The lowdown on RRSPs and RRIFs

In conversation with Steve Runnalls CFP®, Investment Advisor with TD Wealth Private Investment Advice.

In simple terms, can you explain how an RRSP works?

An RRSP is basically a tax shelter that postpones tax on your earned income, while allowing your money to be invested and grow, without income tax, until such time as you retire – normally when you are at a lower tax bracket.  Effectively, it shifts your income tax from a higher level while you’re working to a lower income tax level in retirement. 

In an ideal world, when should people start investing?

Like planting a tree, the best time to start investing is yesterday, the next best time is today. Preferably one would start early in their career with smaller amounts, allowing time, and compounding, to do the hard work for you – it will grow quicker. The later you wait, the more you’ll have to set aside to make up the difference for lost time. 

Is there a cut-off age when RRSPs are not profitable?

There is no hard and fast rule to this situation. However, it shifts income tax to the future. If at a point your income is lower than it may be in retirement, then it might not make sense to contribute to an RRSP. As such, it is not age dependent but, actually, income dependent. 

How long should people continue to contribute to RRSPs?

As with the above question, so long as higher income is being earned, there is always the value of contributing to an RRSP. A high-income earner. who’s 75 with a younger spouse, could still contribute to a spousal RRSP to enjoy the tax advantage of sheltering his or her income. The point is to contribute when your income is higher than it will be in the future. 

What is a RRIF?

The S in RRSP is “savings” and the I in RRIF is “income”. While the investments can remain the same, the government prescribes an age where one can no longer put money into their RRSP. Instead, they will be required to take a yearly minimum amount from the plan and start paying tax on this income.

When do you change RRSPs over to RRIFs, and what are the benefits?

One can convert to a RRIF at any age, however are required to at age 71. They stop saving and start receiving a taxable income from the RRIF. This can be paid out monthly to supplement other pensions, including the Canada Pension Plan and Old Age Security. Minimum required payments, while still taxable as income, are not subject to withholding tax. RRIF payments after the age of 65 are considered “pension” in the eyes of the government, and are therefore allowed to be split (up to 50 per cent) with a lower income spouse. This, possibly, has the advantage of lowering income tax through playing with the income tax rates. It also qualifies for the “pension tax credit” at the age of 65, and over, allowing the first $2,000 to be effectively tax free.

Why does the government take taxes off a tax-free investment – like RRSPs?

RRSPs were never meant to be tax free, but tax deferral accounts. By forgoing use of the income today for the future, the government agrees not to tax you today but wait until the future when you make a withdrawal. They further provide the benefit of allowing the account to grow tax sheltered. In most cases, the RRSP is still a great way to save, however there are times where the income tax you save today may be less than the amount that you’ll pay when pulling from the RRSP. And that is when one would question why they did it in the first place.

If you decided to sell your house and live on the equity, what is the best way to manage that money?

If you require the equity to make ends meet, the options are to invest in a way that your funds will continue to grow while paying you a monthly income stream. In a perfect world, your growth would fund your needs and your investment capital would remain intact. Finding that happy medium of what you need, and what level of risk you are comfortable with, is the challenge, but a financial advisor’s role is to find something suitable to one’s needs and objectives.

If you find that your savings and investments have deteriorated due to poor planning, an expensive divorce or paying off debt, what would you advise those who find themselves in a very precarious position – financially?

Sadly, many folks find themselves in this situation and the best thing to do is to look at their current obligations. Unfortunately, it involves the “b” word – budget. See what can be removed, or reworked, to limit the outflows. Take stock of what is available when the dust settles to allow for a cushion (when needed) and to create the “nest egg” to work from for new growth or income generation. Investigate government benefits such as Canada Pension Plan and Old Age Security at age 65.  That, along with revisiting other income generating sources such as part-time/gig, and, perhaps postponing retirement. The key is to bring more IN, while delaying what is going OUT, but it’s not always easy.