I know you think it’s the right thing to do. Your mother, father, teachers and anyone who cares about your financial future probably set you on the path of doing it with diligence. It’s not something that you hear from your financial advisor every day. But today you’ll hear it from me. Please, please, please, for the love of all things sacred, stop putting all of your money into your RRSPs.
Now before you take this the wrong way, understand that I’m most certainly not telling you to stop saving. Rather I’m suggesting an alternative to the conventional way of thinking. This post is for those who took Mom & Dad’s advice. The hands of time have them marching steadily towards retirement and they have fat RRSPs, full from years of contributions… and little else.
My message to them is as follows. Please continue to save. In that regard, you’ve been doing the right thing. RRSPs have served you well in that they have grown tax-deferred all these years. You never received a tax slip when the funds do well, but the day is coming when you will have to start taking income, and for that reason, it’s a good time to review your strategy.
Here are a few reasons why having all of your money in RRSPs can be a bad thing during retirement:
Potential for taxation in a higher tax bracket
When all of your money is in RRSPs, there is no where else to go when you need money for a large purchase. A lump sum withdrawal is taxable at the your highest tax bracket. It’s added to your other taxable income for the year, and this can bump you up into the next tax bracket.
More taxes withheld OR larger quarterly installments
When you make a withdrawal from registered money, withholding tax is taken off the top before you get the withdrawal in your hands. It’s as if the CRA is saying – okay, we’ve let you defer taxes this long, now that you’re taking money out of the RRSP, we’ll take some of the tax that we know you’ll have owing off the top, and we’ll square the rest with you at tax time. The percentage they take depends on the size of your withdrawal: up to $5,000-10% is withheld, $5001 to $15,000, 20% is withheld and $15,001 +, 30% is taken off. So if you wanted to make a $20,000 withdrawal, taxes would be $8,571.42, which means you’d have to take out $28,571.42 to end up with the same $20,000 in hand.
Potential for OAS Clawback
When income during retirement starts to exceed $69,562 (2012 rate), part of your Old Age Security will begin to be clawed back. If you’re saying to yourself that your income during retirement won’t be that high, consider those lump sum withdrawals – to fix a roof, go on vacation, buy a new car – that could put you over the threshold and cause you to start having to repay your OAS.
What Should you Do?
Now that I’ve told you what you shouldn’t do, here’s what you should do. Talk to a financial advisor about a Tax Free Savings Account and when those are maxed out, non-registered savings. You can think of both of these as having tax paid capital. In a Tax Free Savings Account, your growth didn’t cost you anything. In a non-registered savings plan, you will receive a tax slip for growth every year, but this means you won’t get one when you make a withdrawal. Well balanced income during retirement is about having RRSPs and other investment vehicles so that you can structure your withdrawals in the most tax efficient way.