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  • Adrian Harasymiw

Reconsider Your RRSP Contribution

Updated: May 1, 2023

I know what you're thinking: "Why would I rethink my RRSPs now, in the thick of RRSP season?"


Indeed, posing such an audacious suggestion with two weeks to go until the magical RRSP contribution deadline is sure to ruffle some feathers.


Frankly, I count on it because far too many Canadians have become too complacent and uninformed when it comes to their wealth. They miss the mark in properly designing a portfolio that creates and protects their wealth.


Before you rush to the bank to beat the buzzer and make your RRSP contribution so you can "make it count" for your tax filing in April, contemplate this simple questions first:


"Why am I contributing to an RRSP?"

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Some will respond simply with a shrug of the shoulders and mumble something about their bank saying they had to do it, with reasons unknown. The banking representative made it sound urgent, rousing a feeling of lunacy if you missed the deadline. Rushed decisions is what the banks like, without any planned reason for dumping money into an account without really understanding how it influences your overall desire to win at life.


And it gets worse when the banks convince you to borrow money to make the contribution. But that's a controversy for another time.


Hint #1: If contributing to an RRSP this year is a must in your mind, make this the last year of doing so without taking the next 12 months to intentionally design your financial portfolio. It might turn out that making RRSP contributions is actually the best course of action for you. At least you will have more confidence that you're not being swayed merely by emotions and slick talking sales representatives in your odyssey to create and protect wealth so you can also enjoy it along the way.

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A few other readers will likely respond with the tax deferral answer. You recognize that contributing to your RRSP will likely generate you a tax refund this year. Getting tax money back from the government? Yes please! More sheer folly for those who don't take the opportunity, right?


But wait. In all the excitement about receiving a tax refund, the word "deferral" gets lost in the shuffle.


"Deferred tax" means the government piper will eventually need to be paid, regardless of whether it's today or decades from now. Yet many fail to appreciate this means they might owe more in taxes in the future than today. If you knew it was likely that your future tax liability in the future would be heftier, would you still chase the tax refund today?


How could a tax liability be more substantial in the future than today?


Firstly, future tax rates and brackets are undoubtedly going to increase. With growing mountains of government debt and demands for government spending on "free" services, our citizens' tax bills is not decreasing any time soon. As such, today you might be in the bracket paying 20.5% in marginal tax but what if in the future, even if you remain in the same "bracket", your bracket's rate increases to 30%?


Remember, your RRSP withdrawals are taxed as income in the year you make the withdrawal. So, withdrawing at a 30% clip results in more taxes in the future than had you paid the tax today.


Secondly, if we suppose tax rates do not increase in the future, it's possible your professional and/or investing success will push you into higher tax brackets as time progresses. Today you're in the 20.5% tax bracket but at retirement you could be in the 33% tax bracket, assuming we're using 2023 rates. Does that look like a tax savings to you?


Hint #2: If tax deferral or tax avoidance (not evasion!) is your motive to create and protect wealth, other better strategies are available that will reduce the chances of today's intention backfiring in the future. You don't need to compile a 50 page financial plan to guide you in this decision. Wealth models are much friendlier in helping devise strategies as you go.

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Lastly, a few sophisticated readers may counter with funding retirement and legacy ambitions. Besides, some may be in the higher tax brackets today and foresee themselves sliding into lower tax brackets at retirement.


Even if we assume tax brackets and tax rates remain the same, these readers may be setting themselves up for an unwanted surprise when transferring wealth to future generations at the time of their passing.


On the surface, Canada does not have an official estate tax. In other countries, such as the USA, the value of the remaining assets at the time of your death are taxed at the going estate tax rate. True, there are spousal rollover provisions but to keep this discussion simple, let's keep that out of the equation as the piper will still be paid eventually.


No such estate tax exists in Canada, at least not right now. However, outside of any spousal rollover provisions, the remaining assets within an RRSP/RRIF are taxed as income to the estate.


This sounds complicated. It's not. Let's use a simple example to highlight the point. If you amassed a $1M RRSP over the years and passed away with that amount still in your RRSP, your estate will be deemed to have earned an income of $1M in the year of your passing, meaning your estate will be taxed at the highest tax bracket rate, at least by 2023 tax standards. This means that while you were collecting tax refunds in lower tax brackets over the years, your estate will now cover the tax liability at the highest rate.


Hint #3: RRSPs are not optimal creating and protecting retirement and legacy pools of money. Depending on your most important goal, there are various other strategies available to reach your wealth aspirations without risking this scenario playing out.

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While it may seem bypassing RRSPs is a strategy more suitable for younger wealth builders as they have a longer time horizon to "retirement" (or, as I prefer to call it, "independence"), it's never too late to re-evaluate one's wealth design and making adjustments before it's too late.


At Pinnacle Sovereign Wealth, it would be an honour to have a discussion with you about your wealth concerns and aspirations. Click the link below to connect with us and learn more about what we do to help you achieve your why.


To summarize:

  1. Contributing to an RRSP just because someone tells you to do so, is not a strategy. Model and strategize first to determine if RRSP contributions are, in fact, in your best interest.

  2. RRSP contributions for the sake of tax refunds is not a strategy. Don't forget that tax will be due at some time in the future.

  3. That future "some time" may come when least opportune for your wealth portfolio and could cost your estate substantially more tax than had you just paid it today or deployed other more suitable methods to deter and avoid now.

Together to self-ownership and happiness so we can win at life,


Adrian


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