Dale Jackson

Personal Finance Columnist, Payback Time

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The registered retirement savings plan (RRSP) marketing blitz has begun.

It’s a reminder from the finance industry that the deadline to deduct a contribution against last year’s taxable income is March 1.

The short-term reward is a tax refund in the spring, but there are at least three situations when it’s probably better to take a pass.

1. RRSPs ARE GREAT…IF YOU’RE RICH

Contributions to an RRSP will grow just about any investment tax-free, but the entire RRSP will be fully taxed when the funds are withdrawn. 

Ideally, those contributions will be claimed in years when the plan holder would have been taxed at a high marginal rate, and withdraw the funds in retirement at a low marginal rate.

Marginal tax rates rise as an individual’s income grows. Canadians who made less than $45,000 last year, for example, normally pay less than 20 per cent. The rate grows as income grows; sometimes over 50 per cent on the top tier amount.

If you make a contribution when it would have been taxed at a low marginal rate, your refund will be much lower than those with income taxed at a high marginal rate.

If your income was lower than usual in 2022, an RRSP contribution can be made at any time and claimed in a higher-income year. 

Young Canadians might want to take a pass and save their RRSP space for their higher-income years. Contributions to a tax-free savings account (TFSA) might be a better idea because - while the contribution is not tax deductible - withdrawals are not taxed.

Online calculators or a qualified advisor can help take you through various scenarios to determine the potential size of your refund. 

2. DEBT COULD BE THE BETTER INVESTMENT

Canadian households were already drowning in debt before interest rates skyrocketed in 2022. In many cases, regular payments have doubled; leaving less to pay off the actual debt.

Interest on credit card balances can be higher than 25 per cent, while student and consumer loans have reached the mid-teens. Some secured fixed-rate mortgages have even surpassed five per cent.  

In comparison, if you invest in an RRSP, the best comparable guaranteed return from a guaranteed investment certificate (GIC) is close to five per cent. 

If the rate on your debt is much higher than you can safely make on the market, it’s better to pay it down even when you factor in the tax perks of an RRSP.

3. YOUR RRSP HAS GOTTEN TOO BIG

Even if you don’t contribute the maximum amount, there’s a possibility of getting into a tax trap if the holdings in your RRSP grow too much over the years.

As mentioned, RRSP contributions and all the gains they generate are fully taxed when withdrawn. Larger withdrawals generate larger marginal tax rates.  

And there’s no escape. Ottawa will eventually impose minimum withdrawal amounts when they force you to convert your RRSP to a registered retirement income fund (RRIF) the year after you turn 71.

If those minimum amounts exceed a certain threshold, the government will begin clawing back benefits such as old age security.

This happens to many older retirees who did not have the option of splitting their RRSP contribution dollars to a TFSA before it was introduced in 2008. 

How much the value of an RRSP grows depends on how well it is invested, but to avoid running into a tax trap consider redirecting some of your RRSP contributions and beefing up your TFSA over time. That would allow you to withdraw from your RRSP at a low marginal rate, and top it up with whatever you need from your TFSA.

Another option to avoid a tax trap is to borrow against your home and top up your RRSP income with a tax-free home equity line of credit (HELOC). It’s a good argument for choosing to pay down your mortgage before contributing to your RRSP.