Is an RRSP still worthwhile?

There’s a myth that surfaces every once in a while. It suggests a Registered Retirement Savings Plan (RRSP) isn’t worthwhile because of the tax on eventual withdrawals.

The myth is based on comparing RRSPs and non-registered accounts only by the taxation of withdrawals. All RRSP or Registered Retirement Income Fund (RRIF) withdrawals are taxed as income at your marginal tax rate, while retirement income drawn from a non-registered account that includes equity investments is taxed more favourably.

Why RRSPs come out ahead

While this comparison is fair as far as it goes, it ignores the amounts of the original contributions. Say that an individual wants to invest $10,000 of their taxable income and has, hypothetically, a 35% marginal tax rate. If they make a non-registered investment, they pay $3,500 in tax and invest $6,500.

However, if they choose an RRSP, they can contribute the entire $10,000. Furthermore, the $10,000 contribution is deducted from their taxable income. Instead of paying $3,500 in tax, they receive $3,500 in tax savings or as a tax refund. The larger annual contribution amounts, growing tax-deferred, enable an RRSP to provide greater retirement income than non-registered investments, even after accounting for the taxation of withdrawals.

Managing tax

Keep in mind there are ways to manage and effectively minimize the tax on RRIF withdrawals. For example, once you’re 65, you can transfer up to 50% of your RRIF income to your lower-income spouse, splitting income to pay less tax overall. Another strategy, known as “topping up to bracket,” involves withdrawing RRSP or RRIF funds to the upper limit of your current tax bracket to potentially reduce your tax bill down the road.

Additional benefits

RRSPs offer built-in discipline, important for retirement savings. You’re motivated to save every year, as contributions reduce your taxable income. Also, you’re less likely to spend retirement savings on vacations or other discretionary expenses since withdrawals are taxable at your marginal rate.