There are tons of excuses for not contributing to a registered retirement savings plan (RRSP). Maybe that’s why, according to Statistics Canada, only about half of Canadians contribute to one each year. Big mistake – big. In fact, if you make one resolution this year, putting more into your RRSPs should be it. Here’s why – whether you’re just graduating from university or approaching retirement – now’s the right time to start.
The saving habit
Have you ever noticed that some people consistently tuck money away for later while others barely make it from one paycheque to the next? This may be because saving is a habit. And just like getting a workout in, the more you do it the more likely you are to keep doing it. This means that even if you are at a point in your life when you don’t have much money to save, you should make eking out a regular RRSP contribution a priority. If you can commit to putting away just $25 a month now, you’ll be more likely to boost the contribution when you can.
Money + time = happily ever after
Young people who are starting a career and working toward major financial goals such as paying off student debt or buying a home often put contributing to an RRSP on the backburner in the hope that they’ll be able to catch up later. The truth is a small amount invested earlier in your life has a greater financial impact than more money invested later on. This is because of compound interest. So let’s look at some really conservative numbers... Suppose that you contribute just $250 to your RSSP each year beginning in your 20s until you retire. Over 30 years at a 3 percent interest rate, you will amass $12,857.49 (more if you retire later). Now suppose you start contributing 15 or 20 years later and contribute for 15 years before you retire. In order to reach the same figure, you will need to contribute $600 each year – more than twice as much. These are small contribution numbers, but the more you aim to contribute later in life, the more daunting it’ll be to play catch up – and at some point, it’ll become downright impossible.
One excuse we often hear for not contributing to an RRSP is that the money is taxed. That’s true, but so is virtually every dollar you earn. What’s different about RRSPs is the way they are taxed. Unlike the rest of the money you earn in a given year, upon which you must pay tax in April, you don’t pay tax on your RRSP until you withdraw it – and you don’t pay capital gains tax at all. This is why you can use your RRSP to get a tax deduction. At a later date, your RRSP funds will be taxed as income when you withdraw them for retirement. The good news is that the vast majority of people have a lower income when they stop working, which means that RRSP money is likely to be taxed at a lower rate than the income you made during your working years. The bottom line is that while an RRSP is subject to income tax, using it still provides a tax advantage.
The Canada Pension problem
While the Canada Pension Plan is likely to be around for retirees for years to come, other countries’ financial difficulties suggest that even government funds aren’t always a sure bet. Plus, even if you can rely on a pension, you won’t exactly be living in the lap of luxury. For people retiring in 2011, Canada Pension pays between $512 and $987 per month. Many seniors can survive on this, but that retirement won’t involve sunny climates and golf carts. All the more evidence that having even a relatively modest RRSP to supplement your pension will make a huge difference in your standard of living.
It’s not just for retirement
When you’re young, retirement can seem like a long way off, but RRSP funds can also be used for two other things without penalty: post-secondary education and purchasing a first home. This means that you can essentially borrow up to $25,000 for a down payment on a first home; you have 15 years to repay the funds to your RRSP. If you want to get a degree or go back to school to pursue a new career, you can withdraw $10,000 per year (up to a maximum of $20,000 at a time) from your RRSP to do it.
The bottom line
The bottom line is that an RRSP gives you options – and that’s a beautiful thing.
Many people put off contributing to an RRSP and then never get to it. If you save any money in your lifetime, consider putting it here to reduce your taxes and save for the future - whatever it may hold.
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Nothing contained herein is intended to provide personalized financial, legal or tax advice. Before implementing any financial strategy, you should obtain information and advice from your financial, legal and/or tax advisers who are fully aware of your individual circumstances.