status that your RRSP gives you. That means you could be taxed on it even if you’re not making withdrawals. Plus, many financial institutions require you to be a Canadian resident for your accounts to remain active.
If you suspect you’ll be leaving the country, you may want to speak to an experienced accountant about your potential tax burden before making any additional RRSP contributions.
Decide if your RRSP is right for you
Although saving for retirement is essential, and a potential tax refund is appealing, you need to consider your overall tax obligations when contributing to your RRSP.
There are plenty of scenarios where using your RRSP makes sense, but with the TFSA also available, you should keep in mind you have other options.
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